The Basics of Cryptocurrency Exchanges:
Quite simply, cryptocurrency exchanges are platforms that facilitate the trading of cryptocurrencies and fiat currencies. Cryptocurrency exchanges are an intermediary between a buyer and a seller and make money through commissions and transaction fees.
For example, on a cryptocurrency exchange, USD$1,000 can be exchanged for bitcoin of equivalent value, and vice-versa. Similarly, bitcoin worth $1,000 can be exchanged for Ethereum of equivalent value.
Centralized vs. Decentralized Cryptocurrency Exchanges
Centralized cryptocurrency exchanges act as a third-party between a buyer and a seller. Since they are operated and controlled by a company, centralized exchanges offer more reliability. Approximately 99% of all crypto transactions go through centralized exchanges. Examples of centralized cryptocurrency exchanges include:
Decentralized cryptocurrency exchanges (DEX) allow users to execute peer-to-peer transactions without the need for a third party or an intermediary. Due to some of the issues associated with centralized exchanges, decentralized exchanges are preferred by some users.
However, decentralized exchanges do not facilitate the trading of fiat currencies for cryptocurrencies. Examples of decentralized cryptocurrency exchanges include:
Advantages of Centralized Cryptocurrency Exchanges
Centralized exchanges offer beginner investors a familiar, friendly way of trading and investing in cryptocurrencies. As opposed to using crypto wallets and peer-to-peer transactions, which can be complex, users of centralized exchanges can log into their accounts, view their account balances, and make transactions through applications and websites.
Centralized exchanges offer an extra layer of security and reliability when it comes to transactions and trading. By facilitating the transaction through a developed, centralized platform, centralized exchanges offer higher levels of comfort.
Downside Risk of Cryptocurrency Exchanges
1. Hacking risk
Centralized exchanges are operated by companies that are responsible for the holdings of their customers. Large exchanges usually hold billions of dollars worth of bitcoin, making them a target for hackers and theft.
An example of such an incident is Mt.Gox, which was once the world’s largest cryptocurrency exchange company before it reported the theft of 850,000 bitcoins, leading to its suspension.
2. Transaction fees
Unlike peer-to-peer transactions, centralized exchanges often charge high transaction fees for their services and convenience, which can be especially high when trading in large amounts.
Advantages of Decentralized Cryptocurrency Exchanges
1. Mitigate hacking risk
Users of decentralized exchanges do not need to transfer their assets to a third party. Therefore, there is no risk of a company or organization being hacked, and users are assured of greater safety from hacking and theft.
2. Prevent market manipulation
Due to their nature of allowing for the peer-to-peer exchange of cryptocurrencies, decentralized exchanges prevent market manipulation, protecting users from fake trading and wash trading.
Decentralized exchanges do not require customers to fill out know-your-customer (KYC) forms, offering privacy and anonymity to users.
Disadvantages of Decentralized Cryptocurrency Exchanges
Users of decentralized exchanges must remember the keys and passwords to their crypto wallets, or their assets are lost forever and cannot be recovered. They require the user to learn and get familiar with the platform and the process, unlike centralized exchanges, which offer a more convenient and user-friendly process.
2. Fiat payment Issues
Decentralized exchanges do not allow for the trading of fiat currencies for digital ones, making them less convenient for users that do not already hold cryptocurrencies.
Some 99% of crypto transactions are facilitated by centralized exchanges, which suggests that they are accountable for the majority of the trading volume. Due to the lack of volume, decentralized exchanges often lack liquidity, and it can be difficult to find buyers and sellers when trading volumes are low.
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