If you’re just getting into cryptocurrency trading, or even if you’re highly experienced, there’s no doubt you could be overwhelmed by the over 1,600 digital currencies and more than 200 exchanges you can trade them on. And while there are similarities, each exchange is different. The one similarity that does distinguish the exchanges though is whether they are centralized exchanges or decentralized exchanges.
While centralized exchanges have grown to massive size and are dominating the cryptocurrency trading ecosystem, there are some out there who believe using centralized exchanges to trade is counter to everything the decentralized cryptocurrencies stand for in the first place. But there are also those who claim the benefits of the centralized exchanges, such as economies of scale and increased security features are necessary. Let’s take a deeper look into centralized versus decentralized cryptocurrency exchanges.
Centralized Exchanges Benefit New Traders
Centralized exchanges, often refered to as a CEX, are run like a typical company, with a management team overseeing the operations and a clear hierarchy that is split into functional areas such as finance, operations, IT and so on. You would recognize the business model of this type of exchange as being very similar to that of a traditional securities exchange. It is a third-party intermediary that profits from connecting buyers and sellers with each other. You’re likely familiar with some of the largest centralized exchanges, which include OKEx, Bianance, Huobi, Bittrex, Coinbase, Kraken and other similar exchanges.
We can definitely say that these exchanges have begun to bring cryptocurrencies to the masses, making it easy for new users to create accounts, and buy their first Bitcoin or Ethereum. This has also helped to rapidly increase liquidity in the crypto markets.
There’s no doubt that centralized exchanges provide an easy point of access for those new to cryptocurrencies. Because they are similar to traditional securities exchanges they may operate similarly, and centralized exchanges often provide additional client services. It isn’t likely that you’ll find a decentralized exchange offering stop losses, margin trading, or lending, but these services are becoming increasingly standard at centralized exchanges.
Centralized exchanges also commonly offer exchange from fiat to crypto currencies, and from crypto to fiat currencies. This makes them very convenient for many new users. It also means they are typically regulated by the government and required to conform to Know-Your-Customer and Anti-Money Laundering laws in their country of incorporation and residence.
This adherence to government regulations, the need to give up personal information, and the fact that these exchanges require users to relinquish their privacy and control to a third party entity goes against the very essence of cryptocurrencies, which were created to free people from the need for third-party intermediaries and government interference in their financial and personal lives. When you look back even on the short history of blockchain technology there are many instances that show centralization often ends with bad results.
You probably already know that centralized exchanges have their problems, some of which include:
– More than 30 cryptocurrency exchange hacks resulting in hundreds of millions of dollars of losses since 2009.
– Government interventions and bans such as the China ban, the Russia ban, and the South Korea ban.
– Poor customer support. Anyone who’s used one of these centralized exchanges knows just how poor their customer support is, pretty much across the board.
– Lack of user privacy. We know for sure that Coinbase caved in and released client personal and financial data to the IRS in 2017. This is likely just the beginning.
Many of these problems can be traced back to the fact that when you purchase cryptocurrencies on one of these centralized exchanges and leave your coins in their wallets, you don’t actually control the private keys. If you don’t control the private keys you don’t actually own the cryptocurrencies. It turns cryptocurrencies into a fractional reserve system, which is one of the downfalls of the current banking and fiat currency systems that cryptocurrencies are meant to replace.
Centralized exchanges have also pulled away from the cryptocurrency ecosystem to some extent recently as many have declined to list new ICO coins due to regulatory pressures and worries over future legal problems. This lack of listing at the large centralized exchanges can create liquidity issues for all new ICOs, even those that are backing excellent projects.
Decentralized Exchanges Remain Autonomous
Decentralized exchanges, also known as a DEX, can operate somewhat autonomously thanks to the use of smart contracts. The smart contracts turn these exchanges into something similar to a peer-to-peer exchange by allowing buyers and sellers to trade directly without the need for a third party intermediary. This keeps the decentralized spirit of the blockchain movement.
The DEX is a fairly new development, and while they currently make up just a fraction of all cryptocurrency trading, they are growing in number and popularity. Currently the largest dApp on the Ethereum network is a decentralized exchange known as IDEX.
The shortcoming that’s been holding back the DEX movement is the same one that has blockchain developers scrambling to fix – namely scalability.
You’ve no doubt heard of at least some of the DEXs, such as the Kyber Network, EtherDelta, 0x, Bancor Protocol, and Counterparty DEX to name just a few.
In addition to the scalability issues, there seems to be issues with user experience and design, because most of the decentralized exchange websites give the feeling of websites from the late 1990s. They often have strange design, and can run slowly, despite not having much traffic. That lack of traffic is a huge problem for some as it hurts their liquidity and ability to operate as a proper exchange.
Decentralized exchanges do provide decentralization in trades, but they also have some centralization in the developers that oversee the operation of the exchange. These are the people behind the scenes who write the code for the dApps and smart contracts. Because of this partial centralization the DEXs still charge trading fees, although they are much less than their centralized counterparts.
DEXs do provide one great benefit for the marketplace. Some initial coin offerings find their way onto one or more DEXs soon after listing, and this can help them eventually get listed on the larger centralized exchanges. While a DEX will easily list a new coin, the CEXs require a more developed and mature project before listing a coin.
The DEX is also quite intimidating to those new to cryptocurrencies in most cases. They require a higher degree of technical knowledge, and lack the user-friendly interface you’ll usually find with centralized exchanges. They also lack features such as fiat purchases, margin trading, stop loss orders and other more traditional exchange offerings.
There is also some feeling that some DEXs suffer because they can only offer tokens native to their platform. For example, a DEX running on the Ethereum network can only offer Ethereum based tokens on their exchange. I’m not sure this is true, as centralized exchanges like Coinbase grew massive offering just three coins. Plus, the eventual atomic swaps that will permit easy exchange of any blockchain currency will remove the need to offer only native assets.
All of these things combined keep DEXs from seeing massive adoption so far, and this presents them with a liquidity problem as many times they simply don’t have enough users.
Currently there are many good arguments for centralization, but at the end of the day we have to consider how this will ultimately impact cryptocurrencies – which at their heart are meant to be decentralized and separate from the current banking and financial ecosystems. That said, there are good exchanges and bad exchanges, whether you’re looking at centralized or decentralized.
When it comes right down to it the decision has to be left with each individual. Those who desire an easy to use exchange that works to keep them safe and offers advanced features can choose to use centralized exchanges. And those who appreciate the attractions of decentralization and privacy will remain with decentralized exchanges.
And some will choose to use both. Using the centralized exchanges to move fiat currency into cryptocurrency and the decentralized exchanges to trade the smaller altcoins that haven’t been listed on the more mainstream centralized exchanges.