Crypto Exchanges…Centralized or Decentralized?
The rise of bitcoin in 2008 and other cryptocurrencies popularly known as altcoins had necessitated the need for people to have the ability to change your fiat currencies (eg. the US dollar) to these various cryptocurrencies. A solution, modelled after the traditional stock exchanges and forex was created known as Crypto Exchanges.
These exchanges are businesses that allow customers to trade cryptocurrencies for other assets, such as conventional fiat money or other digital currencies. Payment methods involved credit and debit card payments, wire transfers, mobile money, PayPal and other methods.
Crypto exchanges were first popularized in the 2010s with a Centralized form. These Centralized exchanges have total control of all transactions, meaning they have the authority to control how capital is deposited, order books, and matching orders. They serve as a point of contact between buyers and sellers of cryptocurrencies. Examples include Binance, Bitfinex, Yellow Card, Bundle and Coinbase.
Some pros of Centralized Exchanges include:
- Speed in transactions — Centralized exchanges are typically fast in the transfer and exchange of currencies be it fiat or cryptocurrencies. This is due to the availability of such funds in their systems as well as their reserves. Speed is one of the reasons of their large user base as they improve upon the user’s experience.
- Ease of use — Centralized exchanges provide tools and resources that allow users to be easily perform transactions as well as a smooth onboarding process for new users. Although these experiences have been difficult in the early days, years of user research have improved it drastically.
- High Liquidity — This means that the exchanges have ability to convert assets to cash or acquire cash — through a loan or money in the bank — to pay its short-term obligations or liabilities.
- High Trading Volume — Centralized exchanges have a high trading volume meaning they have a high amount of units or tokens of each cryptocurrency to serve the demand of users.
Aside the pros of centralized exchanges, there are some cons. These are:
- Bankruptcy Risk — Like any private business, centralized exchanges have a risk of defaulting on a loan from investors or manipulating fake numbers as what they have at hand. In this case, users have the risk of losing all their funds should the exchange go bankrupt. Good examples of popular exchanges that have gone bankrupt include Mt. Gox and FTX.
2. Less variety of cryptocurrencies — These exchanges focus more on safety than variety. As such users have a limited list of cryptocurrencies to trade from as compared to the number of available cryptocurrencies. At some points these exchanges have the right to suspend trading on some cryptocurrencies which could be at the inconvenience of a user.
3. Custody — Having cryptocurrencies in a wallet on a centralized exchange does not mean you have total control of what you have there. The exchange has the right to put a freeze on withdrawals and deposits of such funds.
Decentralized exchanges (DEX) on the other hand, are peer-to-peer (P2P) exchanges where crypto assets are transacted directly between buyers and sellers. Unlike Centralized exchanges, decentralized exchanges give users full control of their funds. Decentralized exchanges rely on the use of self-executing smart contracts that keep track of every transaction and log it to the blockchain. Examples of decentralized exchanges include Airswap, SUSHI Swap, Waves DEX, DyDx and Raydium.
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Some pros of DEX include:
- Custody — Users have full control of their assets and funds.
- Listing Variety — Users have a variety of cryptocurrencies to exchange or trade from as compared to Centralized exchanges.
- Anonymity — Users don’t have to go through a KYC to conduct transactions. As such, transactions are anonymous.
- Lower fees — DEX have lower fees since fees arre just taken from smart contracts as compared to the various factors Centralized Exchanges consider when charging fees.
Some cons of DEX include:
- Complexity — Decentralized exchanges are very difficult to use for people new to Web3 without any prior knowledge.
- Lack of fiat payments — Most decentralized exchanges do not support fiat payments due to their decentralized nature. Transactions are mainly done from one cryptocurrency to another.
- Low liquidity — Due to its nature, assets are low volume as this depends on the availability of people willing to sell their assets.
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