Centralized vs Decentralized Exchanges – The Tug of War
In the debate of whether a cryptocurrency will dominate as an alternative method of payment or only exist as an asset for exchange, it was the cryptocurrency exchange that won the battle. However, the next battle for supremacy is the centralized exchange vs the decentralized exchange.
Both of them have their own set of advantages and disadvantages. We have, in the below paragraphs, highlighted the duel between centralized and decentralized cryptocurrency exchanges.
Introducing cryptocurrency exchanges
The cryptocurrency was considered a technological marvel since it brought a lot of advantages along with trading without geographical restrictions, quick transfers, round-the-clock availability, and complete immunity against counterfeit currency.
However, all these advantages right now are limited by one disadvantage – volatility. The extreme fluctuations in the values of cryptocurrencies had not even spared the most prominent crypto coins like the Bitcoin. The Bitcoin, for instance, was worth about $20,000 in December 2017, and $3000 in December 2018. These fluctuations might mean that the person who transacts in this kind of currency might not find the business sustainable.
Turning this bane into a boon, cryptocurrency exchanges were born. Cryptocurrency exchanges are platforms that allow investors to trade, buy, or sell cryptocurrency instantaneously. They usually are built as a website and sometimes, a mobile application. A trader who has meticulous knowledge of the fluctuation patterns can make a great profit using cryptocurrency exchanges.
Cryptocurrency exchanges have positioned themselves as one of the most dependable means of learning from the crypto world apart from mining. The lucrativeness of cryptocurrency exchanges is strengthened by the fact that there are about 22 million monthly visits just for the top 100 cryptocurrency exchanges in the United States alone.
The Centralized vs Decentralized Standoff
Cryptocurrency exchanges are quite similar to the way in which banks operate. Every cryptocurrency exchange has an owner, and people put their funds into the exchange believing that they are safe. These exchanges are also expected to follow certain rules and regulations as mandated by the banking system, and all the requirements of a financial business apply to cryptocurrency exchanges as well.
This presents a major challenge for cryptocurrency enthusiasts and purists. The cryptocurrency was created, in the first place, to exist as a financial instrument beyond any centralization or regulation. Cryptocurrency exchanges, however, seemed to violate both the key philosophies on which cryptocurrency was created.
The possibility became a reality when people came to realize that they do not have complete control over their crypto assets. One of the exchanges temporarily disabled the withdrawal of money from their exchange, which disappointed the traders. In addition, there are also possibilities that a centralized crypto exchange can be hacked, and even more so that they can disappear overnight.
To counter these demerits, decentralized cryptocurrency exchanges were introduced. These decentralized exchanges, true to their name, eliminate the need for a centralized authority, third-party trust, and a lot of other disadvantages associated with a centralized crypto exchange. It also reduces the possibilities of fraud and the stealing of crypto money from the exchange. The decentralized exchange makes this possible by ensuring that the users have complete control over their funds.
To encapsulate it all, if centralized exchanges function like Amazon, decentralized exchanges function like craigslist.
How do centralized exchanges work?
Centralized cryptocurrency exchanges are simple and easy to work with. The initial sign up/registration process might take some time because of the KYC/AML formalities that need to be completed.
Once the user signs up, they can quickly engage in trading. All they need to do is deposit some money from the bank using a payment gateway, and with that money, they can buy certain crypto assets based on the price quoted. When the time is right, they can place their orders to buy or sell their assets on the order book, and when the counterparty notices these orders, they can execute the desired task.
The process is almost simple and immediate as the transfer happens within the exchange, and the funds are settled within the ecosystem itself.
How do decentralized exchanges work?
- A decentralized exchange is characterized by a few features like the absence of KYC/AML processes, no requirements of deposit or withdrawal, and with no point of failure, control, or regulation.
- The functioning of a decentralized exchange is almost similar to that of a normal crypto exchange, but with a small variance that makes all the difference.
- The owner signs into the blockchain decentralized exchange using their wallet credentials.
- The owner of the token can place an order letting people know that their crypto assets are available for exchange. In addition, they also will need to specify the number of units, the cost of the token and the time until which the bidding for the tokens are allowed.
