Centralized Exchanges VS Decentralized Exchange? Why Centralized Exchanges Will Lead Crypto To The Future
Will centralized exchanges continue to provide the regulated environments required for digital assets to evolve into the mainstream, or will the future belong to Decentralized Exchange?
A decentralized exchange (DEX) is a cryptocurrency exchange that operates in a decentralized way, i.e., without a central authority.
Decentralized exchanges are undoubtedly an exciting development in crypto. DEXs facilitate the trading of cryptocurrencies directly between users, without the need for a trusted intermediary. This, in turn, allows users to keep custody of their funds.
DEXs Benefits and Drawbacks
- Because users do not need to transfer their assets to the exchange, decentralized exchanges reduce the risk of theft from the hacking of exchanges.
- Decentralized exchanges can also prevent price manipulation or faked trading volume through wash trading, and are more anonymous than exchanges which implement know your customer requirements.
- While DEXs offer non-custodial solutions and run everything on-chain, the fact that every single order and transaction is made public on-chain leads to a possibility of blockchain node operators frontrunning users’ trades. This can hinder the individual trading experience as well as the growth of the crypto community.
DEXs vs Centralized Exchanges: Scalability And Liquidity
DEXs still have room to grow when it comes to scalability due to its limited capacity.
Some of the fastest blockchains claim to process as many as 50,000 transactions per second. However, this may be misleading, as this metric may not mean throughput of 50,000 transactions per second across each pair or product listed. If more than one product is listed, the capacity may drop to 500 transactions per second per product.
With more users pouring into DEXs, this may cause delays to the network, increase network transaction fees, as seen on Ethereum, and hinder the scaling of blockchains.
Meanwhile, centralized exchanges have proven to be scalable, high-performance infrastructures, and their connectivity supports a variety of strategies, including high-frequency trading. This allows centralized exchanges to attract professional investors and institutional investments that the crypto industry needs to scale and eventually achieve mass adoption.
There are some signs that decentralized exchanges have been suffering from low trading volumes and market liquidity. The 0x project, a protocol for building decentralized exchanges with interchangeable liquidity attempts to solve this issue.
While growing in popularity, DEXs tend to have lower volume and liquidity than centralized exchanges. Having sufficiently deep liquidity helps centralized exchanges contain big market swings and volatility spikes.
Such deep liquidity can be found on exchanges such as Bitfinex, which has the most depth of liquidity for Bitcoin (BTC) and Ether (ETH). Bitfinex’s underlying strength and depth of liquidity were most evident over a 24-hour period on March 12 and 13 when the price of Bitcoin plummeted by 50%. Bitfinex was reported to have represented the majority of top-tier exchange trading volume across BTC/USD and BTC/Tether (USDT) markets during this period.
DEXs vs Centralized Exchanges: Regulations And Requirements
DEXs tend to not be regulated and not require their users to undergo Know Your Customer verification. DEXs may be peer-to-peer marketplaces running on a blockchain and run by smart contracts, but many wrongly believe that DEXs have no liability.
In the current landscape, it will be increasingly unlikely for DEXs to avoid regulations or fly under the radar of regulators, especially as customer protection takes on greater prominence in this space.
Centralized exchanges are ahead in this regard, as they are already subject to regulations and most have KYC verification processes in place. The centralized exchange verification process, for example, is a standardized compliance measure for KYC, Anti-Money Laundering, and counter-terrorism financing laws and regulations. These security practices discourage illegal transactions and improve wallet security on the platform.
In fact, centralized exchanges have even been taking a page out of DEXs’ book and offering features such as non-custodial solutions. Such hybrid solutions allow centralized exchanges to provide a high-performance experience and the benefits of self-custody while remaining compliant with regulations.
As DEXs gradually find their place, it is clear that centralized exchanges will continue to evolve and play a key role in leading the crypto industry and community in the years ahead.
However, while DEXs have their advantages, they still lack in terms of regulations and scalability, which are key considerations that could determine the future trajectory of the crypto industry. Centralized exchanges will continue to play a pivotal role in this ecosystem, providing the depth of liquidity needed to grow the wider crypto community.