Centralized Exchange vs Decentralized exchange: Traders’ need for exchanges to carry out trading has increased as the number of cryptocurrencies has dramatically increased in the last couple of years. These cryptocurrency exchanges allow traders to, buy, and sell cryptocurrencies instantly.
Now the biggest question is which exchange to be selected. Should you choose Coinbase, Binance, or choose from the extensive list of crypto exchanges?
Before answering this question, it is important to understand the difference between centralized exchanges vs. decentralized exchanges.
Centralized crypto exchange
Centralized cryptocurrency exchanges, functions as a middleman between buyers and sellers. Almost all crypto transactions are made through centralized exchanges, which provide more trustworthiness.
How does a centralized cryptocurrency exchange work?
Centralized exchanges are platforms that allow users to buy and sell cryptocurrencies for fiat currencies or paper currency such as the US dollar. They operate as a broker in deals and frequently serve as custodians, keeping and safeguarding your cash.
Centralized crypto exchanges are:
- Huobi Global
Decentralized crypto exchange
Decentralized crypto exchanges distribute responsibility for facilitating and verifying crypto trades. Anyone willing to join a decentralized exchanges network can certify transactions, much like the way cryptocurrency blockchains work. This may help to increase accountability and transparency.
How does a decentralized cryptocurrency exchange work?
Decentralized crypto exchanges vary from centralized crypto exchanges in that way DEX allows users to keep control of their assets by running their activities on the blockchain. So, how decentralized exchange works? Decentralized exchanges work on an AMM (Automated market maker) or traditional order book model.
The order book model
- An order is placed by a coin owner to swap his or her assets for another asset offered on DEX. The owner of coins determines the number of units they must sell, the coin’s price, and the time limit for accepting bids for the assets.
- Other users can offer bids by putting in a purchase order after the selling order has been done.
- Once the sellers have chosen the time, both sides evaluate and execute all of the offers.
The AMM Model
- Liquidity for an asset and its swap pairs are pooled in a smart contract. Those who pool funds are worthy to receive the fees generated from the swaps using this pool.
- When someone makes a swap in the pool, the balance of assets in the pool is automatically rebalanced to a 50/50 value, and the price of the tokens changes to reflect the new supply.
- When there is not enough liquidity in a pool, and a large swap is made, the trader will run into high slippage issues; meaning the lack of liquidity will result in an above-market purchase price.
Decentralized crypto exchanges are:
- Uniswap PancakeSwap
- 0x Protocol (Matcha)
Pros of decentralized exchange
- Completely anonymous and private
- No need to transfer assets to any third party
- Fees are redistributed to liquidity providers, not to a centralized entity like the centralized exchange.
Cons of decentralized exchange
- Trading in fiat currency or paper currency is not permitted.
- Risk of impermanent loss for liquidity providers included.
- Liquidity can be thin, which makes it harder to execute large orders.
One of the greatest faults of decentralized exchanges is that it has failed to achieve liquidity levels comparable to centralized exchanges. Some decentralized exchanges have recently introduced a new liquidity mechanism to solve this issue named: Automated Market Makers (AMMs).
The majority of cryptocurrency traders have concerned with trading charges.
A white-label decentralized exchange works similarly to a Centralized Exchange in that it charges a percentage of the cost for each transaction, but a centralized exchange works like a per-trade fee!
Its means, that when a transaction is ready to be put on a decentralized exchange, you must pay a gas cost in order for your trade to be confirmed via blockchain, which can be expensive depending on the chain.
One thing that goes in the favor of centralized exchanges is speed. They are much faster than decentralized exchanges. While a centralized exchange takes 10 seconds on average to complete a transaction, a decentralized exchange takes 15 seconds to match and complete the order.
In terms of usability, centralized exchanges are best compared to DEX. They have a very easy-to-use interface as compared to decentralized exchanges. In the CEX there are tools at their disposal such as online banking apps that help them visualize their assets with visually appealing platforms.
The government licenses and regulates the majority of the centralized exchanges. Crypto exchanges may be prohibited in some countries like China, South Korea, India, Pakistan, and Russia thus the CEX’s best interests are to abide by the regulations.
In contrast, Governments and regulators, have no influence on decentralized exchanges. They just cannot be turned off. That is their greatest advantage, but it also comes with a number of drawbacks; customer support is not on their side.