Nowadays, it’s hard to find a person who has never heard a word about cryptocurrencies. If you’re just starting your journey with trading digital assets, you may want to learn more about crypto exchanges, which are online platforms where you can conveniently buy and sell cryptocurrencies.
Typically, there are two types of crypto exchanges — centralized (CEXs) and decentralized (DEXs). Both have their pros and cons, and trading experience may vary greatly from platform to platform. However, decentralized exchanges are often regarded as being more in line with the ethos of crypto due to their permissionless nature and censorship resistance.
Centralized exchanges: pros and cons
The majority of crypto exchanges in the industry, such as Binance, Coinbase, Kraken, and Huobi, are centralized. It means that behind the platform there is a for-profit corporation that operates under regulatory supervision and has to comply with the laws to prevent money laundering and fraud. The platform founders also own the exchange, which means that at any moment, they can halt all operations, ban certain users from transacting, and more.
Centralized exchanges operate in a way similar to traditional finance exchanges, centrally matching users’ buy and sell orders via an order book model. Despite its convenience, this model has its risks — just like any centralized service. In theory, CEXs can spot market patterns in the order book and trade against their customers, a practice known as front-running.
At the same time, most people, especially crypto newcomers, still choose centralized exchanges due to the numerous benefits they offer. So, what are they?
Fiat to crypto conversions
If you’re new to crypto trading, you will need to purchase some coins for fiat currency like U.S. dollars. Centralized exchanges offer the easiest and cheapest way to purchase crypto through instant credit card, bank transfer, Apple Pay, or Google Pay.
However, there are also ways to get crypto for fiat without turning to CEXs — luckily, there are crypto ATMs, local forums, and crypto exchange offices. Read our detailed guide on How to buy crypto anonymously to learn more!
Since most people choose CEXs as the gateway to crypto finance, these platforms are highly liquid. The volume of orders and transactions there is usually significantly higher than on DEXs, so you will always find the necessary liquidity for your trade.
Another perk of using a centralized exchange is its clear and intuitively understandable interface. Since most people set their first steps in the world of crypto on CEXs, the platforms are committed to making the trading experience as seamless as possible.
No matter how user-friendly the exchange’s interface is, problems will always emerge — that’s just how things are when people first interact with a service. For such cases, all CEXs have a dedicated customer support team that helps users resolve problems quickly. Some platforms are lightning-fast with their responses, while others may be not as speedy, but at least you can be sure that your immediate needs will be met.
Now that we’re done with the benefits of centralized exchanges, let’s take a closer look at their limitations.
Ownership and security
One of the key features of CEXs is that they’re custodial, which means that users’ funds are kept in integrated wallets whose keys are managed by the platform. Sure, if you ever forget your password, you can always ask the exchange to reset it. On the other hand, hackers may breach the security of CEX and steal everything you have in your wallet. Of course, such heists are rare in crypto, but the risks are still there.
Besides, it’s not just a security breach that may evaporate your funds kept on CEXs — an unexpected bankruptcy may do the same trick. In May 2022, Coinbase, the second-largest crypto exchange, announced that users’ assets could become inaccessible in case of insolvency after its shares plunged 50% following the May crypto crash. And given the recent wave of crypto companies’ bankruptcies, such risk seems more plausible than a multi-billion hack.
As government agencies worldwide push for more regulations on digital assets, centralized exchanges are forced to comply with the rules and collect user data. To open an account on CEX like Binance or Coinbase, every new customer is asked to go through a KYC (Know Your Customer) procedure that often includes submitting your ID document and proof of residence. This policy also cuts off many users from sanctioned countries, such as Iran or Russia, who are banned from using the platforms.
Fewer tokens available
Since CEXs have to comply with regulatory requirements, all coins listed on such platforms undergo rigorous checks that assess their source code and legal compliance. On the surface level, this is beneficial for crypto newcomers, as they are less likely to come across the outright scam on centralized exchanges. On the other hand, veteran investors hunting for exotic coins and lesser-known promising projects may be dissatisfied with the selection of tokens offered by CEXs.
