May
21
2021
How Much Energy Does Mining a Bitcoin Consume?

How Much Electricity is Needed to Mine Bitcoin?

By | Growing Wealth, invest, Investing | Comments Off on How Much Electricity is Needed to Mine Bitcoin?

It’s very challenging to figure out how much electricity is used for Bitcoin mining. That’s because the cost of electricity—and the equipment used to run mining rigs—varies from miner to miner, depending on the equipment being used and the region it’s housed in, among other factors.

Bitcoins are mined by computers that solve complicated mathematical calculations. This process not only creates new bitcoins, it also secures the network and validates every transaction that takes place on the Bitcoin blockchain. This global decentralized network of miners keeps Bitcoin running, since it isn’t centrally controlled by a bank or other entity.

Although the estimated figures can differ greatly, there’s no disputing that the Bitcoin mining electricity cost is high because of the constant mathematical calculations required to verify transactions and mine Bitcoin.

Why Does the Bitcoin Network Need Electricity?

The Bitcoin blockchain is designed to issue new blocks every ten minutes, regardless of how many mining machines are in operation. All the miners in the network are competing to mine those blocks, because whoever mines the block gets the Bitcoin reward.

While the rate of mining blocks stays more or less the same the difficulty in doing so varies according to the current hash rate, which is the amount of computational power being contributed to the network through mining. As more hash rate is added to the network and newer, faster machines calculate more computations within the same amount of time, the difficulty adjusts. A high difficulty means that it will take more computing power to mine the same number of blocks, making the network more secure against attacks.

How Bitcoin Miners Impact Electricity Usage

Bitcoin mining drives the majority of electricity use. Generally, when the price of Bitcoin goes up, more people become interested in mining. The more machines on the network, the more electricity they use—not only because there is an increase in equipment being devoted to Bitcoin mining, but because as more miners join the network, it becomes harder to mine Bitcoins, so more computational power and electricity get used in the process. Only one miner can win the Bitcoin reward for mining any particular block, so the miners are competing using computational power.

How Bitcoin Transactions Affect Electricity Usage

Once all bitcoins have been mined and are in circulation, electricity will only be needed to verify transactions and keep the network running.

The way the Bitcoin blockchain works, there are currently a limited number of transactions that can be recorded on each new block created, and each block can only hold 1MB of information. So an increased number of users transacting with Bitcoin doesn’t mean more electricity gets used. It just means there is a longer wait time for transactions to get verified, and higher transaction costs.

Will the Bitcoin Network Use more Electricity as it Grows?

One often-misreported concept is that as the Bitcoin network expands, it will consume a greater amount of electricity because there are more transactions taking place. It may sound counterintuitive, but as time goes on the network may actually use less energy. It’s the increase in overall number of Bitcoin miners and increased difficulty of mining that increases electricity use, and not the expansion of the Bitcoin network as more transactions take place.

Will Electricity Required for Bitcoin Mining Ever Decrease?

There are a few possible scenarios in which less electricity will be used for Bitcoin mining:

•  At some point in the future, it may become too expensive for new miners to start an operation, so the number of miners in the network may plateau or decline.

•  If the Bitcoin price plateaus, fewer new miners will join the network and existing miners may shut down their operation. Mining can be a costly pursuit, as miners constantly need to upgrade their equipment and pay for electricity and facilities.

•  Over time the equipment used to run the entire network will gain efficiency as old machines get phased out. New equipment will likely be more efficient—with more sophisticated cooling mechanisms—and use less electricity than older models, resulting in lower energy bills.

•  Demand to join mining pools has been increasing. Individuals who don’t want to run their own mining operation but want to invest in mining can also pay to join a mining pool, in which costs and energy usage is shared among investors.

How to Calculate Bitcoin’s Electricity Usage

Annual energy consumption is recorded in terawatt hours (TWh). This is a unit of energy that’s equal to outputting one trillion watts for one hour.

