What are centralized and decentralized cryptocurrencies?

Every pro cryptocurrency trader knows how important it is to know the differences between centralized and decentralized exchanges. However, telling their differences doesn’t come easy for crypto newbies. So what are centralized and decentralized cryptocurrencies? This article will provide you with a general overview of centralized and decentralized crypto exchanges, their advantages and disadvantages, as well as their differences. We also provide what we think about both types of exchanges in general. Read through the information below for more details. 

What is a cryptocurrency exchange?

Before we fully talk about what are centralized and decentralized cryptocurrencies, let’s take a look at the meaning of crypto exchange. Essentially, crypto exchanges are platforms where everyone can buy or sell crypto. Every crypto exchange out there has some specific unique rules and regulations, however, they all give you direct access to the most predominant cryptocurrencies.

What is a centralized crypto exchange? 

We’ve already explained that crypto exchanges are digital platforms that allow users to buy and sell cryptocurrencies. Centralized exchanges (CEX) are types of crypto exchanges that serve as mediators between buyers and sellers. The platforms are called centralized because they are managed by a company with centralized decision-making power. 

Trading on a CEX

Before you can start trading on a CEX, they have to register and verify their account first. If you already own crypto tokens, you can deposit them to your exchange wallet and your account gets credited, ready for trading. However, if you don’t own cryptos, you can start by using fiat on-ramps to buy a crypto token with bank transfers, credit cards and many other methods. 

All crypto trading that occurs on centralized exchanges happens via order books. Basically, CEXs provide traders with different order kinds, including stop orders and limit orders. 

In order to provide competitive token spreads, CEX puts liquidity conditions for market makers on the listed cryptocurrencies as well as tokens. CEX is run via sophisticated and extremely fast matching engines that help to match its users’ orders in milliseconds. Essentially, this facilitates a very smooth experience for the user and minimizes price swings that tend to happen during volatile market times.

What are the advantages of a CEX?

Here is a list of some of the advantages that CEX has to offer: 

1. Fiat support 

CEXs offer crypto traders and potential crypto traders different ways to buy cryptocurrencies using local fiat currencies that support off-ramps to fiat.

2. Wide range of supported instruments and assets   

Since centralized exchanges are the authority that validates transactions on CEXs platform, the platform has the capacity to support a wide range of native cryptocurrencies. This makes it easy for people to trade cross currencies.

3. High liquidity and volume 

CEXs have better liquid markets and offer institutions a very attractive set for their trades due to the market makers, and the quick execution of trades. 

4. User experience and support 

Centralized platforms offer solid customer support including instinctive interfaces that assist crypto traders with any problems or questions they may have.

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What are the disadvantages of a CEX?

Regardless of the advantages listed above, centralized exchange value largely relies on the physical location of the traders. Here is a list of other disadvantages of using CEX to trade:

1. Requires trust 

When depositing tokens into centralized exchanges, traders have to give up possession of their cryptocurrencies. This removes the capacity for traders to retain the utmost control of their tokens. 

2. Lack of transparency 

Money that flows through CEXs isn’t completely visible to the public eyes. Sometimes, users will not even get their transaction hash when withdrawing. They must wait until after accepting their transfer.

4. Single point of failure 

Just like every centralized platform, CEXs are a high target for hackers. In fact, a few CEXs have gotten hacked in the past few years. 

If you are seeking an alternative to CEXs, you can start with decentralized exchanges. Let’s explain in detail what they are. 

What are decentralized exchanges?

Decentralized exchanges (DEX) operate as smart contracts on public blockchains, such as Solana or Ethereum. The first types of decentralized exchanges were run based on order books and the concept of promoting crypto trades between peers. This kind of DEX is known as the Orderbook DEX and here, order books can easily be hosted either on-chain or off-chain. 

Off-chain order books rely on third parties bodies to regulate orders and this stops them from being really decentralized. 

On the other hand, on-chain order book DEXs are not mainstream either. This is because many users realised the absence of liquidity on the platform and the period it took for the orders to fill.

What are the advantages of a DEX?

DEX offers its users numerous advantages due to its creative model of enabling trading without any intermediaries. 

1. Non-Custodial

On DEXs, traders are fully in control of their accounts and tokens at all times. As a trader, you just have to connect to a DEX directly to your crypto wallet to start trading. Also, any transaction you intend to make has to be first signed and duly confirmed before you execute it. This implies that a user of DEX will never have to give up custody of their crypto, which fully aligns with the whole concept of crypto self-sovereignty.