Shady business practices
As any centralized entity, CEXs wield disproportionate power over other market participants. The huge gap in knowledge between centralized exchanges and retail investors can lead to the abuse of such power when the platform trades against its customers to make profits.
"Crypto's got a lot of those challenges — of platforms trading ahead of their customers," SEC Chair Gary Gensler told Bloomberg in May. "In fact, they're trading against their customers often because they're market-marking against their customers."
Decentralized exchanges: pros and cons
Unlike their centralized counterparts, most DEXs (or at least the new gen) facilitate buy and sell orders through the automated market maker (AMM) system. This model removes intermediaries by pooling users’ funds into liquidity pools managed by the platform’s smart contracts. Any user can provide liquidity to the pool in exchange for passive income, and the prices of tokens in a pool are adjusted automatically based on supply and demand for those assets.
The benefits of AMM are quite obvious — since there’s no central entity controlling the market, there’s also no central point of failure, plus this model ensures that both sides of the trade are provided with a fair price and sufficient liquidity.
So, what are the benefits of decentralized exchanges?
Permissionless by nature
Perhaps the greatest advantage of DEXs over CEXs is their lack of KYC procedures. You won’t be asked to reveal your identity, which makes decentralized exchanges a superior choice for people valuing their privacy. Just connect your wallet and you are all set to start trading on a DEX.
Today, most decentralized exchanges have their governance tokens that grant their holders voting rights and are often distributed as rewards for providing liquidity to pools. By enabling users to influence the decision-making process of the platforms, DEXs stay in line with their values of democratic decentralization and sovereign ownership.
A wider selection of coins
What makes DEX different from CEX is that you can find everything there. And by everything, I mean even the shittiest of shitcoins, since the only requirement for listing a coin on a decentralized exchange is to provide enough liquidity to the pool. Sure, thorough due diligence and research is a must when investing in less popular altcoins, but the returns can exceed expectations.
Finally, decentralized exchanges are much safer than centralized ones. Since DEXs rely on noncustodial ownership, traders and investors maintain full control over their private keys and assets, and the risk of losing money to hacking incidents is minimal. However, one should keep in mind that the recovery ability of decentralized exchanges is limited, so always do your own research before sending your funds to such platforms.
Despite the many benefits of decentralized exchanges, there are still several flies in the ointment. Before starting off your crypto journey, you should be aware of the certain limitations of DEXs.
Crypto to crypto only
First of all, decentralized exchanges only facilitate crypto-to-crypto transactions and do not accept fiat currencies. If you want to trade on DEX, you have to hold some crypto in your wallet, which means that it’s unlikely to be your first step into crypto.
Less user-friendly interface
Unlike CEXs, which are designed to accommodate crypto newcomers, DEXs tend to be less friendly to new users. The graphical UI is aimed at more experienced customers and may be difficult to navigate at first glance, so be prepared for a steep learning curve.
Lower liquidity and slower trades
Since centralized exchanges accumulate most of the trading volume, DEXs often struggle with liquidity, so it can be pretty challenging to find buyers or sellers for less popular cryptocurrencies. Moreover, trading on DEX is significantly slower than on CEX since each transaction must be validated by miners. For that reason, decentralized exchanges are hardly suitable for high-frequency trading where milliseconds matter.
Decentralized exchanges offer several advantages over centralized exchanges, including self-custody, anonymity, a wider selection of crypto assets, and higher security. However, there are also certain limitations that make DEXs a less obvious choice for crypto newcomers, namely complicated UI, slow trades, and lack of fiat on-ramping. For those who only begin their crypto journey, centralized exchanges offer a smooth onboarding experience and fiat-to-crypto conversions. Both types of exchanges have their pros and cons, as tradeoffs have to be made between usability and alignment with crypto values. Ultimately, the decision of whether to choose CEX or DEX is yours and will depend on your needs and preferences.