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Centralized vs. Decentralized Exchanges

July 13, 2018

blockchain decentralization

With the rise of Bitcoin and other popular cryptocurrencies, so came exchanges to trade them. However, after countless large-scale hacks, systemic failings, and billions of dollars lost at the hands of centralized cryptocurrency exchanges, users started seeking an alternative. Cue decentralized exchanges.

Not only did users start looking for a safe-haven to trade cryptocurrencies without having to go through a costly and monolithic middleman, they started placing emphasis on investing in altcoins and smaller blockchain projects - which weren’t otherwise able to afford high listing fees associated with popular centralized exchanges.

In this blog post, we’re going to address the fundamental differences between decentralized and centralized cryptocurrency exchanges, touching on not only their benefits, but disadvantages as well. If you’d like to read up on what a decentralized exchange is, check out our recent blog post breaking down what they are, the value they bring to the blockchain and trading ecosystem, how they work, and more.

Wondering how to participate in the COOPEX ICO running until August 3rd? Head on over to https://coopex.market/ and click on “Markets” in order to purchase your COOP tokens with either Bitcoin, Bitcoin Cash, or Ethereum.

Intermediaries

Centralized

Just as their name suggests, centralized exchanges are at the hands of a central authority - or intermediary who oversees and controls your funds, personal information, and transaction history.

When trading and transacting on centralized exchanges, keep in mind that your funds aren’t sent P2P - or directly to another user - and must first pass through a centralized middleman, who authorizes and executes the trade on your behalf.

Central points of authority boast central points of failure, making them an enticing target for malicious actors.

Look no further than the case of Mt. Gox, one of the largest cryptocurrency exchanges that has ever existed - after “crashing,” it became evident that user private keys weren’t 100% protected due to being held by a vulnerable central entity.

Decentralized

The most fundamental difference between centralized and decentralized exchanges are the omittance of an intermediary and centralized third-party. Decentralized exchanges (DEXs) operate on a peer-to-peer (P2P) basis, meaning they use a combination of smart contracts and payment mechanisms to execute cryptocurrency trades.  

Simply put, users just need to fill in their order requirements in the order book, and leave it to smart contracts to automatically execute the transaction. DEXs run on hundreds, if not thousands of nodes, keeping with the decentralized ethos and ideal of the blockchain.  

Think of centralized exchanges as connecting users and traders to an entity, while decentralized exchanges connect traders to other traders.

Volume & Liquidity

Centralized

One of the biggest selling points for centralized exchanges are higher volume and liquidity - mostly due to the fact that they boast a user-friendly interface and ability to fill orders immediately. Centralized exchanges ease novice investors and traders into their foray into crypto, by allowing them to easily buy and sell their favorite cryptocurrencies.

Furthermore, because of high volume and liquidity, centralized exchanges aren’t as likely to be affected by large-scale orders (ex. Taking a large sum out of the liquidity and altering the price), allowing users to rest assured there won’t be large price swings.

Note that some centralized exchanges are facilitating billions of dollars in volume per day, making them an attractive option for users looking to immediately have their orders filled.  

Decentralized

As DEXs have typically been geared towards users who have some experience trading and transacting on exchanges, their user interface is less friendly and may seem daunting for novice investors. As a result, decentralized exchanges typically have a smaller user-base, and thus, lower liquidity and trading volume.

When using a decentralized exchange, it’s not a guarantee your order will be filled immediately (think back to the fact that DEXs connect users). As such, most decentralized exchanges in the cryptosphere at the moment are considered hybrid-decentralized exchanges, integrating with centralized exchanges to fill orders they wouldn’t otherwise be able to fill.

Finally, decentralized exchanges only allow for the exchange of cryptocurrency to cryptocurrency, and don’t allow users to directly purchase altcoins or cryptos with fiat (USD, EUR, SGD).

Trading & Transaction Times

Centralized

Since volume and liquidity are significantly higher on centralized exchanges, finding a compatible trade and matching order often doesn’t take very much time. As centralized exchanges hold their listed cryptocurrencies in their actual custody, it often makes for a smoother process when trading them.

Note that because of the ability to fill orders in a timely manner, margin trading is popular on centralized exchanges.

And, living in a consumer society where users want it now, centralized exchanges offer the most appealing option at the moment for fulfilling such mentality.

Decentralized

It might actually surprise you, but decentralized exchanges process substantially less orders per second than centralized exchanges due to the need to validate each transaction on the blockchain. As mentioned above, due to it taking longer to execute trades and find matching orders, DEXs have significantly lower daily trade volumes.

However, keep in mind that as decentralized exchanges grow and users start to acquaint themselves with the security benefits and token diversity of DEXs, volume and transaction times will increase.

Security & Up-Time

Centralized

Security is and will likely always be the biggest drawback to using a centralized cryptocurrency exchange. Since the entire platform and exchange depends on central servers controlled by a company or entity, there exists a single point(s) of failure - meaning users could lose their funds entirely or not be able to access them for long periods of time.

Hacks and other malicious attacks are much more common with centralized exchanges due to larger “rewards” and payouts, and the crypto-sphere has already seen billions lost in its tenure due to failed centralized exchange security.

Centralized exchanges do employ modern security and storage techniques to keep users’ funds safe, such as cold storage, two-factor authentication, and multi-signature, however, these are more of deterrents than failsafes.

Decentralized

Decentralized exchanges operate in a peer-to-peer fashion, meaning there isn’t a processing center or platform behind user transactions. Users are connected to one another, so there’s little worry about not being able to access one’s funds or having them stolen.

If a node goes offline, there’s countless others picking up slack instantaneously, ensuring users are always able to access and control their crypto funds. Simply put, DEXs are “trustless” mechanisms, where users are not required to place trust in any single central authority, allowing users to actually control their funds and private keys.

Additionally, DEXs don’t typically require personal information or other identification, keeping users protected and shielded from having their anonymity and identity compromised.

Final Thoughts

With the blockchain ecosystem established on values of transparency, fairness, and cooperation, it’s only natural that users looking to promote and experience such firsthand are turning to decentralized exchanges. While decentralized exchanges still have a ways to go in terms of user-interface and overall liquidity, they are quickly making strides. And, what they are lacking in volume and liquidity, they make up for in uptime and security.

At COOPEX, the world’s first cooperative decentralized exchange, we’re tackling not only core issues that have plagued centralized exchanges over the years, but ones that have been slowing the mass adoption of decentralized exchanges. The Cooperative Exchange boasts a user-friendly interface, targeting both novice and seasoned traders, while offering secure and diverse trading options.

Head on over to our homepage to participate in our ICO, which runs until August 3rd, 2018, and pick yourself up some COOP tokens today. At COOPEX, we’re not only rewarding users who grow with our exchange, we’re giving them a voice.

 

Read more:

COOPEX: The Cooperative Exchange

 

posted by Jonathan Downing

View all posts by Jonathan Downing