Centralised and decentralised cryptocurrency exchanges both have their own trade-offs.
The type of exchange you use will depend on your priorities. For instance, if you are looking for margin trading or a fast, intuitive and easy to use platform then a centralised exchange is the best option.
On the other hand, if you prioritise anonymity and having full control over your assets, then a decentralised exchange would be more suitable.
First, let’s provide an overview of centralised exchanges.
- More liquidity/volume,
- More features (margin trading, derivatives, etc.),
- User friendly, fast, intuitive design.
- Often there are KYC/AML requirements,
- Custody of client’s funds, and
- Vulnerable to data breaches/hacks.
Centralised exchanges (CEXs) are operated by for-profit companies that make money from the trading fees they charge their customers and are similar to traditional exchanges such as Nasdaq and NYSE, except they allow you to trade cryptocurrency.
CEXs account for the majority of all cryptocurrency trades in terms of volume. Higher volume translates into higher liquidity, which means traders can enter and exit large positions easily and get their orders filled with ease. These exchanges are also termed ‘centralised’ because they hold most of their client’s funds in a hot wallet, which is used to transact on behalf of their clients. The private key of any bitcoin or crypto deposited to an exchange remains under their control until the user withdraws their funds.
As the easiest way to get in and out of a cryptocurrency position, CEXs execute all trades off-chain, which provides fast settlement. These platforms are also very user friendly, where all you have to do is sign up via a website and you can quickly start trading. Moreover, centralised exchanges generally offer a wider variety of cryptocurrencies to trade, deposit options, and more features (including margin trading, derivatives and advanced order types).
One drawback of CEXs is that they often require personal information to conform with Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations and this personal data could be leaked if the exchange’s servers are hacked.
Since CEXs are in full control of their customer’s funds, they are big targets for hackers who have caused misery for various exchanges over the years. Since users are trusting the exchange with their funds there is a small risk that the company will make off with their money. However, if a user loses access to his trading account, the exchange can resolve the situation and ensure that the user does not lose their funds.
Security measures vary across exchanges so be sure to check how they secure customer data and the cryptocurrency they hold. CEXs are likely to continue to innovate by offering more features to retain their large market share, as well as adopt newer and more effective security measures.
- Better privacy,
- No single point of failure or control,
- User has custody of their assets.
- Basic features (e.g., no margin trading),
- Lower liquidity/volume,
- Not as user friendly.
Decentralised exchanges (DEXs) are run on top of a blockchain network (such as Ethereum) in a peer-to-peer fashion to conduct trades using smart contracts. Since there is no company or entity responsible for vetting traders, most DEXs have no KYC/AML requirements in place making it useful for people who do not want to share their personal data.
Another advantage of DEXs is that users are in full control of their assets the entire time they are trading. With the user retaining control over their private keys, there is no risk that the exchange can exit scam and steal the trader’s funds. However, users have to be more careful in protecting their details, as if the individual forgets their login, password or private key, they will lose access to their funds.
DEXs have not yet achieved critical mass as they are still lacking in liquidity. Because CEXs are much more convenient, most investors provide liquidity to these exchanges instead of DEXs. Since DEXs have a much smaller audience, it can often be difficult to match orders and you might find that volume is insufficient to fill a large order.
Also, DEXs can be cumbersome to use since the interfaces are not very intuitive and trade settlement times are much longer since they are executed as on-chain transactions. Many DEXs also create another layer of friction by introducing their own pegged tokens to trade cryptocurrencies and requires users to trust that the DEX will maintain these pegs.
While some platforms are termed DEXs, the reality is that there is no purely decentralised exchange today. An ideal DEX has no downtime, single point of failure and does not take custody of the user's assets. However, it is still the norm that DEXs have some elements that are centralised (such as data storage, order matching, software or servers), and makes them vulnerable to DDoS and DNS attacks on their servers (e.g., the EtherDelta DNS hack in December 2017 resembles a breach of a centralised exchange).