Centralized digital asset exchanges are online platforms through which people can trade cryptocurrencies/tokens (crypto/crypto pairs) or switch from fiat money ($, £, €, etc.) to crypto (fiat/crypto pairs). Centralized exchanges are run by companies which oversee and manage all the interactions between the users, arbitrate the disputes, fix the bugs, provide liquidity and they collect fees for doing all that.
Centralized exchanges (CEXs) are the most utilized by traders and users, have the biggest trading volumes (liquidity) and the highest fees. In some instances, the companies running the exchanges are regulated (CEXs are regulated in Japan, South Korea, Switzerland, USA, Gibraltar, Malta and other countries) and they may also offer some degree of protection for investors.
Huobi Pro is a great example of centralized exchange, they offer almost any kind of service a traditional financial exchange platform would offer: trading, margin trading, investors protection, 24/7 customer service, custody (see also the case of non-custodial exchanges, e.g ShapeShift), listing services for new tokens, segmentation, high liquidity , API for professional traders (algo-trading) and even some innovative crypto-financial product. At present, in order to enjoy all of these services, and in light of the current state of blockchain technology, a central counterparty is necessary. But as the technology evolves also the exchanges will evolve.
The theme of centralized exchanges vs decentralized exchanges is one of the oldest in the cryptocurrency space. Being that digital assets are decentralized in nature (this is true for cryptocurrencies or tokens running on top of open blockchains such as BTC, ETH, ZCash, Monero… Not Ripple, just to mention one), having centralized “gatekeepers” that eliminate part of the decentralization has always been seen as a major problem by many in the crypto space, especially by bitcoin maximalists, libertarians, cypherpunks, Austrian scholars and whoever else really care about decentralized systems and decentralized money (Ecash). Recently, Vitalik Buterin has again slammed the concept of centralized exchange, hoping for a major presence of decentralized players in the future.
In the second part of the article, we will point out some of the most important pros and cons of centralized and decentralized exchanges.
Centralized Exchanges (CEX)
Pros.
Better liquidity (thanks to the presence of market makers who fill the order books).
Easy to use thanks to user-friendly interfaces.
Compliant with financial regulation (sometimes).
Instant transactions.
A wider diversity of services (margin trading Long/Short, options, futures, other derivatives, investor protection, etc.).
Less responsibility (which comes together with less security), thanks to the custody services (hot/cold storage) that all custodian exchanges offer. So that users don’t need to use many wallets when they hold a wide variety of tokens.
Allow fiat/crypto pairs.
Enable automated/algo trading.
Many new security features (cold storage, multisignature, two-factor authentication, payment channels, bitcoin vault, etc).
Cons.
CEXs are considered a honeypot by hackers who are very incentivized to attack these platforms (here's a summary of all the major hacks in the crypto world, billions of dollars have been stolen all over the world).
The company makes the decisions.
There is a chance your cryptocurrency will be confiscated or compromised ( e.g. recently Coinbase froze accounts because it probably keeps a list of tainted coins/UTXOs).
CEXs don’t fit with the philosophy of the Bitcoin/blockchain community (We don’t like gatekeepers).
Decentralized Exchanges (DEX)
Decentralized exchanges allow users to control their own funds and keep them in their own wallets (you never hand over your private keys to a third-party). Trades on a decentralized exchange happen directly between users, peer-to-peer (P2P), they don’t rely on a third-party service to match orders in the order book. Usually, DEXs uses the Ethereum blockchain and atomic swaps. Hash time-locked contracts ensure that the atomic swap process is completely trustless by ensuring both matches the requirements of the trade. Some DEXs don’t have any order book and maintain a reserve warehouse (of tokens) to meet the need of the users in terms of liquidity.
Today we have quite a few examples of DEXs: AirSwap, Bisq, EtherDelta, Hodl Hodl, OpenANX, Swap, KyberNetwork, 0x, Augur, Gnosis, Herdius and Bancor (recently, hackers were able to hack Bancor, and stole US$23.5m of ETH, NPXS and BNTC, this show that DEXs are not yet ready for massive usage nor for mission-critical use cases).
https://twitter.com/vitalikbuterin/status/916926487172968448?lang=en
- vitalikbuterin
Pros.
Better security (allegedly, there is still a lot of work to do, Bancor is the latest example).
Anonymous (enhanced privacy, no KYC/AML because of its P2P nature users do not set up accounts).
Run by users.
DEXs route orders and information through a peer-to-peer protocol in a manner that is scalable.
Censorship resistance (there isn’t any central counterparty who can control the platform and users don’t lose their private keys, meaning that nobody can censor the trades).
Low fees or none.
Cons.
Low Liquidity (there are not many market makers ready to join DEXs).
They are often complicated and not easy to use for everyone.
Usually there are tight trading limits (so it is hard to trade big amounts of crypto).
They offer few services, the most basic ones.
Front Running (please read this article for more information about the many issues faced by DEXs).
It will probably take years to see a fully decentralized exchange (that is basically a DAO), in the meantime, it seems like we will see hybrid forms of exchanges rising in the crypto world. Because of its huge technical complexity, DEXs will probably be the last piece to be created in order to have a meaningful decentralized economy and decentralized global money.
The author of this article works along with Huobi Pro, the world famous crypto exchange, and everything written here represents only the author’s view.