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Centralized vs Decentralized exchanges

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To date, there are two main types of cryptocurrency exchanges for cryptocurrency trading: centralized and decentralized. This article will discuss the features, and differences between centralized and decentralized cryptocurrency exchanges, their pros and cons.

Centralized crypto exchanges

Centralized Exchanges (CEX) are the better-known type of exchanges in the cryptocurrency industry. Both cryptocurrencies and fiat money can be traded here (Fiat money is legal tender whose value is tied to a government-issued currency such as the U.S. dollar, while cryptocurrency is a digital asset whose value is determined by a blockchain). A centralized exchange is managed by a specific organization, which controls all activities performed on the exchange and receives income in the form of commissions from transactions.

This type of exchange is similar to a broker: you deposit your funds to buy an asset, and the organization acts as an intermediary and is responsible for your funds.

Types of centralized exchanges:

  • Spot or derivatives. Spot trading is the instant transfer of cryptocurrency between buyers and sellers. In the spot market, you are the owner of the cryptocurrency assets. By contrast, derivatives are contracts that reflect the value of the underlying cryptocurrency. When you buy a futures contract, you are not buying the underlying asset itself, but conditionally agreeing to transfer funds on certain terms and times.
  • With or without a fiat gateway. A fiat gateway allows you to convert fiat to a specific cryptocurrency and vice versa. Exchanges with a fiat gateway are convenient because you can buy cryptocurrency just using a bank card or an e-wallet, but you will need to provide your confidential data to pass the KYC verification procedure.
  • With or without leverage. The trading leverage is a loan provided by the exchange or its users. You can increase your trading capital with the help of credit funds. The credit is returned with interest. This type of interaction on a cryptocurrency exchange is called margin trading. Some exchanges provide very high leverage - up to 200x.
  • Highly liquid and illiquid. Liquidity on the trading floor is provided by the participants themselves. The more participants on a cryptocurrency exchange, the more liquidity there is. For market participants, high liquidity is a big advantage, because a transaction can be made at any time.

Advantages and disadvantages of centralized exchanges

On the one hand, centralized exchanges usually offer their clients support, multiple trading pairs and gateways for receiving and withdrawing, as well as additional services such as staking, storage options, IEO (Initial Exchange Offering), and high liquidity. On the other hand, first, such options are not well developed on all exchanges; and second, the main disadvantage faced by CEX users is the lack of decentralization with all its consequences. You can't be anonymous and free from the influence of a central authority and you don't own your money directly.

The most popular centralized exchanges

Below is a screenshot from the CoinMarketCap website with a ranking of cryptocurrency exchanges. The 10 most popular exchanges for spot trading are highlighted.

CoinMarketCap ranks and scores exchanges based on traffic, liquidity, trading volumes, and confidence in the legitimacy of trading volumes reported

Below is the ranking of the top 10 cryptocurrency exchanges for derivative trading

Decentralized Crypto Exchanges

Decentralized cryptocurrency exchanges (DEX) enable cryptocurrency trading without the restrictions and rules set by central exchanges and without intermediaries. All funds are stored in the wallets of cryptocurrency owners where they themselves own private keys. The exchange in this case acts only as a tool for exchange and is not engaged in the storage of customer funds. An account on such an exchange is not in the form of email, password, and KYC verification, but in the form of a user's wallet.

Unlike traditional CEXs, on decentralized exchanges, transactions and trades are automated using smart contracts (a special program in the blockchain that ensures the transaction and its reliability) and decentralized applications. DEXs cannot be shut down by any government or regulators, as no organization is responsible for them.

When trading on decentralized exchanges, it is desirable to have some experience with cryptocurrency, because for a newcomer it can be difficult to understand the interface and the trading system.

The main reasons for the emergence of decentralized exchanges:

  1. Data privacy. You can remain anonymous. Not everyone wants to disclose their confidential data and go through KYC like on centralized exchanges.
  1. Security when storing assets. No one can deny access to assets, block an account, or place restrictions on trading, and decentralized exchanges are much less vulnerable to hacking attacks because they are protected by a well-written smart contract.
  1. Weakened oversight by the authorities. Centralized exchanges do not conform to the ideology on which blockchain is built. CEX crypto exchanges are run by a few specific individuals who make all decisions themselves, can manipulate the market, and are subordinate to the government. Decentralized exchanges solve this problem because they are not owned by specific individuals and are managed by the community.

Advantages and disadvantages of decentralized exchanges

As we can see, basically all disadvantages of decentralized cryptocurrency exchanges are reduced to the fact that they have low liquidity and are more difficult to use. However, as the cryptocurrency industry grows and develops, many problems will gradually be solved and DEX will reach a new level.

The most popular decentralized exchanges

Below is a screenshot from CoinMarketCap with the ranking of the top 10 DEX exchanges. The ranking is based on the trading volume of the exchange and market share among DeFi.

When choosing an exchange, everyone is based on their needs. At the moment, centralized exchanges dominate the market, but traders are increasingly attracted to DEX, because they comply with the basic principle of cryptocurrency - decentralization - and optimize technology for greater convenience, develop functionality, improve scaling mechanisms, etc. With the arrival of new clients comes liquidity, which means that probably soon there will be no obstacles to completely switching to decentralized exchanges.

About Pontem

Pontem is a product studio working toward global financial inclusion powered by blockchains - primarily Aptos, the most scalable and safest L1 network. We are partnered with Aptos to build foundational dApps, development tools, AMMs, and more. The first dApp, LiquidSwap - the first-ever AMM for Aptos - is already available as a test version.  

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