Centralization vs Decentralization

Perhaps you’ve asked yourself why some crypto exchanges ask you to complete elaborate user verification checks before they let you buy crypto with fiat currency, while others allow you to trade coins through their platforms with an email verification only but don’t allow crypto purchases with fiat at all.

To make this work, we need to ask a few more questions.  When it comes to a particular market, who has the final say on user authorization? Which makes more sense, a centralized financial structure or a decentralized blockchain where members vote on matters collectively?

At this point, I suggest we take a step back to define some terms and see how they apply to cryptocurrencies before we dig into the centralization vs decentralization debate surrounding crypto exchanges.

What Is a Decentralized Cryptocurrency?

Cryptocurrency refers to a specific sort of digital money that is protected by encryption and built on a blockchain. These digital currencies are utilized as a means of exchange to facilitate fast, secure, and decentralized trades online. Furthermore, cryptocurrencies are distinguished from fiat currency by their decentralized character.

Yet, what does it mean for a currency to be decentralized? By design, they are more decentralized than fiat currencies because they are not controlled by a single entity (such as a government or a national treasury department).

Decentralization and Blockchain: A Look at the Relationship

Cryptographically secure and open digital asset transactions are made possible by blockchain technology, which is a distributed ledger system that facilitates secure and transparent online transactions. Due to its decentralized nature, the blockchain is sometimes referred to as an immutable repository of data. But, before grasping the decentralized nature of the system, one must be familiar with the inner workings of a blockchain. 

The term blockchain refers to the distributed network of cryptographically secured blocks of information used to record cryptocurrency transactions. Every encrypted transaction log is linked to the block that precedes it, thus forming a chain. 

Instead of relying on a central server for all of its data, blockchain relies on a distributed network of nodes scattered all over the world to store copies of the blockchain’s ledger. Therefore, it will be impossible for any single entity to monopolize the blockchain. Rather, blockchain mining nodes oversee the network and ensure that all transactions in it are legitimate by tackling the cryptographic hash of the transaction data contained in each block.

In this way, crypto miners can easily identify any modifications to transaction records that might signal illegitimate network access by solving those intricate computations. That information is immediately broadcast to all nodes of the distributed blockchain, rendering it virtually impossible for a cybercriminal to corrupt the blockchain without getting caught.

Because of the way the blockchain operates, practically all monetary transactions on it can be decentralized, meaning that they can be safely transferred across the network without the need for a middleman.

Crypto Exchanges: Centralization vs Decentralization

A cryptocurrency exchange serves as the sole point of entry for those looking to move from the fiat currency domain into the crypto market. Crypto exchanges’ primary purpose is to facilitate the buying and selling of digital assets and cryptocurrencies in exchange for fiat and digital currencies.

Different cryptocurrency trading platforms have different methods of running their business. In the case of decentralized exchanges, for instance, the decision-making authority is given to the ecosystem’s members rather than being vested in a single entity, as is the case with centralized exchanges.

Here’s a closer examination of the distinctions between the centralization and decentralization of cryptocurrency exchanges.

How Does a Centralized Cryptocurrency Exchange Work?

Centralized cryptocurrency exchanges (CEXs) are online marketplaces where users trade digital currencies with one another through the use of a single server or node that is managed by an external authority. Your personal details will be required by the exchange in order to validate your identification. This is because transactions carried out on centralized platforms are not recorded on the blockchain.

These particulars are often obtained by CEXs by way of the Know Your Client (KYC) or Anti-Money Laundering (AML) protocols, both of which can be pretty in-depth and lengthy procedures. Nonetheless, the more private data you supply via the AML/KYC user-authentication protocols to the exchange, the more advantages you obtain when trading through the platform. These benefits may include increased daily limits and other perks.

In addition, centralized exchanges have a stellar reputation for their user-friendliness and diversity of cutting-edge coin and financial product offerings. One of the key advantages of centralized exchanges is that they provide deeper liquidity than decentralized exchanges.

The Pros of Using a Centralized Exchange

• CEXs empower traders with intuitive interfaces and streamlined trading features.
• Centralized exchanges allow trading in fiat currencies because they are governed by the highest local and global financial authorities and adhere to AML rules.
• Traders can choose from a greater variety of financial instruments on CEXs.
• Centralized exchanges offer greater liquidity since they process more trades than DEXs on average.

The Cons of Using a Centralized Exchange

• Trading on a CEX requires extensive Know Your Customer (KYC) and Anti-Money Laundering (AML) processes, which involve the submission of a wide range of personal documents, such as a photo ID, proof of residency, proof of income, etc.
• Again, due to the regulations that govern the financial industry, centralized platforms typically impose arbitrary regulations on crypto investors.
• When using the CEX’s financial services, users are subject to a variety of fees.
• Since DEXs have their nodes spread out, they are less likely to be hacked than CEXs because hackers are less likely to be able to concentrate their efforts on one point of entry. 

How Does a Decentralized Cryptocurrency Exchange Work?

Decentralized exchanges, or DEXs, are peer-to-peer platforms that facilitate transactions between users directly, without the need for an intermediary like a bank or broker. Most decentralized exchanges (DEXs) are built on the Ethereum blockchain because smart contracts provide these markets with security in place of traditional banking systems. 

To be more precise, DEXs utilize smart contracts to establish virtual currency rates and employ algorithms and AI optimization methods while maintaining their independence. Moreover, liquidity pools are also used in decentralized exchanges, where traders can risk their capital for potential financial gain. 

DEXs, in addition to a wide variety of other DeFi solutions, are developed with an eye toward the continued development of technological innovation. To achieve this goal, DEXs are typically created with open-source code, which means that anyone is free to make their own changes to the programming script and use it to create their own unique software.

As a leading example of a decentralized exchange, Uniswap‘s progress in the cryptocurrency market has inspired the creation of similar but independent marketplaces built on the same open-source code. These include PancakeSwap and SushiSwap.

The Pros of Using a Decentralized Exchange

• The only thing you need to begin trading on a decentralized exchange is an active email address, as DEXs will typically not request any other information about you.
• To trade on a decentralized exchange, you’ll pay fewer or no fees at all. However, it’s important to be aware of all of the potential costs associated with your crypto venture before you get started, even if the platform itself doesn’t charge any transaction fees. This includes mining fees, crypto wallet fees, crypto withdrawal expenses, and payment option costs.
• Because DEXs do not rely on a single point of failure, they are much more difficult for malicious hackers to exploit than other types of systems.

The Cons of Using a Decentralized Exchange

• Because of lower investor interest and a smaller selection of digital assets, DEXs face a major challenge in terms of liquidity compared to CEXs.
• By design, DEXs typically offer a minimal set of trading services.
• DEXs do not facilitate trading in fiat money. Since a decentralized trading platform can’t accept fiat currency, clients should first convert their funds into crypto before making any investments.
• It takes more time to complete a transaction on a decentralized platform as opposed to a centralized trading platform. DEXs generally have smaller trading volumes, meaning that you could have to wait a while for your trading bid to be matched with the offer of another crypto trader.

Conclusion

The blockchain community frequently debates the merits of centralization vs decentralization. Actually, blockchain technology could easily make traditional, centralized financial infrastructures obsolete.

Centralization and decentralization refer to two radically different approaches to allocating authority in the realm of virtual currencies. If you understand these two ideas better, you’ll be able to find the best cryptocurrency exchange for your trading needs.