While traders and investors continue to stake their resources in cryptocurrencies, a persisting debacle is the tussle between centralized and decentralized exchanges.
What Decentralization is, anyway?
Decentralized basically means the process of distributing the decision making power from a central authority. Decentralization is the fundamental feature of blockchain and cryptocurrencies meaning that the peer-to-peer transfer of value or information happens without the involvement of a central authority. Transactions are validated by a group of ‘miners’ on the network while cryptography and distributed ledgers make sure no foul play occurs.
While cryptocurrencies are largely decentralized, the idea of removing the central authority has not yet fully materialized when it comes to cryptocurrency exchanges. While there are quite a few decentralized exchanges, the majority of the crypto trade is happening on the traditional, centralized exchanges.
Centralized exchanges are trading platforms which essentially function like traditional stock exchanges and market. Essentially these exchanges act as a middle-party to facilitate trade between the trading parties. In exchange for this service, the trading parties also have to pay a small fee in the form of trading fees. Centralized exchanges have total control over the transaction happening through them.
Centralized exchanges own the private keys of their user’s wallet essentially putting the users’ trust in a central authority. So only those transactions happen which go through the mechanisms provided and approved by a central authority.
The operation of these centralized exchanges is pretty simple and straightforward. They act as platform for both buyers and sellers to trade. People can file buy or sell orders setting a certain price and the matching algorithms then help to match the corresponding orders.
Services only centralized exchanges provide
While centralized exchanges go against the decentralized ethos and essence of blockchain and cryptocurrencies, they are able to do certain things that are otherwise not likely to be carried on a DEX.
For one, the centralized exchanges act as an easy starting point for newcomers. Users can join one of these exchanges and easily convert their fiat money to cryptocurrencies and vice versa. These exchanges also provide additional services to their users like margin trading, stop losses and lending which are as of yet, not available on the decentralized exchanges.
List of some famous centralized exchanges:
Unlike centralized exchanges, these exchanges do not require the presence of an intermediary party to make the trades happen. Instead of matching buy and sell orders in a central order book, these exchanges match people behind the buy/sell orders directly. A preprogrammed matching algorithm takes care of the matching part thus eliminating the need for an intermediary.
There are many advantages of trading on a DEX. Firstly, because of the absence of any kind of middle party, users don’t have to pay the trading fees. DEX’s are also more private as you do not have to divulge any private information to the exchanges which the centralized exchanges require. Additionally, the exchange is not in charge of the users’ wallet or private keys, making the trades more secure.
Looking at the history of cryptocurrencies, there have been several instances when a centralized exchange got hacked and the all the users’ assets got hacked. Mt. Gox is perhaps the most obvious example of a centralized exchange failing its users when in 2014, 650K Bitcoin got stolen due to poor security. Decentralized exchanges basically eliminate this problem.
So, what’s the problem?
While they solve many problems, the use of these exchanges is just not as prominent as their centralized counterparts. Almost 90% of the cryptocurrency trade happens on centralized exchanges. Due to lower trade volume, decentralized exchanges struggle when it comes to the liquidation of assets. Smaller trade volumes also mean users have to wait longer for their trades to happen. Users who want to capitalize on quick market movements will find it difficult to do so on decentralized exchanges. Lastly, services like margin-trading, lending etc which are common in all of the major centralized exchanges aren’t offered on these decentralized platforms.
List of some famous DEX:
So what does all of it mean? Both centralized and decentralized exchanges have their own sets of advantages and disadvantages. While decentralized exchanges certainly provide benefits of privacy and security to their users, centralized exchanges like Binance, Bitfinex etc. are here to stay due to the convenience and ease of use their users get on these platforms. However, as the decentralized exchanges get more improvements, we might see more users moving to these exchanges in the future.
Also Read: How to trade Cryptocurrency?