What is a Centralised Exchange?
A centralised exchange is analogous to an insurance broker; You want car insurance, the insurance company wants to sell car insurance and the broker introduces both parties and takes a fee for doing so. To explain how a centralised exchange works, it will help to use a different analogy.
If you're more interested in learning about a Decentralised Exchange (DEX), go here.
How do Centralised Exchanges Work?
Imagine you want to sell a car.
You could take it to the car dealer, where he will offer to sell it for you (taking part of the profits as a fee). Whilst this is your easiest option, it does have its risks. For starters, the dealer will require you to leave your car and keys in his showroom.
Potential buyers can visit the showroom and decide which car to buy (the dealer obviously has lots to choose from). If a buyer decides to buy your car, they pay the dealer and drive off into the sunset. The dealer takes his cut and (hopefully) gives you the remaining cash.
It’s true, car dealers have been around for many years and are trusted however, should the showroom burn to the ground or get broken into, you’re going to lose your car and have nothing to show for it.
Also, the dealer is making money from your car sale, surely you’d get more cash if you cut him out?
For this example, we will paraphrase a well known saying in crypto by stating…” not your keys, not your car”!
“With a maturing DeFi market, more and more trading volume will be syphoned off by decentralised exchanges like Cardax.”
What’s the Difference Between a Centralised Exchange and a Decentralised Exchange?
Centralised exchanges like Kucoin and Binance etc. run on an order book system that matches buyers and sellers. They use a similar interface as stock or currency trading platforms.
For this reason, they are very popular with investors and traders.
Decentralised exchanges on the other hand are autonomous, smart contract-based trading platforms. Users can directly swap one asset, with another and the transaction is recorded directly on the blockchain, without the need for a third party.
Centralised exchanges are custodial, decentralised exchanges are non-custodial.
Centralised exchanges require you to deposit your assets on their platform and, while they technically still belong to you, the CEX has control over them. Decentralised exchanges however leave you in full custody and control of your assets.
Advantages and Disadvantages of using a CEX
It is well documented, that centralised are less secure than their decentralised counterparts but they do, however, have features that DEXs don’t have.
- High liquidity.
- Having a much higher trading volume, centralised exchanges offer seamless, quick transactions of even large, high-value trades.
- Fiat on and off ramps and conversions.
- Centralised exchanges enable users to buy cryptocurrency directly using their fiat currency (e.g. USD, GBP or Euro) to crypto and vice versa.
- More tools.
- Other than swapping one crypto for another, Centralised exchanges have features such as margin and derivatives trading as well as staking, lending and borrowing products that are not available on all DEXs (however,DeFi platformslike Cardax are catching up quickly).
- As we mentioned earlier, the user interface that centralised exchanges use is similar to other, more established trading platforms (stocks or currency trading). This familiarity is attractive to experienced investors and traders. For newbies, many CEXs have a lite version that simplifies trading and allows an easier introduction into the crypto world.
- “Not your keys, not your coins”! Centralised exchanges will have control of your assets while they are on their platform. Remember our car dealer analogy? Would you trust someone else with your valuables? Crypto should be kept securely in anon-custodial wallet.
- Before allowing you to use their platform, CEXs are required to follow KYC (know your customer) protocols. You will usually have to provide an ID and a photo of yourself in order to trade.
- On the back of the custody problem above, your assets are at risk of hackers while they are on centralised exchanges. Hacks of centralised exchanges happen with frightening regularity. A quick Google search will reveal that billions of dollars of crypto have been stolen from centralised exchanges over the years.
Are there any Risks of using CEXs?
Compared with traditional financial markets, the crypto market is still very new; with this infancy comes price volatility. This is a risk on any type of exchange, however, there are risks that are unique to each exchange type.
The Risks of using Centralised Exchanges.
- Vulnerability to hacking. As we mentioned earlier centralised exchanges have lost billions of dollars to hackers and given that they have control over your assets, this is a big risk!
- Data breaches. Because centralised exchanges require you to verify your ID (KYC), your personal data is stored with them, if an exchange platform has a data breach, your data may be stolen and used for identity theft.
- The mercy of financial regulations. Centralisation requires adherence to regulatory bodies. These regulations can change very quickly and may result in you temporarily (or even permanently) losing your assets.
Centralised exchanges still host the lion share of crypto trading but with a maturing DeFi market, more and more trading volume will be syphoned off by decentralised exchanges like Cardax.