The range for the annual consumption of the Bitcoin network is likely between 100MW and 3.4GW, which is such a wide range it isn’t particularly useful. Some estimates also claim it is much higher, such as the Cambridge Bitcoin Electricity Consumption Index.

How Much of the Bitcoin Network is run by Renewable Energy?

It’s difficult to figure out precisely how much of the network is run by renewable energy sources. However, there are some likely estimates. Approximately 73% of Bitcoin miners use renewable energy for at least some of their operations, according to a 2019 report from CoinShares , and about 39% of all Bitcoin mining is done using renewables, according to a September 2020 report from the Cambridge Centre for Alternative Finance, although other estimates put the percentage much higher.

Incentives to Use Renewable Energy to Power the Bitcoin Network

The Crypto Climate Accord was formed to help make the entire cryptocurrency industry run completely on renewable energy by 2025. Already, there are a number of reasons miners are either using renewable energy or considering it:

•  It benefits Bitcoin miners to seek out cheap renewable energy, because it lowers their operating costs and increases their profits. Some Bitcoin mining is done using renewable energy, especially hydropower and geothermal—but mining also takes place in regions that primarily use coal power.

•  Many miners also seek out colder locations, because mining rigs create a lot of heat, so if they run in cooler climates the miners don’t have to pay to cool them down. In fact, some miners even use the heat to heat their homes and offices.

•  In countries like China and Norway, the government offers subsidies to miners, which adds an additional incentive for them to seek out cheap renewable energy.

•  Many Bitcoin miners also set up their operations in areas where there is excess energy being created that was previously going to waste. So they aren’t contributing to an increase in energy production and they are helping keep energy companies in business. For instance, some miners use natural gas that gets leaked out from oil fields.

•  In some regions, Bitcoin mining is also creating an incentive for renewable energy development, so the industry is helping to accelerate the transition to renewables. But it’s yet to be seen how this will scale as both demand for renewable energy and demand for Bitcoin increase.

Why Does Bitcoin’s Electricity Use Matter?

The deeper debate around Bitcoin’s electricity use is about whether people believe Bitcoin has value or if the electricity use is worth it for what Bitcoin provides.

There is a full spectrum of beliefs about Bitcoin and the cryptocurrency industry. If someone doesn’t see value in Bitcoin, they may think using electricity to keep it running is a waste.

On the opposite end of the spectrum, some people think Bitcoin could ultimately replace USD or other major currencies or act as a hedge against the traditional financial system and the depreciating US dollar. In that case, they might argue that the huge amount of energy used to keep the USD system running is a waste. There is not a clear right or wrong answer to this debate.

Millions of people around the world now use Bitcoin every day, including people who previously didn’t have access to any form of banking system and people whose governments and currencies are unstable. So there is a proven use case for the Bitcoin network.

Still, like every industry, the cryptocurrency industry needs to continue working on ways to reduce its energy use. Some ways the network can improve are by mining in regions that have underutilized energy sources and making adjustments to the code that make the network run more efficiently. Switching to a different consensus mechanism is another option.

The Takeaway

The Bitcoin network is operated by miners who mine Bitcoin and validate transactions on the blockchain network. These complicated mathematical computations are done by machines developed expressly for this use, around the world. Bitcoin’s electricity use is a complicated topic and the conversation will continue to evolve over time. It’s just one of many things that are good to know about before investing in cryptocurrency.

Photo credit: iStock/MicroStockHub

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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May
18
2021
Bitcoin vs. Gold: Prices & Investment Benefits

Bitcoin vs. Gold: What’s the Better Investment?

By | Growing Wealth, invest, Investing | Comments Off on Bitcoin vs. Gold: What’s the Better Investment?

In conversations around portfolio diversification, the merits of Bitcoin vs. gold has become a topic of much debate among investors. The question itself is problematic, implying that one asset is categorically better than the other for all investors.

There are different factors to consider for each, and depending on someone’s risk tolerance and financial or technical knowledge, they may choose to hold gold, Bitcoin, or both. It’s largely a personal decision and any statements made here regarding future price potentials are only estimations based on past trends. Past performance does not indicate future results.

