The cryptocurrency market revolves around a core known as the cryptocurrency exchange. Without this exchange, digital assets would not only be untradeable but also lack any security and maintenance.
Whether you are just starting out in cryptocurrency or already an expert, all your transactions depend on your understanding of exchanges. This article provides insights into what a centralized cryptocurrency exchange is, and how it differs from a decentralized exchange.
It is not uncommon to feel uneasiness when you see the word “centralization” in the cryptocurrency market. Crypto tokens are supposedly decentralized, so why are they traded in centralized exchanges?
In the blockchain world, centralization and decentralization are the respective terms for the presence and absence of a middleman during transactions between buyers and sellers.
1. Centralized cryptocurrency exchanges are not as flexible as their decentralized counterparts. They do not allow anonymity and charge a percentage of the traded amounts.
2. Excellent security and large trading volumes are marked features of a reliable centralized cryptocurrency exchange.
What Is a Cryptocurrency Exchange?
A cryptocurrency exchange is a platform used for the purchase, sale, and arbitrage of digital assets that may be from token to token, or from fiat currency to digital currency. Aside from functioning as trade markets, cryptocurrency exchanges can also function as reservoirs for tokens used for basic purposes.
For this, a fiat-to-crypto payment processor is used. This processor is a part of the blockchain ecosystem where fiat money (paper money) is exchanged for digital assets, and then placed in a digital wallet for use in off-market operations.
What Are the Advantages and Disadvantages of Digital Wallets?
1. Enhanced Security: Any financial solution must guarantee maximum security for your fiat and digital currencies. Digital wallets are encrypted using high-end technology to secure your digital currencies. Although security breaches are never entirely preventable, digital wallets promise more security than the leather wallets in which you keep fiat currencies.
2. Financial Intelligence: Digital wallets store all your digital financial information in an accessible application that tracks all your transactions. This allows you to better track how your cryptocurrency is moving.
However, even with the points above, it’s important to weigh the advantages and disadvantages of digital wallets. Interestingly, the strong security of digital wallets could be seen as a shortcoming, as the funds aren’t always readily available. Not all wallets are created equal either. Some are more vulnerable to attacks than others. Make sure to use trusted digital wallets only, and always make sure your information is coming from a reliable source.
What Does it Mean for a Cryptocurrency Exchange to Be Centralized?
Think of the ancient postal system and how people used to send parcels through postal companies. Parcel senders only use postal companies that can guarantee the security of their messages and also deliver to the exact location of the recipient.
Centralized cryptocurrency exchanges are like these postal service companies. They ensure the security and prompt delivery of digital assets across the blockchain. The parcel sender is the cryptocurrency seller, while the recipient is the buyer. And as long as delivery and security are guaranteed, the centralized cryptocurrency exchange continues to grow in market share and value.
Centralized and Decentralized Cryptocurrency Exchanges
Centralized cryptocurrency exchanges have a few perks. But what is the difference between centralized and decentralized cryptocurrency exchanges?
1. Centralized cryptocurrency exchanges are middlemen in the transaction of trading digital assets. Decentralized cryptocurrency exchanges are open fields of cryptocurrency transactions where buyers and sellers of cryptocurrencies transact without limitations.
2. The presence of formal protocols in centralized exchanges makes them prone to governmental regulations. However, decentralized cryptocurrency exchanges conduct business without regulations, as they lack a central authority.
3. Centralized exchanges typically allow only crypto-to-crypto arbitrage and trading. Aside from cryptocurrency-to-cryptocurrency trading, decentralized exchanges allow fiat-to-cryptocurrency arbitrage.
4. Centralized crypto exchanges usually charge a percentage of the total amount traded for every transaction, whereas decentralized exchanges have a fixed per-trade fee.
5. Cryptocurrency owners with digital assets docked in a decentralized exchange have full ownership over their tokens. As great as this may sound, it also means they may lose all their assets in the event of a hack. Their centralized exchange counterparts have their ownership withheld, which speeds up transaction time.
Features of a Centralized Cryptocurrency Exchange
Aside from the differences between both types of cryptocurrency exchange, what are the core elements of a centralized cryptocurrency exchange?
Similar to the way supermarkets have merchandised goods in their stores, cryptocurrency exchanges have digital assets in the form of tokens entrusted to them by cryptocurrency companies and traders. The higher the number of patrons, the greater the market value of the exchange and the greater its chances of remaining in the market.
In the crypto market, the trading volume is estimated based on the number of visits and transactions done on an exchange in a day. But in the digital world, manipulations aren’t uncommon. Some centralized cryptocurrency exchanges fake this data to get the exchanges on the list tracked by the widely followed CoinMarketCap website.
Normally, after a huge sale, the price of a digital asset increases. Large trading volumes cushion the effects of this sale, ensuring equilibrium and lesser volatility on the market. Also, large trading volumes are used as pointers to the reliability of a cryptocurrency exchange. Binance’s global reputation as the most reliable cryptocurrency exchange owes to its large trading volume.
This is by far the greatest concern in the digital currency world. In the crypto world, no exchange is completely immune to security issues. Does this mean all digital exchanges are unreliable and should be boycotted? No, it doesn’t. What it does mean is that some exchanges are safer than others as theft is always occurring.
To add some perspective, about $1.2 billion was stolen across cryptocurrency exchanges in the first three months of 2019 through various malicious activities. Even Binance, the world’s largest cryptocurrency exchange, lost more than $40 million in crypto assets to security attacks.
So, when selecting a cryptocurrency exchange, it is key to consider a number of factors like pairs traded by the exchange, its security, its readability, and market value, among others.
To recap, a centralized cryptocurrency exchange is a conduit between cryptocurrency traders to allow transactions. It charges a percentage of the total amount of the transaction and does not allow anonymity, but guarantees the long-term safety of your wallets in case something happens to your keys.
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