Here’s all you need to know about centralized and decentralized cryptocurrency exchanges and how they differ from each other
Tradable assets such as cryptocurrencies need a platform where they can be traded. By nature, cryptocurrencies differ significantly from fiat money, and this is why trading cryptocurrencies in a traditional foreign exchange market isn’t feasible. This is what cryptocurrency exchange markets do: they provide a viable place for trading between cryptocurrencies and/or fiat money.
Cryptocurrency exchanges provide for liquidity of the cryptocurrency market. The exchange establishes the rate of conversion of fiat money to cryptocurrency, and the conversion of different types of cryptocurrencies. Within the realm of cryptocurrency exchanges, there are two types: centralized and decentralized.
Here we’ll talk about what centralized and decentralized cryptocurrency exchanges are, their advantages and disadvantages, and how the two types are different from each other.
What Is a Centralized Cryptocurrency Exchange?
A centralized cryptocurrency exchange is a platform owned and controlled by a central entity where traders are able to buy, sell, and exchange cryptocurrencies for fiat currencies, or for other cryptocurrency tokens. In a sense, it works the same way as any traditional foreign exchange market, but a centralized cryptocurrency exchange is one that’s especially tailored for online cryptocurrency commerce.
This type of cryptocurrency exchange is far more popular than its decentralized counterpart, mainly because of how easy and intuitive it is to use, which is great for beginners. One of its many appeals is that it enables non-cryptocurrency holders to buy cryptocurrency coins and tokens using fiat money. It also offers advanced trading features, such as margin trading and stop loss.
However, as platforms go, there are limitations to centralized exchanges. As the platform is controlled by a single entity, users don’t have complete control over their funds, and as such, they are bound by the rules set up by the governing agency, including high transaction fees and non-anonymity of transactions. There are also risks if the centralized server is compromised, which is more susceptible to malicious attacks from hackers as there is a centralized point of entry.
What Is a Decentralized Cryptocurrency Exchange?
A decentralized cryptocurrency exchange (dEX) is a platform that does not rely on a third-party entity to enable trading of cryptocurrencies. Cryptocurrency trading is usually facilitated by an open-source decentralized cryptocurrency exchange protocol, such as the 0x Protocol and the Kyber Network. In this kind of exchange, trading occurs directly between peers, thus termed as a peer-to-peer exchange.
As the technology applied is fairly new, a number of decentralized exchange methods and protocols have been introduced. The pioneering dEX technology introduced by the 0x Protocol facilitates cryptocurrency exchanges on the Ethereum blockchain; that is, exchanges are run on smart contracts. The technology leverages the blockchain to facilitate off-chain ordering relays, together with on-chain settlements.
Other decentralized exchanges have an automated process when creating proxy tokens that represent a certain cryptocurrency or national currency; while some others utilize a decentralized multi-signature escrow system.
Decentralized exchanges aim to solve the limitations of control, security, speed, and cost-efficiency that are the bane of centralized exchanges. On a dEX platform, users have full control of their funds and their anonymity. As there is no central entity to control the system, transaction fees are held to a minimum or, in some protocols, are provided for free. Downtime risks are also evaded in a decentralized exchange. And because there are multiple points of entries safeguarded by the whole network, malicious attacks are virtually impossible.
However, decentralized exchanges are not without fault. One of the main reasons that dEX platforms are not as widely embraced as the centralized ones is its ease of use. Decentralized exchange platforms usually have complex interfaces that even the most tech-savvy users would find difficult to navigate. And despite the complexity of its interface, decentralized exchanges only offer basic trading features.
Summary: Centralized vs. Decentralized Cryptocurrency Exchanges
While both centralized and decentralized exchanges aren’t perfect and are still in the process of continuing development, both offer unique benefits for the needs of all different types of cryptocurrency hodlers.
Centralized exchanges allow any user, both beginners and experts, a platform to trade national currencies with cryptocurrencies, and offer many trading features that are also available in traditional foreign exchange markets. Decentralized exchanges, while not for everyone, leverage the blockchain itself to offer a level of security and freedom that only decentralization could offer.
– Article written by Tinny
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