If you are thinking about where to buy or sell crypto assets, then you have to look at cryptocurrency exchanges, that work like the stock exchange which helps users to buy and sell assets digitally like bitcoin, Ethereum etc. Cryptocurrency exchanges come in 2 main types and they are centralized exchange (CEX) and decentralized exchange (DEX). Both exchanges play crucial roles in the economy of cryptocurrency with their unique features. They are accessible and easy to use which is possible for new users to exchange their fiat money for crypto.
Centralized cryptocurrency exchanges participate in the crypto markets directly by opening trades. Typically, they keep order books digitally, which are the lists of open buy and sell orders, which involve prices and volumes. Buyers and sellers are matched and announce the market’s current prices based on the last price an asset sells for.
Cryptocurrency exchanges are where most crypto traders buy and sell bitcoin, Ethereum, dogecoin and other types of cryptocurrency. Crypto exchanges make it fairly simple to trade all sorts of crypto tokens and coins. So, let’s dive into knowing the value of centralized crypto exchanges, how they operate and the benefits of centralized crypto exchange.
Importance Of Crypto Exchanges In The Industry
-Image illustration From Dosula
A digital asset portfolio being managed is operationally compounded with investors who are required to have a comprehensive set of capabilities such as custody, trading, investment products, advisory services, and efficient fiat on/off ramps. In this regard, lots of centralized exchanges (CEXs) have combined the solutions into a single platform, which has massively reduced the technical complexity of owning and managing tokens native to different blockchains. This value concept is clear as we consider the alternative:
- It is where investors manage several wallets and participate directly in multiple liquidity pools across the different blockchains.
- The fiat ON/OFF ramps in Centralized Exchanges (CEXs) do form a critical infrastructural surface to do it quickly during market volatility.
- They function as a third party between buyers and sellers.
- It also helps users conduct transactions and handle their digital assets.
- It gives the sense of safety and security that are offered to all users which they can store as well as trade large numbers of coins confidently.
What Are Centralized Crypto Exchanges:
Centralized crypto exchanges which are also called CEXs are online platforms used to buy and sell cryptocurrencies. CEX are an organization that coordinates cryptocurrency trading on a large scale, using a similar business model to traditional asset exchanges like stock exchanges.
To explain further, they are useful when large numbers of users might be at the same moment trying to buy and sell the same type of assets. They typically keep digital order books, which are lists of open buy and sell orders, consisting of volumes and prices. They often require users to deposit their crypto assets at the exchange before trading can happen.
Examples Of Popular Centralized Exchanges
Several CEXs are operating in the cryptocurrency market. And we will list out some of the notable exchanges, which are as follows:
- Binance: They are the largest and the number one (1) best CEXs in the crypto world (last updated in July 2023 by cryptohead). It was founded in 2017 and a home to thousands of cryptocurrencies and millions of users/investors.
- Coinbase: They are the most commonly used in the United States of America (U.S.A) and are a publicly traded industry which was founded in 2012. It’s easy to use but it comes with high fees.
- Kraken: One of the most trusted centralized exchanges which was founded in 2011 and is known for its low fees. It is a suitable option for intermediate and expert crypto users.
Other examples are Gemini, Bittrex, Bitstamp, Bitfinex, Kucoin etc.
How Do Centralized Exchanges (CEXs) Operate?
Knowing how they operate is for us to know the role they play in their transaction over a blockchain. It uses an order book system to facilitate crypto trading. This order book is an electronic list, which CEX maintains and it lists out all the buy and sell orders that are displayed in the price and quantity of each other. An order book records an ongoing trading activity and allows the investors/users to see the recent depth of the crypto market and liquidity.
They make it more favourable for people to exchange cryptocurrency and convert their real currencies(USD/EUR) to cryptocurrency, likewise acting as a bank of cryptocurrencies. So, if a transaction occurs, you are not transacting on the blockchain, instead, you are transacting on a centralized exchange, which is just to maintain records for those transactions.
Centralized Exchanges (CEXs) typically charge higher fees than their decentralized counterparts, they are often more secure and easier to use— By Benedict George
——Image From Medium
In this image illustration above, you can simply say the following:
- First, you must deposit money into the exchange’s wallet. This is done by using a payment gateway which is used by the company and this money is then transferred to the company’s wallet.
