Currently, more than 1600+ digital currencies are operating in the digital space. We can trade those currencies on over 200 different exchanges, according to Coinmarketcap. While each exchange strives to give its audience something unique, broadly, they are either categorized as centralized exchanges or decentralized exchanges.
Both exchange types are integral to the blockchain ecosystem. Several crypto-enthusiasts believe that relying on centralized exchanges to trade digital assets is counter-intuitive to blockchain’s decentralization. However, it is important to consider that centralized exchanges offer benefits such as additional security and liquidity leading to efficiency and lower costs.
Similarly, there are many other important aspects that investors must take into consideration to ensure the success of crypto exchange business. So, let’s begin with understanding the basics of these exchange platforms for a comprehensive view of their underlying differences.
Centralized cryptocurrency exchanges involve intermediaries like companies and regulatory authorities that act as middlemen to facilitate trading on the platform. In exchange for providing services, these intermediaries collect some trading fees. Essentially, centralized exchanges are the first place to go for neophytes interested in investing and trading cryptocurrencies. Many users want to have an interface that connects them to both cryptocurrency trading and the conventional economy. Centralized exchanges are effective at connecting the two.
The operation of centralized exchanges is relatively simple. For instance, if Bob wants to purchase 5 crypto coins, one of two situations can occur. Bob can access the order book and find an offer that he is willing to accept. Typically, a matching order book automates this process. So, when Bob agrees to trade at the set asking rate, his buy order gets matched with the order that fulfills his requirements. Bob can also create his buy order. It will enable him to set the terms of the trade, such as price and quantity.
Unlike centralized exchanges, a decentralized exchange does not depend on any intermediaries to trade cryptocurrencies. It follows the peer-to-peer transaction model. Instead of matching buying and selling orders in the order book, it matches people behind these orders. For instance, if Bob wants to purchase 5 crypto coins, he will directly be matched with Alice, who also wants to sell 5 crypto coins. From there, Bob and Alice can agree on the mentioned price and finalize their trade. A pre-programmed match and exchange software facilitate this entire process. So, there is no need to involve an intermediary.
Now, let’s understand some core differences that differentiate both from each other to determine what business needs they fulfill.
A comparison between centralized and decentralized crypto exchange platforms
Volume and Liquidity
Decentralized exchanges are simply not as well adapted as centralized exchanges. It sometimes creates trading on them an issue.
Due to audience limitations, the trading volume on them is lower than centralized exchanges. It means that finding an acceptable trade on them is difficult. Also, these platforms currently do not generate sufficient liquidity due to lower trading volume. It makes buying and selling cryptocurrency and liquidating them a difficult task. However, users can opt for a centralized exchange that deals in cross-currency conversion with a global audience base to ensure liquidity.
The transaction time in decentralized exchanges is longer than centralized exchanges. A crypto trader has to wait for a transaction to complete before a trade is final. So, traders who want to make quick transactions to capitalize on market trends face challenges. Also, they do not provide advanced trading features like margin trading and stop losses. It makes trading on decentralized platforms a difficult task.
In addition, decentralized exchanges are relatively new to the crypto domain, which makes their operation difficult. However, as their adoption increases and technology improves, they will become more user-friendly. They are not recommended for newbies due to their complex usability. Those who have good knowledge of decentralized exchanges can go for it.
Contrarily, centralized exchanges are user-friendly, especially for beginners. They provide instant market orders with no need for traders to wait until a transaction is fulfilled. They provide the advantage of entering a volatile market and capitalizing on market trends.
Unlike centralized exchanges, no centralized authority governs or controls decentralized exchanges. There is no centralized server maintaining details like customers’ accounts, logins, balances, and so on. Several decentralized nodes participate in the network using blockchain to process trades and information as ‘transactions’. Since there is no central authority, there is no single point that controls users’ funds. Decentralized exchanges work on a trustless basis (use smart contracts), which means users can always control their funds and private keys at all the time. On the other hand, users who hold or trade funds on centralized exchanges do not control their private keys.
As mentioned earlier, centralized exchanges rely on customers’ fees, which is their primary source of revenue. They charge relatively higher fees to execute trades, especially in fiat to cryptocurrencies. Thus, they are able to generate consistent revenues, whether the market is down or up.
In decentralized exchanges, the absence of intermediaries eliminates trading fees entirely or minimizes them significantly. It depends on the exchange platform and the blockchain protocol being used. Some exchanges charge some fees, which is distributed to the network service providers.
Centralized exchanges operate under the supervision of regulatory authorities, and require approval to avail their services. For instance, they ask for Know Your Customer (KYC) documents to verify a user’s identity, like an image of the proof of identity. It takes time and requires users to wait until the exchange approves the use of the platform. In contrast, if users want to remain anonymous and begin trading right away, a decentralized exchange is the solution.
TPS (transactions per second)
Majority of decentralized exchanges use blockchain as their underlying technology to achieve a faster transaction rate. However, blockchain also has some limitations. Most of the blockchains, even after being built using the best consensus model, do not find it easy to process large volume transactions. On the contrary, centralized exchanges can process more than 1.4 million transactions per second.
Conclusion: Centralized and Decentralized Crypto Exchange Platforms?
Decentralization and its attributes are at the core of the blockchain and cryptocurrency space. However, this philosophy is missing in how users conduct trades in this space. Decentralized exchanges continue to be overlooked due to centralized exchanges that offer better trading functionalities and services. User preferences may shift with more advancements in the development of decentralized exchanges.
At Oodles, we believe that both centralized and decentralized crypto exchange platforms will co-exist in the future. Drop us a line if you want details about our cryptocurrency exchange development services in this space.