You’ve read up about blockchain technology, have a basic understanding of how to analyze cryptocurrencies, and are ready to dive into the cryptocurrency markets. You’ve probably heard about different cryptocurrency exchanges, but how do you know which one to use?

One of the key decisions you will have to make is to decide whether to invest/trade using a centralized exchange, or decentralized exchange. Centralized exchanges have been the most popular choice over the past several years.

In the past, many cryptocurrency investors and traders expressed concern about the liquidity of decentralized exchanges. Centralized exchanges also have their own issues.

With the rise of DeFi, there’s an argument to be made that the decentralized exchange could eventually become the norm. The DeFi sector is already growing quite rapidly.

The history of cryptocurrency exchanges

paper money covered in bitcoinThe history of cryptocurrency exchanges is relatively short, especially when you consider that Bitcoin was invented in 2009. Many centralized exchanges have failed throughout the years, whether because of regulations, exit scams, or hacks/thefts.

Many early cryptocurrency exchanges have since shut down. Mt. Gox was a Tokyo-based cryptocurrency exchange, and was the largest centralized exchange in the world at one point. By 2013, the exchange was handling 70% of all Bitcoin transactions worldwide. Mt. Gox eventually shut down that year.

Millions of cryptocurrency traders and investors currently use popular centralized exchanges to purchase and sell their crypto holdings. Binance and Coinbase are two of the most popular cryptocurrency exchanges in the world, and both are centralized exchanges. Binance is valued somewhere around $4.5 billion, and Coinbase boasts a market capitalization around $14 billion. 

The rise of the DEX, or the decentralized exchange, is rather recent. The DeFi space has attracted billions of dollars in the past several years, and exploded in 2020. Many different decentralized exchanges are gaining traction, most notably Uniswap and dYdX.

Centralized vs decentralized exchanges

Many cryptocurrency enthusiasts have argued that the existence of centralized exchanges conflicts with the cryptocurrency sector’s values in general. Bitcoin was invented so that individuals could rely LESS on institutions. One obvious difference is that a centralized exchange owns its assets, while a decentralized exchange does not control a user’s private keys.

One of the recurring themes regarding cryptocurrency is the idea that two parties can enter agreements, or “smart contracts,” without requiring a trusted intermediary or third party. A centralized exchange, in effect, acts as a trusted intermediary. This is one reason that the DEX is becoming so much more popular, and DeFi is growing at such an impressive rate.

What are some main features you should know about a centralized exchange?

  1. They operate as the central authority responsible for maintaining customer accounts, facilitating transactions, and offering additional services.
  2. They usually offer better UI and UX than a traditional DEX.
  3. The volume/liquidity is usually consistent.
  4. A centralized exchange usually offers faster transactions.
  5. These exchanges follow rules/regulations.
  6. A centralized exchange controls the exchange assets.
  7. A CEX is easier to hack/breach.

This is quite different from the way that a DEX, or a decentralized exchange, works.

  1. A decentralized exchange is completely permissionless, so there is no central authority.
  2. There is usually a more demanding learning curve with respect to DEXs.
  3. While the DeFi space may have had liquidity issues in the past, it seems as though that is changing.
  4. Transactions are slower, and the experience is less convenient (there is no “support center” for a DEX, for example).
  5. Smart contracts are open-source and transparent, and it is currently unclear how a DEX could be “regulated.”
  6. Users remain in control/ownership of their digital assets. They are not held “in escrow.”
  7. It is much more difficult to hack a DEX, although it is possible.

Two main differences between centralized and decentralized exchanges involve ownership and security, or #6 and #7 on the above list. It’s also critical to note that a CEX usually offers both fiat-to-crypto and crypto-to-fiat trading, while a decentralized exchange tends to focus more on various cryptocurrencies and tokens rather than fiat currencies.

A DEX is non-custodial, and acts as a peer-to-peer service. The decentralized exchange is never in control or custody of your assets, unlike a centralized exchange.

Centralized exchanges also usually have a “single point of failure,” where cybercriminals could potentially hack the centralized exchange and gain access to investor funds. A massive hack occurred in 2018, where hackers were able to steal somewhere around $500 million from cryptocurrency investors and traders.

This doesn’t mean that it is entirely impossible to hack a DEX. Since decentralized exchanges run on code, cybercriminals can exploit coding flaws for their own malicious purposes. However, they are typically much more difficult to breach than a centralized exchange.

There’s another massive difference between centralized exchanges and decentralized exchanges. Decentralized exchanges can grow despite crackdowns and regulations. In the wake of the recent China crypto ban, the decentralized exchange Uniswap experienced more volume, and its native token increased in value significantly. Decentralized exchanges experienced more volume, in general, after the ban.

What’s next in the future of cryptocurrency trading?

lady thinking Many cryptocurrency investors and traders are wondering about the future of cryptocurrency trading. Will centralized exchanges continue to dominate volume, or are we witnessing a tipping point, where DeFi slowly begins to dictate the ebb and flow of the cryptocurrency markets? Time will tell, but it certainly looks like the DEX is here to stay.

Some believe that the best possible way forward is to establish some kind of a hybrid model, combining the beneficial aspects of both centralized and decentralized exchanges. The DEX is currently offering additional services that are in demand, but time will tell whether the interest in decentralized exchanges will outpace the centralized exchange permanently.

The truth is that there is currently a massive demand for both the centralized exchange and the DEX. While DeFi’s growth has been quite explosive, there will still be many cryptocurrency investors and traders still preferring decentralized exchanges for services like yield farming, staking, and more. Similarly, a centralized exchange will always serve a purpose for newer traders looking for a more user-friendly experience.

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Michael Hearne

Michael Hearne is the CEO of Decentral Publishing and the host of the Uncensored Crypto docuseries.