Understanding Difference Between Centralised and Decentralised Crypto Exchange

Understanding Difference Between Centralised and Decentralised Crypto Exchange

Understanding how centralised and decentralised cryptocurrencies exchange works is key to investing in digital coins. Unknown to some cryptocurrencies fans, and wannabe investors, there are certainly fewer than the obvious facts that they need to understand about the growing activities of crypto exchange.

There are a number of them around, often used to transactional but while making choice, a glimpse about their difference could make a difference in making an investment decision.

Mudrex.com, in a new note, explains that one of the USPs of Blockchain technology is ‘Decentralization.’ It means that no single entity or organization has the power to influence or control the network.

It said decentralization is rapidly picking pace, with several apps being built on this exact premise. These decentralized apps or ‘DApps’ are being built on existing blockchain networks, such as Ethereum, Solana, Polkadot, and so on.

With the exponentially rising demand for cryptocurrencies, it was only a matter of time for the crypto exchanges to come sprawling up. Cryptocurrency exchanges can be broadly classified into centralized and decentralized exchanges.

Centralized exchange

The way a centralized exchange operates can be considered similar to a bank. Depositing cryptos onto a centralized exchange such as Binance essentially means transferring it to a wallet held by the exchange.

It said when cryptocurrency traders, users deposit fiat currency such as the US dollar or any other currency to buy crypto, that crypto is also held in the exchange’s centralized wallet.

Decentralized exchange

With decentralization picking up, the cryptocurrency exchanges want to get into the decentralization space too.

These decentralized exchanges are also known as DEX. Currently, there exist more than 35 DEXs globally. One of the most popular ones is Uniswap, which appears to have recently gotten into trouble with the SEC. Other players include Kyber, Bancor, etc.

Traders simply swap tokens with each other, and there are no middlemen involved here. Key points of contention between centralized and decentralized exchanges:

Fees:

In the case of centralized exchanges, there is a fixed fee which is usually a percentage of the transaction amount. In decentralized exchanges, it works out to be gas fees, which can sometimes vary.

Ownership of your crypto holdings:

Crypto wallets have two keys, public and private keys. Public keys are shared with anyone who wants to send you cryptocurrency, while a private key is what you use to access your own wallet. Centralized crypto exchanges don’t give their users the private key.

It essentially means that the holdings are not actually owned by the users, but by the exchanges. In some decentralized exchanges, the entire process of buying and selling is performed ‘on the chain.’ The holdings are with the user and not held by any central agency.

However, keeping the holdings on the exchange can lead to a faster execution since the user does not need to provide access. But this can be the reason for the crypto theft as well!

Case in point:

In 2018, $713 million was stolen with most of them coming from the Coincheck exchange hack. In a Decentralised Exchange, users are generally free from these risks!

Privacy:

A decentralized exchange script usually does not have a central authority involved. Therefore, no requirement will be imposed on them. One can sign in and start trading without any identity verification.

Additionally, Anonymity allows the user to access the tools which are not available otherwise.

Centralized exchanges require the users to perform a KYC to trade cryptos. It is not the case with decentralized exchanges. It means that the user would not need to hand over the documents to any single entity.

Liquidity:

Barring the large centralized exchanges, several others suffer from a lack of liquidity. It is a major concern that ultimately leads to the downfall of the exchanges. The larger exchanges such as Binance, Coinbase, etc. have high liquidity.

Decentralized exchanges usually follow a different method of price discovery and don’t suffer from problems of illiquidity. Some decentralized exchanges also have Automated Market Makers (AMM).

AMMs look to solve the liquidity problem without depending on large traders using smart contracts — self-executing computer programs that ensure liquidity on the exchange.

The AMM algorithms have pre-defined requirements for an entity or individual to become a liquidity provider. Anyone who meets these criteria can become part of the liquidity pool, and hence maintain continuous trading.

Read Also: DeFi Market Size Plunge 45% to Below $48 Billion

Understanding Difference Between Centralised and Decentralised Crypto Exchange