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  • Arjun Patil

What Are Cryptocurrency Exchanges? Decentralized Better Than Centralized?



Cryptocurrency exchanges are essential tools for facilitating a buy/sell transaction between currencies, which acts like equity exchanges like the NYSE, BSE, NASDAQ, NSE, etc. Due to the nature and complexity of the blockchain, it is hard to conduct the transaction. In this article, I will take you through,

1. Need for Crypto Exchanges

2. Types of Crypto Exchanges:

  • Centralized Crypto Exchange

  • Decentralized Crypto Exchange

3. Working of these Crypto Exchanges


According to Coin Market Cap, at the time of writing this article (Jan-2023), there are currently 22,261 crypto tokens, making the market cap $858 Billion with over 535 crypto exchanges.



Crypto Market Size Coinmarketcap
Crypto Market Size

What Is The Need For Crypto Exchange?

Unlike the stocks of different companies, cryptocurrencies have a blockchain network. Blockchain networks run on specific rules and conditions edged with programming in the smart contract, and all the assets developed on the network work according to these rules.


Hence, blockchain assets can only be compatible with another blockchain network if the network is developed to be interoperable. Due to this, it's very hard for two different blockchains to communicate with each other and conduct any trade.


Hence, on a technical level, it's impossible to transfer Ether, an Ethereum-based cryptocurrency, to the Bitcoin blockchain network and visa-versa.


However, each of these coins has its special purpose. For example, Ether is required to conduct transactions on Ethereum, which hosts most DAPPS in the ecosystem. At the same time, BTC is essential as a store of value. Hence it's of utmost importance to allow the conversion of one currency to the other, as without it, we won't have a successful ecosystem.


That's where exchanges come into the picture and facilitate transactions from one blockchain network to the other.


What are the types of Crypto-Exchanges?

Broadly, there are 3 types of Crypto Exchanges,


1. Centralized Crypto Exchange

2. Decentralized Crypto Exchange

3. Hybrid Crypto Exchange


Hybrid exchanges are still nascent and not widely adopted compared to the other two types of exchanges. Hence this article will dive deep into the first two types of exchanges.


At the time of writing this article, the 24Hr trading volume through the exchanges was $49.2 Billion, out of which only $1.42B (<3%) were from DeFi networks, according to Coingecko.


Top 5 Centralized Exchanges vs top 5 decentralized exchanges
Top 5 Centralized Exchanges vs top 5 decentralized exchanges

The 24-Hr trading volume of centralized and decentralized crypto exchanges in $ Billion.


What Are Centralised Crypto Exchanges?

Centralized exchanges (CEXs) act as an intermediary to conduct complex cryptocurrency transactions. Like a stock exchange, centralized crypto exchange work on the principle of the order book model.


It connects a buyer of an asset to the seller of that asset and charges a small fee in return for handling this complex matchmaking. However, the core question that might arise in many readers' minds is how a centralized exchange can swap tokens of different blockchain networks.


Well, centralized crypto exchanges don't swap tokens from blockchains. Instead, during the transaction, these exchanges allocate random wallets for these blockchains to the users to conduct the transaction.


Let us assume I want to convert my Cardano to Solana. CEXs takes my Cardano and deposits it in a random wallet compatible with Cardano, allocates me a random wallet compatible with Solana, and deposits the equal value of Solana to that wallet.


On the other hand, someone else looking for Cardano in exchange for Solana gets my initial Cardano from the wallet in exchange for depositing Solana in the other wallet. Dapp University has nicely explained the working of centralized exchange in this video.

How does centralized exchange works
How does centralized exchange works

CEXs handle both these wallets; hence, users don't have access to the private keys of these wallets, but only the public keys, which are essential for P2P trading. From the above example, it is evident that there are both advantages and disadvantages to CEXs.


Advantages of Centralised Exchanges:

1. These exchanges don't require a high technical background and are similar to the working of stock exchanges.


2. CEXs manage the wallets essential to store the cryptocurrency tokens and represent all the funds in a clean and crisp dashboard.


3. It has multiple features which improve the trading experience of a user, like Margin Trading and access to multiple investment strategies like yield farming, liquidity pools, and staking, all in a single easy-to-access application.