Is It Better To Invest in Gold or Bitcoin?

There’s nothing preventing investors from holding both gold and Bitcoin in their portfolios—after all, the concept of portfolio diversification allows for spreading your money across a variety of different asset classes.

Some investors might want to hold gold as a safer haven asset (though gold can still lose value) and hold while holding Bitcoin for a chance at outsized gains and additional liquidity (though investing in crypto can be risky).

The decision to invest in one or both of these currencies is individual, and may depend in part on a person’s risk profile. For example, someone risk-averse may not be inclined to invest in Bitcoin because it is so volatile. Whereas an investor with a higher risk tolerance may consider the risks of volatile crypto to be worth it. Alternatively, some investors may choose not to invest in gold or Bitcoin.

Bitcoin vs Gold: Pros and Cons

Bitcoin has two clear advantages over gold: liquidity and potential for price appreciation.

And gold has two clear advantages over Bitcoin: an established history and lower volatility.

Here we’ll examine some of the most important pros and cons of investing in Bitcoin vs gold.

Volatility

Bitcoin’s volatility is legendary. The cryptocurrency has been known to rise or fall by 10%, 20%, or even 30% in a matter of hours or days. Few other assets, aside from penny stocks, see anywhere near this kind of volatility.

Gold, while still seeing some volatility at times, tends to have a smoother ride in the markets. Investors largely see gold as a safe haven, “risk-off” asset. If gold moves more than 1% or 2% in a day, it’s usually considered significant and rare.

History

Gold has a 5,000-year established history of serving as a store of value. This gives many investors confidence in the yellow metal. Throughout generations and across cultures, gold has universal recognition as a form of money and has been a proven way to store and preserve wealth. Investing in precious metals is generally a relatively safe bet.

Bitcoin was created in 2009. That gives it a little more than 12 years of history as of the time of this writing. The blockchain technology that underlies the Bitcoin network is just as new, and no decentralized peer-to-peer network like Bitcoin has ever existed before.

Over its lifetime, Bitcoin has risen from a fraction of a penny to over $50,000 at the time of writing in late April 2021. There may not be any other asset in history that can boast those kinds of returns on such a short time frame.

However, the youth and novelty of the Bitcoin network gives some investors pause. There are some unpredictable variables, such as how governments might respond to this new form of money largely outside of their control. Will Bitcoin be criminalized, heavily taxed, or otherwise regulated out of existence somehow?

How might the network respond to a major, global cyberattack? What happens once Bitcoin has been fully mined, and miners only have transaction fees to incentivize their work, rather than the block rewards of newly minted coins?

These and many other questions create too great an uncertainty for some investors.

On the other hand, some Bitcoin proponents claim that Bitcoin will one day replace gold altogether due to the advantages that a scarce digital currency has in today’s increasingly virtual world.

Liquidity

Gold is considered a liquid asset. To get liquidity out of gold, it has to be sold for the fiat currency of an investor’s choice. This process may be cumbersome and usually involves either taking the physical gold to a coin dealer or selling gold to a private party via the internet, for example, through an online auction house.

While some investors might see this as a con, others might see it as a pro. You might be less likely to spend money saved in gold coins than money saved in cash or bitcoin, which could be a good thing for those looking to curtail their spending habits.

By nature of being virtual, Bitcoin is quite liquid. Crypto markets trade 24/7, every single day of the year. Users can access their wallets from anywhere with an internet connection.

Exchanging Bitcoin for fiat currency is quick, cheap, and easy. In some cases, exchanging for fiat may not even be necessary. A growing number of businesses, organizations, and individuals have begun accepting Bitcoin as a direct form of payment.

Additionally, Bitcoin loans provide the option for using Bitcoin as collateral for a fiat currency loan, creating even more liquidity options.

Supply Limit

Gold is a physical commodity that has a scarce supply. No one knows exactly how much gold lies in the Earth’s crust, but it stands to reason the amount is finite. The process of mining and refining gold is difficult and takes time.

