Cryptocurrencies trade on exchanges, similar to how stocks trade on exchanges as well. An exchange is a platform where users can buy and sell digital assets. There are two types of exchanges to transact crypto: centralized and decentralized.
In a centralized exchange (also known as a CEX), a third party is used to monitor and secure the transactions on behalf of the user. Coinbase for example is a centralized exchange. They facilitate transactions and act as a middleman, meaning that transactions are not directly from one user to the other. Generally, users hold their assets within the exchange’s platform, and the exchange acts as a custodian.
In a decentralized exchange (also called a DEX), no third party exists. Transactions are direct from one user to another. Users hold their assets outside of a third party, centralized-exchange. This creates transactions that are known in the crypto world as ‘trustless’ — which really means trust-free — users don’t need to trust a third party middleman or even the other person because transactions are done entirely based on smart contracts.
Each type of exchange has pros and cons.
Centralized Exchange
Pros:
- Centralized exchanges have high liquidity — you can trade assets quickly and easily without affecting the price.
- They’re typically more user-friendly and easier to understand than DEXs
- They may provide an extra layer of security and reliability when it comes to transactions and trading.
Cons:
- Entrusting an exchange with your private keys means you don’t fully control your money. They could potentially freeze your account or make it difficult to access.
- They can be large targets for hacks and attacks to steal the assets or data held within the exchange.
- They typically have higher fees to transact.
Decentralized Exchange
Pros:
- Decentralized exchanges users do not need to transfer their assets to a third party. Therefore, there is no risk of a company or organization being hacked.
- Traders don’t need to relinquish control of their assets or private keys to transact. They maintain ownership.
- Decentralized exchanges do not require customers to fill out know-your-customer (KYC) forms, offering privacy and anonymity to users.
Cons:
- Decentralized exchanges usually have lower liquidity than centralized platforms because they are new and have fewer buyers and sellers and assets become difficult to trade.
- DEXs have suffered from the same network congestion issues relating to scalability issues as their underlying blockchain networks like Ethereum.
- Unlike centralized exchanges run by private companies with employees, DEXs fundamentally have no recovery ability for scams or lost, stolen, or misplaced funds.
Before participating in cryptocurrency trading or investing, it is highly-important to understand the types of exchanges used. Choose which type of exchange you prefer based on your objectives.
This is not financial advice.
