Crypto exchanges exist in different forms and can be roughly divided into centralized and decentralized exchanges. Decentralized exchanges are interesting because they operate on the peer-to-peer model
How does a centralized crypto exchange work?
Centralized exchanges are trading venues where a centrally operating operator maintains control over all transactions made. This requires that you as a participant have a lot of trust in the exchange operator, after all, you have no control over the private keys used to access your funds. If you want to make transactions of any kind, you must make a request to the exchange, and it enters the relevant data into its own database. Traditional exchanges such as securities exchanges follow this centralized approach. So, in a way, it is the model of the past.
Centralized exchanges can be used to conduct trades from fiat to cryptocurrency (or vice versa). They can also be used to conduct trades between two different cryptocurrencies. While this may seem to cover all the potential transaction types, there is still a market for another type of cryptocurrency exchange as well.
Decentralized exchanges are an alternative; they cut out the middleman, generating what is often thought of as a “trustless” environment. These types of exchanges function as peer-to-peer exchanges. Assets are never held by an escrow service, and transactions are done entirely based on smart contracts and atomic swaps.
The crucial difference between centralized and decentralized exchanges is whether a middleman is present. Decentralized exchanges are less widespread and less popular as compared with centralized exchanges. Nonetheless, there are more decentralized exchanges all the time, and it’s possible that they will give centralized exchanges a run for their money in the future.
How does a decentralized crypto exchange (DEX) work?
In principle, all platforms for peer-to-peer exchanges and thus peer-to-peer exchanges can be decentralized exchanges (DEX). Decentralized exchanges are quite capable of imitating the basic functioning of a centralized exchange with its specific advantages. This is achieved by these exchanges using a blockchain for their backend. Trust in the exchange therefore plays a much smaller role with this approach than with central exchanges.
An important differentiator from centralized exchanges is that you, as the user, own the private keys to your balances. In this respect, you are no longer dependent on the exchange operator and retain control over your deposited coins, for example. The decentralized exchange of digital assets is made possible by protocols such as the 0x Protocol, which runs on the Ethereum blockchain.
What are the differences between the two finance concepts and what are the advantages and disadvantages?
Centralized exchanges offer several advantages, the main ones being ease of access and manageability. These exchanges are easy to use, and they offer various advanced trading features for easier trading. Another advantage is that you can use your balance to pay for virtually any goods and services that are available on the market. This is not always the case with balances stored on decentralized trading venues.
However, the centralized approach also has distinct disadvantages. Users do not receive private credit keys, and centralized exchanges are often a popular target for hackers. The latter has become a significant security problem.
The advantage of decentralized exchanges is that they give you back control over your money. Transactions are stored in the blockchain – in a transparent and tamper-proof way. Intermediaries are not required; trading relationships take place peer-to-peer and thus directly between the participants of the platform. However, storage in the blockchain is costly, and the trading system does not yet achieve the speed and immediacy of central exchanges.
What are the major exchanges for cryptocurrencies?
Here are some of the most used centralized and decentralized exchanges that you can use for your crypto investments:
- Pancakeswap: this is the most popular DEX on the Binance Smart Chain with the ability to earn CAKE.
- Uniswap: This decentralized exchange runs on the Ethereum blockchain and enables automated transactions via smart contracts.
- Sushiswap: An experimental Uniswap clone that introduced the SUSHI token.
- Venice Swap: Trade with confidence on the world’s fastest and most secure crypto exchange
- Coinbase: A variety of coins can be traded through this central exchange.
- Kraken: A central trading platform for bitcoin and other currencies.
- Bittrex: Another central trading platform for Bitcoin, Ethereum and Co.