Bitcoin is a digital commodity that has a fixed supply. There can only ever be 21 million bitcoins mined into existence, as per the Bitcoin protocol.

Advantage Bitcoin Gold
Low Volatility ✔
History ✔
Liquidity ✔ ✔
Supply Limit ✔

Will Bitcoin Be Worth More Than Gold?

At the time of writing, the market cap of Bitcoin is about $1 trillion. The market cap of gold is estimated to be about $10 trillion. That means Bitcoin would have to rise by a factor of roughly 10x before reaching parity with the market for gold.

While such a thing may sound fantastic, it’s not out of the realm of possibility. Five years ago, the market cap of Bitcoin was only $7 billion. At $1 trillion, Bitcoin has grown by a factor of almost 50x during that time.

If recent trends were to continue, it could be possible that Bitcoin reaches or exceeds the market cap of gold in the years to come.

Is Bitcoin a Good Investment?

In terms of returns, Bitcoin has been the best-performing asset of the last 12 years by a wide margin. Bitcoin has also been the best-performing asset nearly every year since its creation (with the exception of 2014 and 2018).

However, when mentioning Bitcoin’s impressive gains, one must also mention the extreme volatility Bitcoin has also experienced, along with the exchanges that have been hacked, and stories of people losing the private keys to their Bitcoin forever. These risks are worth paying attention to.

Is Gold a Good Investment?

Long-term investors might consider gold a good investment, thanks to its low volatility and longevity. It’s a relatively low-risk investment. Generally, gold appreciates in lockstep with inflation, which is why it is considered a safe asset. But gold’s very stability may make it less desirable for short-term investors who hope to turn a quick and hefty profit.

The Takeaway

There are many nuances to the gold vs. cryptocurrency debate, but it’s important to remember that it doesn’t have to be a debate at all—investors are free to choose both. The real decision might be in choosing what percentage of a portfolio to allocate to each asset to maximize returns and minimize risk. And as always, those decisions depend on the individual investor.

Photo credit: iStock/Olemedia

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected]. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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May
13
2021
What is The Synthetix Network?

What is The Synthetix Network?

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What is The Synthetix Network?

According to the Synthetix white paper, Synthetix is a decentralized synthetic asset issuance protocol built on Ethereum. What this means is that the Synthetix network allows people to create synthetic assets, or “synths”.

Synthetic assets are the decentralized finance (DeFi) equivalent of derivatives in traditional finance. Synths take the form of ERC-20 smart contracts that track the returns of a real asset without requiring investors to own that asset. In effect, it can be said that an investor can gain “synthetic” exposure to regular assets in this fashion.

How Do Synths Work?

A synth is a virtual representation of another asset in the form of an ERC-20 smart contract. The smart contract serves to tie the price of the synth to the asset.

Synths can be traded on Kwenta, Synthetix’s decentralized exchange (DEX), and can represent cryptocurrencies, indexes, gold, and more.

Synths utilize decentralized “oracles”, which are price discovery protocols based on smart contracts. These oracles automatically track the price of the asset that a synth represents, allowing investors to hold a synth as if it were actually the underlying asset.

In this way, synths can give crypto investors exposure to assets they wouldn’t normally be able to access through the cryptocurrency ecosystem, such as gold and silver.

Synths are issued on Ethereum, which means users can deposit them on other decentralized finance platforms and earn interest. Some participants in this newly emerging financial system believe that synthetic assets and derivatives are important for the space to mature and become legitimized, as synths and derivatives can help hedge against volatility and facilitate price discovery.

Recommended: What is Ethereum and How Does it Work?

Synths vs Tokenized Commodities

Synths differ from tokenized commodities like Pax Gold (PAXG), created by Paxos, a cryptocurrency backed by physical gold bars. Holding PAXG is intended to give investors a piece of an actual gold bar—someone who holds PAXG has a claim on physical gold that Paxos is holding.

