Crypto Exchanges: The Battle Between Centralized and Decentralized

Understanding Cryptocurrency Exchanges

Exchanges play a crucial role in the cryptocurrency world. They provide the platforms where people like you and me can buy, sell, and exchange cryptocurrencies, contributing to the market value of crypto. 

In this blog, you will gain a clear understanding of the two types of exchanges in the crypto space, their strengths and weaknesses and also some of my advice when using these exchanges.

 

What is a Crypto Exchange?

A crypto exchange is an online platform where you can buy, hold, and sell cryptocurrencies. In simple terms, it acts as a digital marketplace where buyers and sellers of cryptocurrency come together online.

Think of a shopping mall as a physical marketplace. In a mall, various shops sell different items under one roof, allowing buyers and sellers to interact in person. Similarly, in a cryptocurrency exchange, users meet online to trade digital assets, just like they would in a shopping mall. It’s that simple!

Centralized vs. Decentralized Exchanges

What is a Centralized Exchange (CEX)?

A centralized exchange (CEX) is a cryptocurrency exchange that is controlled by a company or organization. Popular examples include Binance, Coinbase, and Kraken. But what does this really mean?

In a centralized exchange, the rules governing the behavior of sellers and buyers, along with various features of the platform, are determined by the company itself. This means that the exchange acts as an intermediary, facilitating trades between users. The company manages the order book, holds custody of users' funds, and sets the terms of service.

If a centralized exchange supports in your country, setting up an account is quite easy. First, you'll need to complete a process called KYC (Know Your Customer) verification. This means you'll provide some personal information and upload identification to confirm who you are.

Once your account is verified, you can buy cryptocurrency by linking your bank card or another payment method to the exchange. Many of these exchanges also offer helpful guides and tutorials to walk you through the buying process. This support makes it easier for beginners to understand how to purchase crypto without feeling lost​.

 

Simple Analogy to remember the idea of a CEX

Centralized exchanges (CEX) operate similarly to banks. Just as you depend on banks to keep your money safe and handle transactions like withdrawing cash, making transfers, and paying bills, centralized exchanges facilitate various cryptocurrency transactions. 

These exchanges allow you to transfer crypto to different accounts, withdraw your digital assets, buy and sell cryptocurrencies, and even stake your crypto to earn interest over time.

Both banks and centralized exchanges employ robust security measures to safeguard your funds. They are also subject to regulations that ensure fair practices and protect users. While banks handle traditional money, centralized exchanges specialize in cryptocurrencies, allowing you to explore a diverse array of digital investments.

Nice! Now you have a good basic understanding about what a centralized exchange means. Now let’s look at the pros and cons of a CEX.

 

Advantages of using a CEX

Convenience: Centralized exchanges offer a user-friendly experience, making it easy for beginners to navigate the platform. They handle the complexities of transactions, allowing users to focus on trading without needing technical knowledge.

High Liquidity: Centralized exchanges usually have many buyers and sellers, which leads to a significant number of buy and sell orders. This means you can quickly buy or sell cryptocurrency, even in large quantities, without worrying about delays. 

For example, if you want to sell a large amount of Bitcoin, you can do so at the current market price and convert it to cash almost immediately. 

Similarly, if you’re looking to buy a substantial amount of Bitcoin or any other cryptocurrency, you can complete the purchase swiftly without waiting in a long queue. This high liquidity ensures that trades can be executed quickly at market prices, making it a seamless experience for users.

Support and Services: Customer support is generally readily available on centralized exchanges. Users can reach out for help with issues, whether it’s troubleshooting account problems or seeking guidance on trading strategies. Many platforms also provide educational resources to help users learn.

Regulatory Compliance: Many centralized exchanges comply with regulations, which can add a layer of trust for users. They often require KYC (Know Your Customer) verification, helping to prevent fraud and enhance the safety of the trading environment.

