Centralized vs. Decentralized Exchanges: What Business Model works best?

People are massively exchanging cryptocurrencies using unique online platforms that offer this type of service. You can either exchange fiat money for cryptocurrencies or simply convert one kind of cryptocurrency to another.

However, they are not created equal. In fact, all of them belong to either centralized or decentralized exchanges. Both of them have certain advantages and disadvantages, which we will explore in this article and try to decide on the best option for people who want to exchange crypto.

First of all, let’s see what centralized and decentralized exchanges are. Read on!

ReadBlockchain Economics 101: The Theories Of Value In A World Driven By The Blockchain

Centralized Exchanges (CCE)

Whenever something has a “center,” it probably means that there is one thing which affects all others that revolve around it. Such is the case with centralized exchanges, where one company dictates the rules of trade, so to say.

In other words, this type of exchanges uses a similar model to the one we see in traditional stock and brokerage markets. The company in the center has total control of all funds and transactions that take place on the platform. Therefore, the users must trust them 100% before they decide to start trading using the centralized exchange.

When we put it that way, it does look like taking a step backward from what cryptocurrencies are supposed to be – decentralized currencies that should not depend on anyone or anything. The idea that powers cryptocurrencies is to get rid of a centralized system as something that is potentially harmful to everyone.

However, centralized exchanges have their advantages as well. First of all, most of them are regulated and cannot scam you. Almost all of them have up-to-date terms and are actively implementing know-your-customer (KYC) and anti-money-laundering (AML) policies.

Furthermore, centralized exchanges are better when it comes to updating their platforms and making them user-friendly, catering to the latest user requirements. The fees that you pay when trading at a centralized exchange are often used to fund improvements on the platform.

Centralized exchanges are much faster than decentralized ones since their internal trading systems are often better optimized, paving the way for higher market liquidity as well. On the other hand, decentralized exchanges have a hard time implementing the latest trading features.

Finally, users can exchange fiat currencies for cryptos and vice versa on centralized exchanges, whereas that is not possible on decentralized exchanges where the crypto-to-crypto transfer is the only type of trade.

This type of exchanges has a couple of disadvantages compared to the decentralized exchanges. The most important one seems to be the fees which users have to pay to make any type of transaction on the platform. In other words, everything is a bit more expensive, which is a price you pay for a quick and regulated service.

The most significant disadvantage is definitely the increased risk of hacker’s attacks. Due to being a centralized system, this type of exchanges is often exposed to hackers and was a subject of both successful and unsuccessful attacks.

Decentralized Exchanges (DEX)

Decentralized exchanges support the viewpoint behind blockchain technology. In other words, there is no central company which is responsible for operating a DEX. Nobody has customers’ information, position, or funds on this type of platform, which increases the level of anonymity of those who trade. All transactions are peer-to-peer, and the platforms are usually open-source.

This type of platforms is usually very well protected from any type of attack because all their nodes are distributed all over the world, making them virtually impenetrable. Although possible in theory, there were not many successful hacking attacks which managed to endanger decentralized exchanges.

However, hackers are not the only threat that an exchange could have. Being decentralized means not being dependent on any government and their regulations. This could be either an advantage or disadvantage, depending on how you look at it. Governments can interfere in how CCEs operate and can even shut them down if they want to. This is not quite possible with a DEX as the decentralized system prevents anyone from meddling with how they work.

The crucial advantage compared to centralized exchanges is definitely fees, which are significantly lower. In CCEs, fees are usually taken by the governing body which provides the service, so to say. There is no such thing on DEXs, resulting in much more affordable transactions on the platform.

There are some issues, though, that a DEX cannot solve due to their decentralized nature. The first and foremost is the low trading volume. DEXs are often very unintuitive and difficult to use, and only expert traders can get around. Moreover, decentralized exchanges often have limited functionality that is very difficult to extend.

As a rule, decentralized exchanges are made in such a way that fiat currencies simply cannot be integrated into the system. Therefore, if you don’t have any cryptocurrencies and your plan is to buy some, you should avoid registering on DEXs as most of them offer no such option. Still, there are a few platforms that support USD.

Key takeaway

When you take a look at the list of popular exchanges in the world, you will notice that most of them are actually centralized. There is a good reason for that because CCEs are much easier to use, and have better functionality as well as other options for the users. Given that most of the people who trade cryptos are not experts, they find it more convenient to stick to CCEs rather than switching to DEXs.

To answer the title question, the centralized model seems to work better at the moment. However, that need not be the case in the future as well. Blockchain technology is still in its infancy, and DEXs have the potential to become much more convenient in the future, which will lead to their jump in popularity.

Read next: Blockchain Economics 101: The Theories Of Value In A World Driven By The Blockchain

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Mary Ann Callahan

An expert on Bitcoin-related topics, and Journalist at Cex.io - cryptocurrency exchange. Mary Ann worked on articles related to blockchain security, bitcoin purchase guides or bitcoin regulations in different countries.

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