2. Transparency 

When buying and selling on a DEX, traders will be allowed to audit all transactions. Essentially, this provides a completely new level of understanding of token trading history and methods to measure overall success.

3. Permissionless 

DEXs are not limited based on the trader’s location. Anyone with a smartphone/computer and internet connection can easily access DEX. The platforms do not discriminate based on trader location.

4. Censorship resistance 

One of the protocols of decentralized exchanges is that “no parties can censor transactions”. This helps to facilitate a better, more transparent and more seamless transaction.

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What are the disadvantages of a DEX?

DEX trading volumes are fast behind the trading volumes of centralized exchanges. This is because DEX comes with some disadvantages that can contribute greatly to lower adoption. These disadvantages include:

1. Impermanent loss 

Liquidity providers are discouraged from deploying their capital via DEX due to the impermanent loss of tokens, which may lead to permanent loss. This reduces their overall liquidity.

2. Limited token support 

DEXs are just limited to providing support for the crypto tokens that are natives of the blockchain they are managed on. This is because decentralized exchanges are solely built on-chain. For instance, Ethereum-based DEXs will be able to support ERC-20 tokens, however, a crypto trader may not be capable of swapping from native Bitcoin to Ether effortlessly. 

3. User experience 

The whole process for utilizing DEXs can be far less intuitive than other alternatives. Trades may take a longer time to get completed and can be quite expensive depending on the blockchain in use. This contributes to friction during user journeys. 

4. Hacks and bugs 

DEXs are just as secure as their codes. This means any problem with their codes will affect the whole platform. If the code is poorly written or contains some bugs, it can easily be exploited.

What are the key differences between centralized and decentralized exchanges?

Here, we compared the differences between CEX and DEX to help you weigh your options and pick the most suitable one for you:

1. Security and hacking

Centralized exchanges are far more liable to data breaches and hacks than decentralized exchanges. A hacker just needs to bypass the securities of the company managing the exchange and they will be able to infiltrate the system. Once the system is infiltrated, hackers will be able to access financial information, users’ holdings, as well as other potentially damaging data.

Decentralized exchanges, on the other hand, are almost impossible to hack because the hacker would need to hack every user on the platform. The system’s unique peer-to-peer model gives no room to manipulate or infiltrate.

2. Privacy

Decentralized currencies provide users with better privacy protections than centralized currencies. Peer-to-peer transactions can easily be executed with almost-total anonymity instead of going through the whole Know Your Customer (KYC) process, which centralized organizations mandate for their users. This means that on DEXs, practically anybody can easily transfer money for any reason.

3. Usability

Centralized exchanges are far easier to operate than DEXs. Since transactions are entrusted to a company, users of CEXs often receive the benefits of effortless and immediate access to their money. Also, CEX platforms are generally visually appealing and easy to use.  

4. Liquidity

A major downside of decentralized exchanges is that the platforms make it very hard to get cash fast. Users of DEXs are usually limited based on how much cash they can spend on a goal. Also, they must pass through several complex steps to convert the value of their crypto to fiat currency. This may even be more complicated because not many businesses currently accept crypto.

5. Control

Although there are certain benefits of using CEX, they all come at the cost of giving up your control. Centralized exchanges have been accused of exploiting the prices of their tokens and their users don’t have full access to their own assets. Also, they have certain market forces and withdrawal limits that may make it impossible for users to access their funds at once.   

So, what are centralized and decentralized cryptocurrencies? Centralized crypto exchanges are run by centralized companies that control the end-to-end operation while decentralized exchanges are run on public blockchains. Decentralized exchanges don’t rely on any bank, company, or other centralized authority, but instead use an interwoven system of users and their devices.

Earlier in the article, we’ve extensively explained what both terms mean, their pros and cons and their differences. Making the best choice for you depends on your specific needs. If you want better security, go for DEXs, as they offer a more secure platform. Nevertheless, you can use the list we provided above to compare both options and choose the right one for you. 

As the best crypto exchange app in Africa, Bitmama offers a secure marketplace for crypto enthusiasts. Perform activities like crypto exchange, crypto staking, and creating virtual dollar or crypto cards for online payment. 

Get started today by downloading the Bitmama app on Android or iOS.