Centralized vs. Decentralized Exchanges: Six Differences to Consider

By Brian Nibley · May 07, 2021 · 6 minute read

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Centralized vs. Decentralized Exchanges: Six Differences to Consider

When it comes to crypto exchanges, there are advantages and disadvantages in both a decentralized vs centralized exchange. Ultimately, the choice an investor makes will likely depend on factors like their trading goals, comfort level with newer technology, and the importance they place on things like security and anonymity.

What Are Centralized and Decentralized Exchanges?

A centralized exchange involves one central entity (e.g. bank, trading platform, government institution, etc.) controlling the operations of the exchange and its wallets for different types of cryptocurrency. This can make things easier for users but can also present all the problems centralization can entail, like a single point of failure.

Decentralized exchanges (DEXs) have no one entity controlling them—instead transactions are made peer-to-peer—and are thought to be more secure because they have no single point of failure. But these exchanges are still very new and can be more difficult to use, especially for those just learning crypto basics.

Recommended: 2021 Crypto Investing Guide

6 Key Differences Between Centralized and Decentralized Exchanges

Centralized and decentralized cryptocurrency exchanges are different in many ways. These are some of the major differences investors should know about.

1. Usability

One goal of centralized exchange platforms is to make it as easy as possible for new users to get started trading cryptocurrency. By design, creating an account and placing trades can be accomplished in very little time and with little technical expertise.

Decentralized exchanges, on the other hand, can make crypto investing somewhat more complicated. That’s primarily because 100% of the responsibility lies with the user, rather than a third party. If you make a mistake, there may be no way to fix it, whereas centralized exchanges sometimes have safeguards in place for certain user errors.

2. Security

Centralized exchanges, in their quest to make things easier for users, create a single point of failure. If hackers attack this single point with success and obtain private keys that protect users’ accounts, they can compromise the entire exchange and all of its funds. There have been several instances of this happening over the years, with ssers sometimes facing a total loss.

For those reasons, decentralized exchanges are thought to be more secure than centralized ones. Nothing’s ever for certain, and it might still be possible for a DEX to have some kind of bug. But for the most part, user error is a more common threat to DEX users than the exchange being hacked.

3. Fees

Centralized exchanges charge customers fees for their use of the service. Every transaction typically involves a fee and withdrawing coins may also come with a fee. For active traders, these fees may add up to large amounts over time.

Decentralized exchanges often have far fewer fees because they don’t have the same overhead expenses. Some decentralized exchanges don’t even have fees at all.

4. Liquidity

One of the biggest differences between centralized vs. decentralized exchanges is in liquidity.

Centralized exchanges tend to have more liquidity because they have more users, and these users are creating more orders. In-demand assets trade in higher volumes almost without fail. There are also market makers who further increase liquidity.

By contrast, because they typically have fewer users and no central entity organizing their order books, decentralized exchanges have less liquidity. The lack of liquidity in decentralized exchanges could pose problems for investors. For example, an investor may want to buy a particular asset but finds that high demand has led to a sharp rise in price compared to other markets, because other investors have bought up all the sell orders.

Recommended: What are Liquid Assets?

Liquidity and Slippage

Another example of a lack of liquidity causing problems for investors is if they attempt to sell an in-demand asset on a DEX—and end up falling victim to a lot of “slippage.”

Slippage refers to the losses that occur when selling large amounts of an asset, particularly in times of low liquidity. If someone wants to sell 100 tokens, for example, each at a price of $1, there may not be enough buy orders to actually sell them all at a price of $1. There might only be a buy order for 10 tokens at $1, then an order for 10 more at $0.99, 15 at $0.98, and so on. By the time a trader has liquidated their position, they wind up with less money.

Greater liquidity (such as one might find on a centralized exchange) means faster trades and less slippage.

5. Anonymity

Creating an account on a centralized exchange typically involves handing over lots of personal information. These exchanges might require a name, email address, mailing address, or even a selfie of the registrant holding their government-issued ID next to their face. This is typically done to comply with cryptocurrency regulations like know-your-customer (KYC) and anti-money-laundering (AML) laws.

Decentralized exchanges, on the other hand, might not require users to even create an account to get started. Traders can convert their gains into a centralized cryptocurrency like a stablecoin (one of many altcoins) and move those funds off the exchange to another crypto wallet, without needing to link a bank account.

6. Speed

Perhaps one of the most noticeable differences between centralized vs decentralized exchanges from a user’s perspective is the speed at which trades occur. Decentralized exchanges perform much slower than their centralized counterparts.

According to some estimates, trades placed on centralized exchanges take about 10 milliseconds on average to execute orders. That’s as good as happening instantly from the point of view of the person placing the trade.

Decentralized exchanges, however, can take anywhere from 15 to 60 seconds to match and fill an order. For investors who create a lot of buy and sell orders, that can add up to a good deal of sitting around waiting for trades to settle.

What Are the Biggest Advantages of Using a Decentralized Exchange?

The two main benefits of using a decentralized exchange might be increased security and anonymity. Some users prefer to keep their trades private and not have their personal information and wallet balances in the hands of a single entity.

Furthermore, the reduced risk of hacking eases both privacy and security concerns. Not only are funds thought to be safer, but the threat of a user’s info leaking and being used for identity theft or targeting for phishing attacks might be nonexistent, since DEX users might not even have to make an account to get started.

What Are the Biggest Advantages of Using a Centralized Exchange?

Centralized exchanges are easier to use (which may be especially important to those just getting started with crypto), have greater liquidity, and execute trades faster.

The Takeaway

Both centralized and decentralized exchanges have something to offer crypto investors. For investors who value usability, liquidity, and speed, a centralized exchange may be the way to go. For those who prioritize anonymity and security, a decentralized exchange is more likely to appeal.

Decentralized exchanges are a new concept and are still a long way from being widely used. Still, their volume has been rising steadily and could one day outpace that of centralized exchanges, especially as their usability improves.

Photo credit: iStock/Vertigo3d

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