One of the most crucial and essential aspects of the cryptocurrency ecosystem and space are exchanges. With the dozens and dozens of cryptocurrency exchanges that exist, it is hard to know which ones to chose and which ones to avoid. Exchanges are often praised but also largely criticized. In this article, we will explain all the differences that exist between decentralized and centralized exchanges.
Decentralized vs Centralized Exchanges
As the crypto space has evolved over the years, and especially in the last few months, two main types of exchanges started emerging and becoming popular: centralized and decentralized exchanges. Although they serve the same purpose allowing users to exchange fiat (like USD and EUR) to digital currencies, as well as exchange crypto to crypto, they differ on a lot of aspects.
The first major difference between the two types of exchanges is ownership. Centralized exchanges are owned by a single entity and operate as a business or a traditional company that aims to make a profit. The most popular ones are Coinbase, Binance, and Gemini. These exchanges have increasingly become more popular as the value of cryptocurrency assets have reached all-time highs at the end of December 2017. Their ease of use allows them to attract beginners, as well as more experienced investors. One can argue that fact that these companies run their business with profit in mind goes against the objective of cryptocurrencies in the first place. Bitcoin was created in 2009 as a response to the financial crisis in the hopes of regaining financial freedom and rejecting the banking system that had too much control on people’s finances.
Decentralized exchanges, however, are not owned by a single entity. These exchanges rely on the blockchain technology and smart contracts to execute transactions and trades. This means that individuals are able to directly interact, exchange and trade assets in a peer-to-peer way, without the need for third-party oversight or authorization. The platform is therefore completely decentralized, which is the objective of cryptocurrencies.
Another difference between the two types of exchanges is the fees. Coinbase and other centralized exchanges charge extremely high fees for transactions and trades. As previously mentioned, these companies always have profit as their main objective. They justify their high fees with ease of use and convenience. Decentralized exchanges, on the other hand, have lower fees, and they are usually dictated by the market.
One of the biggest issues with centralized exchanges is security. Centralized exchanges have been attacked numerous times over the past few years, with the most famous occurrences being Mt. Gox and Coincheck. Thousands of users have lost their funds and the exchanges have not been able to refund them entirely. In most cases, these hacks and security breaches have been the fault of the exchanges themselves. This is because users completely rely on the platforms to safely guard their funds. Individuals do not have control of their private keys, which makes their funds unsafe in the case of a hack. Users only have access to their public address. However, this is not the case on decentralized exchanges. These platforms are much safer and give total control of their assets to the users, with public and private keys. They are less vulnerable to hacks and much more secure than centralized platforms. The assets are safely stored on the blockchain and therefore would not be completely affected, even if a hack were to happen. In addition, when it comes to transactions, users have to approve and validate them using multi-signature authentication and their private keys. This means that hackers could not easily access crypto-assets and transfer them outside of the exchange. Regular, centralized, exchanges could also experience mismanagement issues, which can lead to users losing their funds. This is part of the reason why Mt. Gox collapsed in 2014. Decentralized exchanges are not owned by a single entity, which makes users safe from any mismanagement or trust issues with the ownership. Thanks to decentralized exchanges, investors can regain their financial freedom and keep their liquidity safe.
For all these reasons, it is far more advantageous to use decentralized exchanges and we can almost certainly assume that we will see those types of platforms gain popularity in the future. It is safe to anticipate that users will migrate from centralization to decentralization.
TLDR: Decentralized exchanges are the future of exchanges as they are more secure, more trustworthy, and offer more flexibility than centralized ones.