- You then buy cryptocurrency from the exchange. When the user clicks on buy, no transaction occurs on the blockchain. This exchange uses a trading engine to match a buyer with a seller and then updates the entries in the database for the seller and buyer accordingly, but these transactions are not free, you will make a token or a small percentage will be added.
- And then you sell crypto on the exchange, likewise buying cryptocurrency, while selling as well, and the same thing happens. The exchange will find a matching buyer who is ready to buy at the same or greater price, as the person is selling.
Now, with all this explanation of this particular title, there are other things to consider before a transaction with your exchanger. Users must pass some security checks, pass Know-Your-Customer (KYC), anti-money-laundering (AML), and counter-terrorism financing (CTF), before they can have access to the CEX platform.
CEXs ensure that every user must be verified before they can deposit their fund and start trading. So, on this, we will discuss their security measures:
For Security Measures
CEX represents the main categories of exchanges which boast a set of security measures and considerations. To protect user/investor funds, centralized exchange appoints various security measures, and they include:
- Two-Factor Authentication (2FA): This is very important as centralized exchanges require users to enable 2FA, which adds an extra layer of security by warranting a second verification step during login.
- Secure Custody: It stores user funds in their wallets, making sure their assets are kept safe. A mix of hot and cold wallets is utilized with the end being offline and with less responsive to hacking.
- Encryption: This implements an advanced encryption technique to secure user data and transactions, preventing unauthorized access and preserving user privacy.
- Regulatory Compliance: This exchanges strictly bind to regulatory standards and enforce thorough know-your-customer (KYC) procedures, to mitigate risks such as money laundering financing and theft identity.
Influence Of Centralized Crypto Exchange On The Industry
For several years, there has been an increase in the number of centralized exchanges in the crypto world due to the popularity of cryptocurrencies. This platform has provided a centralized system for trading digital assets, allowing traders(users) and investors to buy and sell cryptocurrencies. So, let’s discuss the influence of CEXs on the crypto industry:
- Impact Of Market Liquidity And Price Discovery: Most of the popular centralized crypto exchanges have a network of personnel that facilitates transactions between buyers and sellers. These exchanges are very similar to the traditional bank we all use (USD/EUR), with the third party to conduct a transaction. And that makes a good place to start if you want to purchase crypto and store it very safely. This in turn makes a great impact in the market liquidity and discovery of price.
- Role In The Adoption And Mainstream Acceptance Of Cryptocurrencies: This exchanges play a vital role in the acceptance of cryptocurrency by the governments, businesses and institutions around the world. And it’s a platform that facilitates the user to buy and sell cryptocurrency, either for Fiat currencies such as EUR/USD or between digital assets such as Bitcoin (BTC) and Ethereum (ETH). They also function as trusted agents in trades and act as custodians by storing and protecting your money.
“Centralized exchanges will continue to control the majority of global digital asset trading volumes” –By JP Morgan– Quote this after the fall of FTX exchange in the crypto world.
Criticism And Controversies Surrounding Centralized Exchanges
Centralized exchanges came into existence to close the gap between Fiat and crypto worlds with easy-to-use interfaces and purportedly solid connections to the banking sectors, which they were able to do so.
But, there has been so much criticism surrounding the industry, like when some of these exchanges in the crypto world like Binance and Coinbase started to control the lion’s share of the crypto trading market. For instance, Binance’s monthly trading volume stood at $474.11 billion as of January 2023, making them the highest trading volume among the other exchanges in the crypto trading market.
The fall of FTX has left millions of investors to lock their assets out, which creates a crisis of trust in the crypto industry. And enable investors to start taking their so-called “Not-Your-Coins, Not-Your-crypto” phrase very seriously. This also makes crypto enthusiasts to start hating centralized exchanges.
After the fall of FTX, SBF mentioned something along the lines of "other exchanges are doing the same thing". The tweet by CZ "selling FTT" was (in my opinion) to cause a run on FTX and force it to lose a series of bets that Binance would then profit from. I am speculating.— luda (@probablyluda) December 3, 2022
Despite all this ease and convenience that centralized exchanges provide, critics will always argue that they create a barrier to the transparency that the blockchain was supposed to usher in. And that’s why there are controversies that need to be address, and they are:
- Your Assets Is My Asset: When trading on custodian centralized exchanges, you will have to trust the exchanges to keep your assets safe. But the problem is while doing so, it exposes your assets which are possible to be hacked or mismanaged by the exchange’s owner.
