Centralized vs Decentralized Crypto Exchanges, How Do They Differ?

A cryptocurrency is a digital currency that is protected by cryptography. Blockchain specifically addresses the structure of data and enables the existence of decentralized digital ledgers in which wrong  cannot affect transactions.  Cryptocurrency Exchanges are places where anyone can purchase or sell cryptocurrency. Every crypto exchange has its own set of terms and conditions, and they all offer users access to the most popular cryptocurrencies.

Over the past few years, trading in digital assets has grown significantly. Exchanges that are centralized and decentralized are the two different kinds of platforms where cryptocurrencies are traded. centralized exchanges are where most cryptocurrency trading takes place in terms of trading volume. Centralized exchanges (CEX) act as the main location for the exchange of tokens and money. The infrastructure that CEXs in cryptocurrency markets keep is comparable to that seen in traditional equities markets, with similar protocols and equivalent transaction execution rules encouraging the provision of liquidity and the price discovery process.

Several asset types are traded on centralized exchanges in contemporary financial markets. An electronic limit order book (LOB), which matches end-user orders in a fairly transparent, effective, and centralized manner, is frequently used in this dominant market structure. For off-chain cryptocurrency trading on centralized exchanges, LOB markets have also been extensively adopted.

Decentralized platforms are the only places where often  freshly released tokens can be traded along with popular cryptocurrencies These decentralized exchanges have lately seen an exponential rise in volume, including automated market makers. Decentralized exchanges are growing in significance for buying and trading a significant portion of cryptocurrencies. The phrase “decentralized exchange” typically refers to distributed ledger protocols and applications that let users trade cryptocurrencies without having to rely on a centralized body to act as a middleman or a custodian for their holdings. 

Decentralized exchanges, however, have come to light as a different market structure for digital assets, propelled by the surge of innovation brought about by the introduction of blockchain technology. These marketplaces are founded on automated market maker (AMM) smart-contract systems that permit on-chain trading.

Decentralized exchanges offer several significant advantages, such as lower counterparty risk, the potential for lower transaction fees, and a more varied selection of trading pairs that can open up access to riskier or less liquid cryptocurrencies. In the coming years, decentralized exchange technology may experience rapid growth in utilization, development, and adoption as demand for these features rises.

The Key Deviations Between CEX and DEX

The benefit of CEXs based on LOB is their capacity to offer a reasonably competitive and efficient price discovery process and liquidity clustering even in extreme circumstances. 

No third party is needed for the trade to be executed on DEXs, full custody of the assets remains with the user. This advantage brought about by the decentralized trust offered by blockchain technology has several significant consequences. The censorship-resistant and trustless nature of users’ crypto assets is the first benefit that users can fully exploit. Second, it gives users access to various protocols in which they can use their crypto assets and gain from their services. Third, it eliminates the possibility of hackers attacking the market and stealing assets.Fourth, it enables users to avoid paying the costs frequently related to putting money into and taking money out of CEXs. Finally, and most significantly, trade and settlement on DEX occur simultaneously.

The market can rapidly integrate and change to meet the demands of its participants in DEXs. Users can, for instance, instantly and without any screening procedures quote any pair of ERC20 tokens at any moment. New tokens will therefore likely become tradeable on DEX sooner while CEX approval processes may take a long period.

Furthermore, DEX could allow dealing on tokens that are not offered on CEXs. On one side, this creates a benefit by expanding the range of investment possibilities, enhancing diversification, and accelerating the process of market completion. But this has the disadvantage of exposing people to resources that might be malicious.

It is essential to note that execution and settlement for DEX trades coincide. Therefore, trading on CEXs entails even higher fees, longer delays, and risks when settlement issues are taken into account.

Also, companies that run centralised exchanges are responsible for their customers’ holdings. Large exchanges usually store billions of dollars in bitcoin, making them an attractive target for hackers and theft. Mt.Gox, which was once the world’s biggest cryptocurrency exchange company before reporting the theft of 850,000 bitcoins, is an example of such an incident.

And, Centralized exchanges allow 99% of crypto transactions, implying that they are accountable for the majority of trading volume. Decentralized exchanges often lack liquidity due to a lack of volume, and it can be difficult to identify buyers and sellers when trading volumes are low.

Conclusion

Decentralized exchanges are still in their early stages of expansion, with greater trade latency, lower liquidity, and less intuitive user interfaces that make them less appealing to mainstream retail users. However, as centralized exchanges continue to suffer security breaches and postpone the listing of new coins, more users will choose to use decentralized exchanges, despite their high friction. 

It is worthwhile to invest in the development and expansion of the decentralized exchange ecosystem to encourage liquidity in an increasingly diverse token ecosystem, greater user control of cryptocurrencies, more privacy features, and reduced censorship risk.

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