Security Measures: While centralized exchanges are not free from risks, they often implement robust security features to protect user assets. These include two-factor authentication (2FA), which adds an extra layer of security during login, and anti-phishing measures that help identify fraudulent emails. 

Additionally, many exchanges have insurance policies in place to safeguard user funds in case of breaches. These combined efforts aim to enhance the overall security and trustworthiness of the platform for users.

 

Disadvantages of using a CEX

Centralization Risks: Centralized exchanges handle serious amount of money and therefore can be more vulnerable to hacks or security breaches. If the exchange is compromised, users could lose their funds and if the breach is very critical in financial wise then compensation to the affected users can take many years.

For example, in 2014 Tokyo based exchange named Mt. Gox suffered a massive breach that led to the loss of approximately 850,000 BTC, worth around $450 million at the time. Mt. Gox started to compensate it users in 2024 July. 

Another example of a massive breach is the FTX hack in 2022, amounting to $600 million wiped out from users. There are many other security breaches these are just a few.

Lack of Control Over Funds: When you store your cryptocurrency on a centralized exchange, you don’t have full control over your private keys as your exchange keeps your private keys on behalf of you. 

This means you are trusting the exchange to keep your assets safe, which may not align with the core principles of cryptocurrency​ which is decentralization, meaning no central authority controls the blockchain technology behind crypto.

But when we handover our crypto to a CEX, a central authority is in control of the custody of our cryptocurrency even though the technology behind crypto is decentralized!

In cryptocurrency a popular phrase is “NOT YOUR KEYS NOT YOUR CRYPTO”. And this 100% true, because if the technology behind crypto is decentralized, then the custody of crypto should also be the same. Otherwise, it is like keeping your cash in a friend's wallet instead of your own!

Privacy Concerns: Since most centralized exchanges require users to complete KYC (Know Your Customer) verification, they collect personal information. This raises privacy concerns, as your data could be at risk if the exchange is hacked​.

Higher Fees: Centralized exchanges may charge various fees for trading, withdrawing funds, or other services. These costs can add up, especially for frequent traders.

Potential for Service Interruptions: Centralized exchanges can experience downtime due to maintenance, upgrades, or high traffic. During these times, users may be unable to access their accounts or execute trades

Perfect! now you have a good understanding about the pros and cons of a centralized exchanges (CEX), now we will move into understanding decentralized exchanges.

 

What is a Decentralized Exchange (DEX)?

A decentralized exchange (DEX) is a digital marketplace where users can trade cryptocurrencies directly with one another without the need for a central authority or intermediary. Unlike centralized exchanges, where a company manages and controls transactions, DEXs allow users to retain control over their funds and trade directly from their wallets. Examples of DEX includes Uniswap, PancakeSwap and SushiSwap.

So unlike in a centralized exchange, you do not have to handover your funds to an intermediary, DEX allows you to connect your software or hardware wallets directly to their platforms and facilitates trading crypto with the help of smart contracts and liquidity pools. 

You do not have to worry about exactly how these things work, I will be talking about smart contracts and liquidity pools in my future blogs.

Just get the main idea that in a DEX, you do not have to hand over your crypto instead you directly connect your Crypto wallet with the DEX platform and trade crypto, once your transaction is done, you can disconnect your wallet. That’s it. Your crypto stays with you in your personal wallet!

 

Simple Analogy to remember the idea of a DEX

Imagine instead of depositing your money in a bank you decide to keep it in your own wallet. When you need to pay bills or make transactions, instead of going through the bank as a middleman, you visit the receiving party directly and hand them the money yourself. 

There’s no one in between, and you always have control over your funds. A DEX works similarly, you keep your crypto in your own wallet and trade directly with others through automated smart contracts, without relying on a central exchange to hold your assets. 

Automated smart contracts are not intermediaries here, they do not hold your funds, instead it makes sure that everything happens fairly between both the parties.

Perfect! Now you have a good basic idea regarding how a DEX work, let’s move into discussing about the upsides and downsides of using DEX.

