Centralized and Decentralized Exchanges: Convenience or Privacy?

Why do different types of exchanges exist? Which is better, and which should you choose? Let’s dive in together in this new article from Banana Education!

Understanding the main differences between centralized and decentralized exchanges is crucial to making the right choice. Depending on an investor’s experience and goals, both types of exchanges have advantages and disadvantages.

Our next article will cover how to choose the proper centralized exchange. In this one, we’ll look at centralized and decentralized exchanges, compare their functionality, and determine which type of exchange suits those just starting their crypto journey.

Why is Choosing the Proper Exchange Meaningful?

Centralized exchanges are similar to traditional stock markets. They are managed by a single organization that controls the exchange’s order book, matches buyers with sellers, and charges a transaction fee. An order book lists all active buy and sell orders for crypto assets on the exchange. Simply put, it’s like a store window where buyers indicate how much they’re willing to pay, and sellers state how much they want to sell for.

To use a centralized exchange, you must create an account, complete identity verification, and entrust the exchange to store your assets.

Decentralized exchanges operate on blockchain-based smart contracts. They function autonomously as long as users provide liquidity. Decentralized exchanges typically don’t use order books but instead, employ an automated market maker (AMM) model that efficiently determines the price of the asset you’re interested in. You only need a crypto wallet and a small crypto to pay for fees to trade on a decentralized exchange. No account creation is required.

Centralized exchanges are more convenient for beginners due to their simple interface and user support. Decentralized exchanges are attractive to experienced traders who value decentralization more than ease of use.

Each type of exchange has pros and cons, so it’s essential to choose a platform based on your experience and goals.

Features of Centralized Exchanges

Centralized exchanges have several key characteristics:

1. Asset storage: Crypto on a centralized exchange is only partially yours. The funds are stored on the exchange, and you can manage them.
2. Identity verification: Users usually need to complete KYC after registration. It involves providing personal data and documents to prevent illegal activities.
3. Trading system: Exchanges use order books to match buy and sell orders. It allows for much faster and more convenient trading than on decentralized exchanges. Market makers are often brought in to provide liquidity and reduce the spread between buy and sell prices. They are financial participants who provide liquidity by constantly placing buy and sell orders. They profit from the difference between buy and sell prices while helping to smooth out price fluctuations and facilitate trading for other participants.

Examples of such exchanges include Binance, OKX, and Bybit. These platforms are the best in terms of available tokens and liquidity and have high trust within the crypto community.

Centralized Exchanges: Advantages

1. User-friendly: They offer simple and advanced trading tools, support card payments (especially relevant for crypto beginners), and the registration process is similar to opening a bank account.
2. User support and protection: They help avoid mistakes common to decentralized exchanges, provide customer support to resolve issues, and protect against irreversible errors when working with crypto.
3. Integrated services: A wide range of products on a single platform, including trading, additional earnings on your tokens, NFT marketplaces, P2P platforms, and other services. They ensure easy fund transfers between various products and offer additional opportunities through partner programs.

These features make centralized exchanges attractive for many users, especially those just starting with cryptocurrencies.

Centralized Exchanges: Disadvantages

1. Centralization: The exchange and its participants’ actions are hidden within the trading platform. This means prices can be easily manipulated when they benefit the platform itself.
2. Lack of complete control over assets: Users transfer their funds to the exchange for trading, giving the exchange control over these funds. In case of bankruptcy or other issues with the exchange, users risk losing their funds. It is analogous to keeping money in a bank: clients may lose their savings if the bank has problems.
3. Legal issues: If you have a passport from a sanctioned country, you may be partially restricted from using a centralized exchange or asked to leave. This also complicates communicating with customer support on specific issues.

These drawbacks highlight the importance of carefully choosing an exchange and following security measures when working with crypto.

Features of Decentralized Exchanges

In our previous article, we wrote about decentralized exchanges and their pros and cons in detail. But in brief, decentralized exchanges work differently from centralized ones:

1. Transparent trading: Users directly exchange crypto with exchange pools on decentralized exchanges, and their actions are visible on the blockchain.
2. Smart contracts: All processes on the exchange are controlled by automatic programs on the blockchain — smart contracts.
3. Anonymity: Users don’t need to verify their identity, meaning they can remain anonymous when trading.
4. Control over funds: Users store their own private keys, giving them full control over their funds and full responsibility for their safety.

Decentralized Exchanges: Advantages

• Relatively easy to use
• Available 24/7
• Transparent
• No registration, personal account creation, or identity verification (KYC) required
• Most notably — your funds belong to you, not the exchange. Decentralized exchanges don’t store crypto assets, so no one can freeze your funds or impose other restrictions.

Decentralized exchanges offer more freedom and privacy but require users to be more cautious and knowledgeable about crypto.

Decentralized Exchanges: Disadvantages

These exchanges also have their drawbacks:

• Often, trading is only possible within a single network, where not all tokens are available
• Complexity for beginners: trading requires “gas” — the network’s native token to pay for fees
• Lack of advanced trading tools
• Irreversible transactions
• Lower operation speed compared to centralized exchanges
• Risks of impermanent loss when earning from providing liquidity
• Lower liquidity on unpopular pairs compared to centralized exchanges
• Risks of smart contract hacks
• Regulatory uncertainty

Despite this, many experienced crypto enthusiasts prefer decentralized exchanges due to their security and asset control advantages.

Examples of such exchanges include 1inch, Uniswap, and PancakeSwap.

So, What’s the Verdict on Centralized or Decentralized Exchanges?

Centralized and decentralized exchanges do not compete with each other. Lennix Lai, Commercial Director of the centralized exchange OKX, put it best: “I wouldn’t speak of triumphing over DEX or vice versa. They both cater to the needs of different user groups and both add value to the development of the crypto ecosystem. Centralized and decentralized exchanges should complement each other, and the gap between them is narrowing. Technologies and innovations emerging on one side are often applied on the other as well.” This means you have a wealth of options at your disposal, each with its own unique benefits.

Thus, the choice between centralized and decentralized exchanges depends on your goals and experience:

• We recommend centralized exchanges for beginners and those who value simplicity and security. Centralized exchanges offer convenience, high liquidity, and a wide range of services, making them attractive to those just getting into crypto. They are easier to use, don’t require in-depth knowledge of blockchain technology, and provide customer support. On centralized exchanges, there’s less risk of making a grave mistake, such as losing access to funds. Centralized exchanges are an excellent choice if you’re starting with crypto or looking for a convenient service.
• For experienced users, decentralized exchange may be a more appealing option. Decentralized exchanges are gateways to the world of decentralized finance (DeFi). They’re ideal for those who value privacy, want to trade crypto freely, and explore new projects. Decentralized exchanges are beneficial for investing in new low-cap tokens, as they often offer trading and liquidity for such coins first.

But remember: regardless of your choice, security remains the key factor. It’s crucial to always exercise caution, use reliable storage methods, and only invest what you can afford to lose. By prioritizing security, you can enjoy the benefits of crypto exchanges with peace of mind.

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