Centralized Exchange Definition: A centralized exchange is a form of cryptocurrency exchange carried out by a company in a centralized way. That is to say that the company has control over the exchanges between a buyer and a seller. Centralized exchanges, also known as CEX, work similarly to the stock exchange. However, it is not stocks that are traded, but cryptocurrencies.
A Centralized Exchange, therefore, acts as an intermediary between people wishing to buy and those wishing to sell crypto-currencies. In concrete terms, it is a trading platform allowing market orders to be executed quickly and transparently. There are also several types of CEX platforms. But in general, each of them has the following characteristics:
- An easy-to-learn interface based on user type or preferences.
- An administrative part for identity verification.
- A tool for trading.
- Has a database in which several pieces of information are stored.
- Generates income through commissions for each transaction which ranges between 0.1% and 1.5%.
- Storage of all users’ assets inside the exchange.
Strengths of Centralized Exchanges (CEX)
Speed
Transparency
A gateway between fiat currencies and cryptocurrencies
Ease of use and Liquidity
#1 Speed
The first advantage of a centralized trading platform is also the most obvious since it is its speed!
Centralized exchanges operate more efficiently during peak times since they run on centralized servers and architectures. They allow them to quickly execute market orders in a centralized order book and reduce the time needed to process orders when volumes are high.
Conversely, a decentralized exchange application needs to synchronize its order books across many nodes, a task that can be difficult when high volatility results in many order creations and execution requests in a short period of time reduced.
#2 Transparency
Centralized exchanges are usually willing to disclose more information to the extent that employees and their headquarters address are made public. Since these platforms also have far more users than their decentralized counterparts, they usually come under increased scrutiny from government authorities as well as the public.
This transparency will only relate to basic information about the platform that is expected to be disclosed. Since the blockchain industry remains mostly unregulated at present, with founding principles based on values of privacy and anonymity, this has led to a lack of transparency in practices.
However, if a platform lacks transparency, it could reduce user trust and deter them from trading on the platform. This is probably one of the reasons why centralized exchanges are currently used more than decentralized platforms, which can sometimes be less transparent due to the decentralized nature of these.
However, if auditors design specific tools for decentralized exchanges, this distrust may disappear over time.
#3 Gateway Between Fiat Currencies and Cryptocurrencies
In addition to greater transparency, most centralized exchanges seek to remain compliant with official regulations in order to be able to offer exchanges between fiat currencies and cryptocurrencies. Regulatory-compliant centralized exchanges can more easily communicate with the financial sphere and provide a gateway from fiat currencies to cryptocurrencies as banking services adhere to their own financial rules and regulations. Platforms like Coinbase, Bitstamp, or Paymium require their users to verify their identity through a KYC procedure.
This means that centralized exchanges provide the ability for users to transfer money from their bank accounts directly to the exchanges to buy cryptocurrencies, as well as convert those cryptocurrencies into fiat currencies as they see fit. .
#4 Ease of Use and Liquidity
Due to the speed and ease of use of centralized trading platforms, users are attracted to the best trading experience and this also translates into higher trading volumes and greater liquidity for all people making operations on the centralized platform.
Additionally, when an intuitive user interface is coupled with fast trade execution, new and experienced traders alike enjoy a great experience on the platform. It is easier to retain users in this ecosystem.
The Weaknesses of Centralized Exchange Platforms
Security
Unavailability
Exposure to Censorship and Lack of Transparency
Monopoly background
#1 Security
Centralized exchanges tend to operate with a single point of failure, be it a central database, wallet or central server, and that means a single hack could result in the loss of millions of dollars.
Mt. Gox is the perfect example of this, having been hacked and stolen $450 million in 2014. Unfortunately, these incidents are all too common in the history of cryptocurrencies and usually lead to a significant drop in prices, scaring people and deciding to withdraw their funds.
#2 Unavailability
A consequence of centralization is the high risk of system failure. Centralized exchanges can experience long periods of downtime due to technical issues or even regular DDoS attacks.
Government authorities also sometimes order exchanges to halt their operations for a period of time. The platform can also choose itself to suspend exchanges for many reasons such as infrastructure modernization, in the event of an attack, or to comply with regulatory standards.
#3 Exposure to Censorship and Lack of Transparency
Centralized exchanges are more exposed to government censorship. They can easily have their operating license revoked, their funds seized, and even be forced to reveal sensitive information about their users or their funds.
It has happened several times in the past that governments have banned and closed exchange platforms, especially in India or China.
Although centralized exchanges may appear more transparent on the surface, due to an absence of regulations in the industry, some platforms engage in questionable activities and behaviors unbeknownst to their users. Some platforms are involved in fictitious transactions aimed at artificially inflating their transaction volumes, while others embezzle the funds that their users had placed under their responsibility.
#4 Background of Oligopoly
The absence of decentralized finance exchanges has created a market where a handful of centralized exchanges hold the bulk of the market share. Some platforms have thus been able to charge millions of dollars to projects wishing to reference their tokens on the exchange platform.
Some see this as a sign of the hegemony of centralized platforms that truly limits the potential growth and adoption of cryptocurrencies. To consider the impact of shifting users to decentralized exchanges, we need to look at the weaknesses of these platforms to determine what improvements can be made.