Centralized vs Decentralized Crypto Exchanges: Which is safer?
When it comes to crypto exchanges, there are two main types: centralized (CEXs) and decentralized (DEXs). With the news of the recent collapse of CEX giant FTX, it is important to note the differences between CEXs and DEXs, as well as which one is safer. Both have their own set of advantages and disadvantages, which we will explore in this blog post.
What is a centralized crypto exchange?
A centralized crypto exchange is an exchange that is run by a company or organization. Binance, Coinbase, Kraken and (the recently-collapsed) FTX are all examples of centralized exchanges. These exchanges tend to be very user-friendly, with intuitive interfaces and easy-to-use features. Centralized exchanges also offer a wide variety of coins and tokens for trading depending on which they decide to list. Usually, they would follow a certain criteria as to which coins they choose to allow to be traded on their platform.
Centralized exchanges tend to offer more robust customer support than decentralized exchanges. If you have any problems with your account or trades, you can simply contact the customer support team of the exchange and they will help you resolve the issue. Furthermore, they have traditional security measures (such as 2FA) which non-custodial wallets usually lack.
However, there are also some disadvantages to using a centralized exchange. As was seen with the recent collapse of the highly acclaimed FTX, when you are storing your crypto in an exchange, if the exchange goes bankrupt, there is a high risk that you lose your funds. In fact, it is reported that $1 billion of client funds remain missing. In other words, the consumer generally ends up bearing the brunt of a collapse. This is usually through a mishandling of user funds, with FTX’s issue being mismanaging liquidity.
Another big risk is that these exchanges are often targets for hacking attempts. This is because hackers know that these exchanges hold large amounts of user funds in central servers, making them a prime target. To make matters worse for FTX, this is just what happened, where after the token collapsed, they were also hacked of $473 million. When it rains it pours.
What is a decentralized crypto exchange?
A decentralized crypto exchange is an exchange that does not have a central authority or organization running it. Instead, it is run by the community of users who use the exchange. Uniswap and Pancakeswap are both examples of decentralized exchanges. In their whitepaper, Uniswap claimed that the project was “designed around ease-of-use, gas efficiency, censorship resistance, and zero rent extraction”, which aims to rival CEXs for mismanaging user funds.
One of the biggest advantages of decentralized exchanges is that they tend to be much more secure than their centralized counterparts. This is because there is no central server for hackers to target—the funds are stored directly into a user’s wallet once a swap has been made. In addition, decentralized exchanges usually charge lower fees than centralized exchanges because there are no middlemen involved in processing trades. DEXs use an Automated Market Maker (AMM) to determine the price of assets as opposed to centralizing the process.
While decentralized exchanges offer many benefits, such as improved autonomy and privacy, there are also potential drawbacks. One of the biggest disadvantages is that decentralized exchanges are often less user-friendly than centralized exchanges. This can make it difficult for new users to get started, and may also lead to users making mistakes that could result in loss of funds. Additionally, decentralized exchanges often have less liquidity than centralized exchanges, which can make it difficult to find buyers or sellers for certain cryptocurrencies. Finally, decentralized exchanges are often not as well regulated as centralized exchanges, which could lead to problems if something goes wrong.
Crypto wallet vs crypto exchange
One must also not confuse crypto wallets with crypto exchanges. A crypto wallet is where funds are held. They may be custodial (managed by a third-party) or non-custodial (managed by a user). Exchanges, on the other hand, are where users usually go to trade cryptocurrencies. When it comes to CEXs, there is the possibility to keep funds on the platform (although it is not generally recommended for safety purposes). With decentralized exchanges, however, you transfer them directly to your wallet (unless you decide to provide liquidity to a platform.
To round up, although both have their advantages and disadvantages, if you’d like to avoid your funds from being taken away from you without much to do about it, the best is to avoid holding funds in CEXs. Since centralised exchange hold the keys to your funds it might well be the case that technically, the funds do not become completely owned by you, hence the mantra “not your keys, not your crypto”.