 

Advantages of using a DEX

Full Control Over your Funds: Using a DEX allows you to have the full control over your cryptocurrencies since DEX does not hold any of your crypto. You trade crypto directly by connecting your wallet and then disconnect it.

100% Privacy: No account creation or no KYC requirement, DEX allows you to trade anonymously.

Security: Since your crypto is not held on these exchanges, the risk of hacks is significantly lower compared to centralized exchanges (CEXs). DEXs operate on a network of computers instead of relying on a single central server like CEXs. 

This means that DEXs do not have a single point of failure. Even if a few computers in the network that run the platform become compromised, the overall system will continue to function smoothly. It’s like driving a supercar with multiple engines; if a few engines are compromised, you can still drive without any issues!

Access to New Coins and Tokens: DEXs often list new or smaller coins and tokens that may not be available on centralized exchanges, offering early access to new projects. While this can be a significant advantage, it also carries risks. You may not know if a new project is legitimate or a scam unless you know how to research and evaluate crypto projects in this space.

Global Accessibility: Anyone with internet access and a compatible wallet can trade on a DEX without geographic restrictions. In contrast, CEXs often face regulatory limitations. For example, Binance had to completely block users in China from accessing its exchange due to the country's regulations. 

This is not the case with DEXs, as they operate on a decentralized network of computers worldwide without a central authority. Because of this structure, governments cannot impose regulations on a single entity, and no one party is held responsible.

 

Disadvantages of using a CEX

Complexity: DEXs are not convenient, the task of connecting your wallets and trading in a DEX is much harder for a beginner in crypto.

Slower Transactions: On a DEX, transactions can be slower and more expensive because they rely on the blockchain to process each trade. When many people try to trade at the same time, the network can get busy, like a traffic jam. This means it takes longer for your transaction to go through, and you might have to pay more in fees to get your trade completed quickly.

No Fiat Support: DEXs typically don’t support direct fiat-to-crypto transactions, meaning you must already own crypto to trade.

Limited Features: DEXs generally lack advanced trading features like margin trading, stop-loss orders, or customer support that centralized exchanges offer.

 

Nice! Now let’s take a quick look at the table below to get a basic understanding of the differences between CEXs and DEXs.

 

My Personal Advice on Deciding Which One to Use. (CEX or DEX)

It doesn’t matter what type of exchange you use to trade cryptocurrencies, as long as you don’t compromise all your assets! Personally, I use centralized exchanges for their convenience, but I never hold cryptocurrency in CEX that I cannot afford to lose, especially if I’m planning to keep it long-term.

Even when using a DEX, remember that you still need to connect your hardware or software wallet. Decentralized exchanges are not guaranteed to be secure, smart contracts can be hacked due to vulnerabilities. 

Therefore, my advice is never to connect your main wallet to a DEX if you have assets that you can’t afford to lose. Always have an alternative wallet so you can use it to trade only the amount of crypto you need. After your trade, transfer the remaining crypto back to your main wallet. This method can incur high fees but it's worth your while.

 

Final Thoughts

Both CEXs and DEXs have their own benefits and drawbacks. In the end, whether to choose a CEX or a DEX depends on your personal needs. If you are more privacy-focused, you might prefer a DEX. If you're okay with providing your personal information in exchange for more convenience, a CEX may be the better option. 

The most important thing is to stay safe. Always be mindful of how much crypto you hold in any exchange, and only use wallets you can afford to lose when connecting to a DEX.

Remember, it’s always better to be cautious and protect your hard-earned assets! 

"After all, it is much harder to retain your wealth than to earn it. You know why? When you're earning money, you often go unnoticed, but once you become wealthy, all eyes are on your money!"

— BcCryptonian

Disclaimer: The contents of this article are for informational purposes only and are not financial advice. The views here are just the author’s opinions. The crypto market is volatile, so be sure to do your own research before investing.