What are Cryptocurrency Exchanges?
The most common way to buy and sell cryptocurrencies and other digital assets is to use a Bitcoin Exchange. In cryptocurrency exchanges, digital and fiat currencies, NFTs, and other crypto assets can be traded for cryptocurrencies.
Centralized Cryptocurrency Exchanges (“CEX”)
The purpose of centralized cryptocurrency exchanges is to act as intermediaries between buyers and sellers and to make money through commissions and transaction fees.
There are several popular Bitcoin Trading Platforms like BBTC, Gemini, and Binance that are very popular. As with stock trading websites or apps, these exchanges allow cryptocurrency investors to buy and sell digital assets at the current price, called spot, or to place limit orders, which get executed when the asset reaches an investor’s desired price target.
It is the intention of CEXs to list and sort buy and sell orders by the intended buy or sell price, using an order book system. Based on the desired lot size, the exchange’s matching engine matches buyers and sellers based on the best executable price. Therefore, the price of an asset will be determined by its supply and demand, regardless of whether it is a fiat currency or a cryptocurrency.
As CEXs decide what digital assets it will be able to trade, this provides a small measure of comfort that unscrupulous digital assets will be excluded from trading on the exchange.
Decentralized Cryptocurrency Exchanges (“DEX”)
In addition to centralized exchanges, decentralized exchanges are another type of exchange that allow peer-to-peer transactions directly from your digital wallet without going through an intermediary. Examples of decentralized exchanges include Uniswap, PancakeSwap, dYdX, and Kyber, which are examples of DEXs.
As opposed to centralized cryptocurrency exchanges, these decentralized exchanges use smart contracts, self-executing pieces of code on a blockchain, which provide greater privacy and lower transaction costs.
Nonetheless, DEXs are meant for sophisticated investors because they lack an intermediary third party despite smart contracts being rules-based.
The advantages of centralized cryptocurrency exchanges
With centralized exchanges, you gain an extra layer of security and reliability when it comes to transactions and trading. By facilitating transactions through a developed, centralized platform, centralized exchanges offer greater levels of comfort and security to their users.
Investing and trading in cryptocurrencies can be easier and more familiar on centralized exchanges for beginners. With centralized exchanges, users can log into their accounts, see their account balances, and make transactions through applications and websites instead of using crypto wallets and peer-to-peer transactions, which can be complex.
Some CEXs offer investors the option of using borrowed money from the exchange to leverage their investments, called margin trading. Margin trading allows investors to reap higher returns, but it can also magnify losses.
The disadvantages of centralized cryptocurrency exchanges
1. Hacking risk
Large exchanges usually hold billions of dollars worth of bitcoin, which makes them a very attractive target to hackers and thefts of bitcoin. Because exchanges are run by companies, they are responsible for the holdings of their customers.
In Mt.Gox’s case, which was once the world’s largest cryptocurrency exchange company before it reported the theft of 850,000 bitcoins, the company collapsed.
2. Custody of digital assets
Rather than letting you store your private keys on your own digital wallet, CEXs will take care of your digital asset as a custodian in their own digital wallet. However, centralized cryptocurrency exchanges can fail and be fraudulent, which can be a drawback when it comes to trading.
3. Transaction fees
There is no doubt that the convenience and ease of centralized exchanges can contribute to higher transaction fees, which can be especially true when large amounts of money are being traded, unlike peer-to-peer transactions.