Synths, by contrast, only provide exposure to the price of the underlying asset. For example, a synth for gold would give investors a token they could hold that would mimic the price of gold.

How Does Synthetix Exchange Work?

Users can trade synths on Kwenta, the decentralized exchange (DEX) for Synthetix, as well as across a variety of different DeFi protocols. Unlike other exchanges, Kwenta has no order book that contains buy and sell orders. Instead, Kwenta uses peer-to-contract trading, meaning all trades get executed via smart contracts.

Proponents of Synthetix claim this type of exchange has a few key advantages.

Infinite liquidity: Traders don’t have to worry about “slippage,” or driving prices down when they place large sell orders, reducing their overall profits.
Censorship resistance: Since the system is decentralized and governed by smart contracts, it is free and open to everyone (and resistant to censorship). In fact, users don’t even have to create an account to start using Kwenta.

Oracles from another DeFi protocol called Chainlink (LINK) provide the price feeds that set exchange rates for each synthetic asset. This differs from traditional exchanges, where prices are determined by the point at which buyers and sellers are willing to meet. Trades come with fees of between 0.3% and 1%, and the proceeds get sent to a pool where SNX stakers claim them as rewards for staking tokens.

Is Synthetix a Good Investment?

As with all altcoins, trading SNX can be highly volatile and is widely considered to be a speculative investment.

There are thousands of altcoins, and over the years many of them have seen their values fall to zero or very close to it. These coins tend to make a few people large profits during the speculative mania phase, and may bring large losses to everyone else afterward, so investors should exercise caution before trading altcoins.

Some investors might believe that certain cryptocurrency projects like Synthetix have the potential to grow into something large and significant in the future. It’s possible that DeFi protocols like Synthetix could wind up becoming part of a new financial system, in which case the SNX token might perform well.

It’s also possible that some DeFi protocols could fail for various reasons, in which case SNX and other tokens like it could fail to be a good investment.

Recommended: 2021 Guide to Crypto Trading

How Do You Make Money on Synthetix?

There are a few ways to potentially profit from Synthetix.

Buy SNX, the Synthetix network token, on an exchange. If the price rises, then a profit will be realized.

Trade synthetic assets on Kwenta. If a trader holds synthetic gold or Bitcoin, for example, and the price of those assets rise, then the price of the synths should also rise.

Users can stake their SNX tokens and earn passive income rewards on a regular basis.

How Do You Trade On Synthetix?

There are two ways to start trading synths.

A user can purchase ETH on an exchange before exchanging that ETH for sUSD on Kwenta. The sUSD can then be exchanged for other synths.

A user can obtain SNX tokens on an exchange, then stake their SNX on a decentralized application created by Synthetix called Mintr. At this point, users can create synths and start trading them on Kwenta.

As of March 2021, Kwenta users have the option to trade 13 different cryptocurrencies and their inverse counterparts (inverse cryptocurrencies inversely track the price of cryptocurrencies, providing a way to short them), synthetic gold and silver, and several synthetic government-issued fiat currencies. The Synthetix website lists five categories of synths, including commodities, fiat currencies, cryptocurrencies, inverse cryptocurrencies, and cryptocurrency indexes.

There are also two synthetic cryptocurrency indexes offered by Synthetix: sDEFI, an index that tracks a basket of DeFi assets, and sCEX, which tracks a basket of exchange tokens (e.g., Binance coin).

The Takeaway

Synthetix enables cryptocurrency users to invest in certain assets via proxy mechanisms called synthetics or “synths” for short. Powered by the Synthetix network token (SNX), users can create their own synths and trade them on a decentralized exchange. To create synths, users must stake a certain amount of SNX to collateralize the new synthetic assets.

Photo credit: iStock/visualspace

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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May
07
2021
Centralized vs. Decentralized Exchange: How to Choose

Centralized vs. Decentralized Exchanges: Six Differences to Consider

By | Growing Wealth, invest, Investing | Comments Off on 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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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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