- The other owners who are looking forward to bu the asset that is put on sale can’t place their bids by signaling a buy order.
After the time limit for bidding expires, all the bids are reviewed and the highest bidder, in most cases, becomes the eligible buyer of the asset.
- The transaction is executed by both parties in an ecosystem of a trust governed by the smart contract.
- Once the transaction is over and acceptable to both parties, they can disconnect the wallet from the blockchain.
The advantages of a decentralized exchange
Decentralized exchanges present a host of advantages that fall in line with the founding philosophies of cryptocurrency.
It should be noted that the advantages brought about by a decentralized exchange are in essence, the disadvantages of a centralized exchange!
It is quite known that every exchange makes its profit from the fees collected. In the case of a centralized crypto exchange, the fee is a percentage charge for every transaction, and the same is the case even with white label decentralized exchange solutions. When the transaction is ready to be placed on the decentralized exchange, the trader will need to pay a fee to confirm his transaction through the blockchain. The discharge would normally cost between $0.05 and $1.
Decentralized cryptocurrency exchanges are truly anonymous. There is no central authority involved in the operation of exchange and therefore, there are no requirements to complete it, or rather no one to enforce the compliance upon! This means that the users also do not have to go through the KYC/AML processes that might result in the privacy of their identities being compromised. This factor of anonymity also widens the scope of access to many tools that might not be otherwise used.
On a decentralized exchange, the ownership of the crypto funds purely rests with the user and the exchange does not have any control over it. This is in direct contrast with a centralized exchange where the ownership of the coins is held by the exchange itself. There are a few advantages when the exchange holds the coins, like faster transactions. On the flip side, this could also result in crypto thefts, and since all the funds are locked up to a single point, an isolated instance of compromise might mean heavy losses.
The biggest disadvantage
Amid all these advantages, there is one disadvantage that deters traders from participating in a decentralized cryptocurrency exchange – liquidity. Just like how it was for decentralized exchanges, this is one of the primary advantages that put centralized exchanges in the front seat.
It is to be remembered that more often than not, traders care for profit and ease of executing the trade more than aspects like security and privacy until it directly bites them. Therefore, centralized exchanges have been able to capture the market.
In centralized exchanges, it is possible to emulate trade volumes by using artificial accounts and bots. In addition to that, since they can operate across multiple blockchains, it makes it extremely easy to trade popular pairs of cryptocurrencies like Bitcoin and Ether.
The trade executed on a decentralized exchange is relatively slower than the one that happens on its centralized counterpart. Considering the magnitude of volatility and the swiftness with which a cryptocurrency can change its value, people prefer quicker trades and this is another reason why centralized cryptocurrency exchanges have been getting the advantage.
The market share
It is quite evident and understandable that decentralized cryptocurrency exchanges are not as popular as centralized ones. If we were to look at the cryptocurrency transaction volume, centralized exchanges like Binance and Coinbase account for about 99% of all the cryptocurrency exchange trading volume. However, with the growing emphasis on privacy and anonymity, decentralized exchanges have slowly started to gain prominence.
The fact that Binance, one of the largest cryptocurrency exchanges – albeit a centralized one is planning to launch a decentralized exchange is a resounding testimony to the fact that people have started to value the basic principles on which cryptocurrency was founded.
Which one should you go for?
There is no question on the fact that a cryptocurrency exchange presents a lucrative business opportunity.. It goes with the philosophy that the house always wins – irrespective of the trader making a profit or not, the exchange is bound to make a profit.
If you are one of those aspiring entrepreneurs who would like to create your own cryptocurrency exchange, the first thing you will need to decide is whether you will go for a centralized or decentralized exchange. As we have discussed above, both of them have their own set of advantages and disadvantages. It all comes down to the market that you would like to target, you will need to know whether they prefer the ease of operation or aspects like anonymity and privacy.
Irrespective of the type of exchange you choose, the time you take to launch your exchange is of critical importance. If you would like to speed up your process of launching your own crypto exchange, it is better not to go for developing your exchange from scratch. You can, alternatively, consider using white label solutions. These white label cryptocurrency exchanges are available for both centralized and decentralized versions. All you need to do is customize the exchange according to your requirements, and you are all set to launch your own cryptocurrency exchange business!