A cryptocurrency exchange is like a stock exchange. This brings together supply and demand for cryptocurrencies listed.
In this article, we will explain the differences between centralized cryptocurrency exchanges (CEX) and decentralized cryptocurrency exchanges (DEX) but also a different type that isn’t really a cryptocurrency exchange a broker. Next, we will also look at the risks associated.
Understanding cryptocurrency exchanging?
Bitcoin and other cryptocurrencies can be traded/exchanged peer-to-peer. In other words from person to person, without the intervention of any third party. If you want to exchange one coin for another coin that can also be done if you find a person that is interested in your offer, for example Bitcoin to Ethereum. This can be peer-to-peer, but like said you will have to find someone who wants to make the same deal as you.
Because such a search is quite difficult, you can use a cryptocurrency exchange. Most exchanges have a wide range of cryptocurrencies which you can trade with other users.
Supply and demand are brought together at an exchange. It is convenient to do cryptocurrency exchanges this way and that for often a small cost but do check, not all are cheap (trading fee, deposit fee, withdrawal fee). If you are ok with cryptocurrency exchange fees which also saves you time then there is one big disadvantage. At cryptocurrency exchanges, you do not have access to your private keys. The number 1 rule in the crypto world is - If you don’t own the private keys, you don’t own the coins -. So once again always do your own research and due diligence when selecting a cryptocurrency exchange to use.
Different type of exchanges
- Centralized Exchanges (binance, bitfinex, poloniex …)
- Decentralized Exchanges (poloniex, tronwatch, shapeshift…)
- Brokers (changelly, simplex, cex.io …)
- Escrow services (localbitcoins, …)
- Physical Exchanges (coinatmradar, …)
What is the difference between a centralized and a decentralized exchange?
The most important difference in decentralized cryptocurrency exchanges is trading without the need of third parties. Users directly interact with each other on an exchange platform: they buy and sell without any need to deposit to the exchange. All goes smoothly through smart contracts. This removes a risk layer but do also your own research and due diligence. Smart contracts are in theory fail-safe but it can happen that some are badly written which allows malicious people to abuse them.
At centralized cryptocurrency exchanges you will have to sign up, most likely do also a KYC (Know Your Customer) and deposit, the funds are then held in pooled addresses. You don’t own your coins anymore until you withdraw them again to your private wallet. The high risk is here the security of the centralized exchange. Every year there are exchanges that get hacked and funds from the pooled addresses are stolen.
And what are brokers or escrow services?
Brokers make it easy to buy cryptos quickly. You can simply pay with USD/EUR/GBP or any other fiat currency by using a debit or credit card. Some allow also bank wire transfers but with the extreme volatility of cryptocurrencies that is not really advised. Brokers do tend to take a hefty fee. The bought or sold cryptocurrencies arrive to your private wallet or bank account or credit card (cex.io)
Some brokers like changelly offer also crypto-to-crypto exchanges where there is no need for you to sign up to any exchange, they act as a third party to execute buy/sell orders at the best price there is at the moment.
Cryptocurrency escrow services, the best-known one is localbitcoins, this is a peer 2 peer platform to buy/sell or even trade cryptocurrencies. The security level here is that funds are held in an escrow till both parties fulfilled the contract they agreed upon.
A Physical Bitcoin Exchange is a kiosk that allows a person to purchase Bitcoin by using cash, credit or debit card. There are two main types of Bitcoin machines: cash kiosks and ATMs. The downside of physical exchanges is that you are limited in choices of cryptocurrencies, mainly the big coins are available to buy/sell. You can check at Coin ATM Radar if there is a Bitcoin ATM or kiosk near you.
What are the risks of a centralized cryptocurrency exchange?
Do you want to trade on a centralized exchange? Then you transfer your coins to the wallet of the exchange you want to use. This cryptocurrency exchange platform has its own internal system for determining which coins belong to who.
For the blockchain, however, there is only one owner of the coins and that’s the centralized exchange, you don’t own the coins anymore. There is only one real wallet with the coins on it and that is the one from the exchange until you withdraw them again to your private wallet.
Your coins are therefore managed by a third party. You do not have the private keys of the receiving address of the exchange. And there are high risks involved. Exchanges have huge numbers of coins on their receiving addresses. This makes them an attractive target for hackers.
Recent and past Centralized Exchange hacks
Unfortunately, it happens now and then that a large exchange is hacked. The digital burglars sometimes manage to get away with an enormous amount of coins. The first major exchange hack was that of MtGox in 2014 when more than 740,000 bitcoins were stolen.
Even after the MtGox hack, a centralized exchange is hacked almost every year. Several exchanges were hacked in 2019 alone. Among them Cryptopia and even Binance.
Personal advice: Never leave large sums on centralized exchanges. You can almost always get your coins from the exchange. Move them back if not instant needed to your hardware or private wallet. That is a lot safer and you manage them yourself. This way your coins cannot be stolen during a hack on a centralized exchange.
What types of exchanging your crypto do you prefer ? Centralized or decentralized exchanges ? Have you been a victim of an exchange hack ? Let us know in the comments below.