If you have to trade or invest in cryptos you need to access exchanges or platforms that will facilitate the process. In a crypto exchange you can trade cryptos for fiat currency or other digital currencies. So, the cryptocurrency exchange really acts as an intermediary between the buyers and sellers, making money vis-à-vis transaction fees and commissions.
What are centralized and decentralized exchanges?
Centralized exchanges work as the third party between buyers and sellers and these are typically controlled by an authority/company. They are believed to be more reliable as a result. Almost 99% crypto transactions take place through these; most popular centralized exchanges include Kraken, Coinbase, Gemini, etc. The centralized exchange works like any bank where you can deposit your money and the exchange behaves like a custodian. The exchange is responsible for protecting your money.
A decentralized exchange, or DEX, works differently because it will not take custody of your funds. There will be an order-matching protocol whereby funds get transferred between parties through smart contracts that can conduct trades automatically. DEX is usually developed on blockchain platforms that will decide the tokens that one can trade on it. In short, DEXs allow users to engage in peer-to-peer transactions without a third party or intermediary.
What benefits can you get from decentralized cryptocurrency exchanges?
- Privacy/Security: Decentralized exchanges are not controlled or run by any centralized authority; as such this platform does not require all the data to go via a single point. It is a peer-to-peer platform where many points can connect. So, rather than a single party staying responsible for all the information, decentralized platforms will operate on P2P basis and consumer data does get shared because third parties do not have access to the data. so, DEXs offer greater control and privacy over assets because they take power away from market leaders like the banks, brokers, and lawyers. As volume of cryptos being traded goes up, exchanges become more prone to hackers; the infamous Mt.Gox incident led to the loss of more than 750,000 Bitcoins. In contrast, DEXs are becoming user-friendly and are being preferred by investors for their security.
- Fund control: Centralized exchanges are not simply troubled by hacking; users here do not have control over their money. This may cause investors to lose money when the exchanges get hacked. For example, HitBTC had made a move to freeze user accounts when they suspected that the crypto community was making an organized effort to take out their money in a single day. DEXs have a non-custodial nature that means that your funds will be in your control and no central authority can freeze it at their will. Even if the exchange shuts down, your funds do not get affected.
- Centralized exchanges have earned the repute of being MSP or money service providers so that customers must undergo compulsory KYC and anti money laundering checks. But many people are not keen to offer private information to such third parties as they fear they will have zero control over this data afterwards. DEXs are advantageous because there is no centralized control and you are not required to meet such registration criteria.
- To respond to increased pressures of regulations many centralized exchanges have limited user access in specific places. For instance, Binance announced that it would start geo-blocking American users before rolling out plans of a US-compliant exchange. DEX s however let you trade cryptos from any location because these are not operated by a central authority which can be forced to comply with a shutdown order.