4. Many exchanges allow transactions in FIAT currencies through ACH. Wire, debit and credit transfers.


Disadvantages of Centralised Exchanges:

1. Centralized exchange doesn't allow users to be anonymous, and users need to constantly rely on the exchange for security and fund storage.


2. The transactions conducted on the CEXs work on the principle of the order book model, leading to transactions being slower than DEXs working on the AMM model.


3. The security of the CEXs isn't on par with that of DEXs and is hence at a higher risk of attack from hackers.


FTX was the second most used centralized exchange after Binance, valuing more than $32 Billion, and its scam was one of the biggest in the history of web3. It was majorly possible due to the centralized exchange, which led to less transparency between the users and the exchange. According to Time, this eventually led to a loss of more than $8 Billion of customers' money.


What Are Decentralised Crypto Exchanges?

DEXs follow the core principle of blockchain by being decentralized and thus are anonymous and of higher security when compared to CEXs. Moreover, all the transactions on the network are carried by an open-source program/smart contract and hence have no room for errors. Also, unlike CEXs, DEXs users don't need to provide any proof of identity in the form of KYC.


Many DEXs have moved to the Automated Market Maker (AMM) model, which has many perks over the Open Book Model. For example, AMM introduces a liquidity pool in the trade and reduces the dependency on another person to conduct a trade, thus increasing the transaction speed.


How does decentralized cryto exchange works
How does decentralized cryto exchange works

Source


Instead of depending on 2 persons to bid, with AMM, the user gets an instant exchange of funds from the liquidity pool. In exchange for providing liquidity, the providers earn rewards in the form of tokens and earn passive income. AMM deserves a detailed article; we don’t want to stray away from exchanges. Users can learn more about AMM from this Chain Link article.

Coming to the topic of DEX,


Advantages of Decentralized Exchanges:

1. DEXs maintain anonymity and are a fully transparent system.


2. The transaction on the DEXs is faster than CEXs since most of them have adopted the Automated Market Maker (AMM) model.


3. There is no human intermediary; hence, scams and hacks are less possible with DEXs.


Disadvantages of Decentralised Exchange:

1. The core problem with Decentralised Exchange (DEXs) is that it's a network-obedient on-chain system and doesn't allow one blockchain to transact on the other.


2. There is no active customer support for users. The system users need to self-search on forums and understand the work themselves.


3. The DEXs have low liquidity, which makes the exchange volatile. Therefore, a crypto whale can drastically affect the exchange and the token's value.


4. The smart contract is open source and accessible to hackers, which they can use to find vulnerabilities.


Since DEXs are network-obedient, Uniswap, the world's biggest DEX built on Ethereum, can only trade Ethereum-supported tokens. Sushiswap, on the other hand, works with multiple blockchains incorporating the Anyswap cross-chain bridge function.


Conclusion:

Both centralized and decentralized exchanges have their Pros and Cons. But if I had to summarise the article, CEXs have low knowledge barriers and give users easy access to quick trading. In contrast, users require basic knowledge of blockchain and crypto assets to trade via DEXs, and DEXs can be better than CEXs for long-term consistent traders. However, in any case, it is recommended to maintain a good hardware crypto wallet to save Crypto tokens from being less vulnerable to hacks, scams, and attacks. You can learn more about similar topics from the below-mentioned articles:

  1. What Is A Seed Phrase?

  2. Ultimate Guide To Safely Self-Custody Your Crypto

  3. Why Seedless Wallets Are The Future?

Frequently Asked Questions?

1. Which are the top 5 centralized crypto exchanges in 2023?

Ans: According to Coingecko, the top 5 centralized crypto exchanges by 24hr volume are, Binance, Coinbase, OKX, Kraken, and KuCoin.


2. Which are the top 5 decentralized cryptos exchanged in 2023?

Ans: According to Coingecko, the top5 decentralized crypto exchange by 24hr volume are, Uniswap (V3), Curve, Balancer, Pancake Swap (V2), DODO


3. Why do crypto exchanges have different prices?

Ans: The token's price is decided by the trade happening on the exchange according to the demand and supply of the token. Its price variance gives the ability to users to participate in arbitrage. P.S. This is how Sam Bankman-Fried made money in his early career in crypto trading.


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