- Getting Cover With Reserves: With the crisis of trust after the collapse of FTX, trust without proof was no longer an option at all. So, in this case, most exchanges do resort to providing proof that their wallet must be backed with their words when it comes to reserves. But still these proof of reserves are a long way from being so perfect and that is why, critics have called for professional audits.
For instance, Binance has improved their own proof of reserves system as of February 2023, which includes Zero-knowledge verification, but still needs some work to be done to make it perfect. And other exchanges have started working on providing proof of reserves which will make it a brilliant idea to perfection.
An Option For Crypto Exchanges
Some time ago, in November 2022, investors were looking for another option to centralized exchanges after the fall of the FTX exchange. This option comes with a newer type of decentralized exchange, such as pancakeswap and uniswap. This allows decentralized exchanges to have an idea of how they can improve their work. And now putting their trust in CEXs with your fund is no longer needed, it’s where I dived into to discuss decentralized exchanges (DEXs).
What Are Decentralized Exchanges?
It allows users to swap their crypto tokens with each other directly. It’s one of the key building blocks of the decentralized finance (DeFi) ecosystem, and cannot be controlled by any government or organization, but controlled by the users/investors.
They are very secure and stronger than centralized exchanges due to their vulnerability to hacking and were created for the exclusive purpose of cryptocurrency trade.Their aim is to offer lower transaction fees compared to a centralized exchange, allowing traders/users to directly hold their own assets and avoid the stress of regulation.
Some of the examples of decentralized exchanges are:
Comparison Of Centralized And Decentralized Exchanges
—-image from Medium.com
Now, that we know what centralized and decentralized exchanges all about, we will delve into the differences between these two exchanges, using table form to differentiate below:
|Criteria For Comparison||Centralized Exchanges (CEX)||Decentralized Exchanges (DEXs)|
|Liquidity||Institutional investors and centralized entities make sure of higher liquidity which makes it more comfortable.||Liquidity is provided by users, and at the moment, it’s very low. But it can be more challenging|
|Regulation||It’s regulated and compliances must be followed, since it’s required a license from the authority||License not required and also not regulated by the authority|
|Anonymity||KYC is needed, including AML and CTF for you to access all features and services||Nothing as such is required.|
|User Experience||User-friendly and it’s system is easy to use||Very complicated, which needs more time to fix before perfection|
|Custody Of Assets||They control your assets||User control their own assets|
|Transaction Fees||CEX collect trading fees is a little bit higher than DEX e.gBinance is 0.1%||Trading fees is more cheaper e.g Uniswap is 0.05%|
This is the difference between the two (2) exchanges which you can decide to choose between them. But before making that choice, let’s discuss decentralized exchange (DEX) benefits and if possible their drawbacks.
Potential Benefits Of Decentralized Exchanges
- It’s gives opportunity to peer-to-peer exchanges which also includes great autonomy and security, improved liquidity and boast privacy
- It offers users a secure trading environment that cannot be manipulated or hacked due to the absence of a main authority.
- Since it boasts privacy, its users are not to submit any personal information given for them to use it.
- And as such, it makes decentralized exchange to be an attractive option for those who value their privacy and security when trading their assets.
However, there are also drawbacks which we need to address before making decisions on which exchanges to use.
Drawback Of Decentralized Exchanges
Despite the benefits of decentralized exchange we draw out, there are a few drawbacks that are associated with this exchanges below:
- They may lack security due to their nature of no trust, since users are not required to provide KYC, it will make it difficult to prevent any malicious activities.
- It will be hard for DEX to enforce regulations which could be helpful in protecting investors from any fraudulent activities, since DEX operates without using regulations from the authority.
- Transaction done in DEX are often slower than that of CEX due to higher network latency and block confirmation times
Now, it’s your choice to make on which exchanges you prefer to invest with.
In general, crypto exchanges are either centralized or decentralized exchanges play a key role in the cryptocurrency industry by facilitating trading, influencing prices and providing liquidity. However, they also both face challenges such as security concerns, and regulatory issues, especially CEXs. But despite all these challenges on centralized exchanges, the future of crypto exchanges looks promising with potential growth and emerging trends. The choice is yours to decide.