Centralized vs Decentralized Exchanges - Valkyrie

Centralized vs Decentralized Exchanges

Key Takeaways

  • Centralized exchanges, such as Binance, Coinbase, Kraken, Crypto.com, or Gemini, allow investors to exchange fiat currencies like US dollars for cryptocurrencies.
  • These exchanges have the look and feel of a traditional brokerage account and offer services such as beneficiaries and password resets.
  • Centralized exchanges generally do not allow investors to be anonymous, as regulators require them to follow know your customer (KYC) regulations.
  • While centralized exchanges may offer access to approximately 50 cryptocurrencies, unregulated decentralized exchanges (DEXes) offer access to hundreds or thousands of cryptocurrencies.
  • DEXes do not require KYC verification and require investors to control their own wallets and private keys.

Most crypto investors will buy their first digital assets on an exchange, such as Binance, Coinbase, Kraken, Crypto.com, or Gemini.  Centralized exchanges allow access to cryptocurrencies in a format that will be familiar to anyone who has an online brokerage account that facilitates investments in stocks, bonds, ETFs, and mutual funds.  Centralized exchanges require investors to verify their identity while providing services such as beneficiary identification and password resets. 

These exchanges offer fiat on-ramps, which allow the conversion of fiat currencies such as US dollars into cryptocurrencies.  Fiat off-ramps allow for the conversion of cryptocurrencies into fiat assets. 

Centralized exchanges may be regulated or unregulated.  Regulated exchanges may allow access to a limited number of cryptocurrencies, with the five exchanges noted above offering access to a maximum of approximately 50 cryptocurrencies.  Cryptocurrencies are accessible on centralized exchanges when the exchange determines that offering the currency doesn’t violate any regulations.  For example, many exchanges delisted XRP when the SEC accused Ripple Labs of selling unregistered securities. 

While centralized exchanges may be convenient to access, investors are cautioned to understand the security implications of allowing the exchange to hold their cryptoassets in custody.  The saying “Not your keys, not your crypto” was coined in reference to centralized exchanges.  Centralized exchanges hold the private keys that allow access to cryptoassets.  If the centralized exchange is hacked and your private keys are revealed, your assets are vulnerable to loss. 

In contrast, some investors prefer decentralized exchanges (DEXes), which are generally unregulated.  The unregulated nature of DEXes allows investors to access hundreds or thousands of cryptocurrencies while they personally control the custody of their cryptoassets in an unhosted wallet.  An unhosted wallet can be created without identification of the user and transactions can be made on a relatively anonymous basis.  Most DEXes are non-custodial, meaning that they simply execute transactions without ever taking control of investor assets.  Decentralized exchanges allow the transfer of value of one cryptocurrency for another.  A DEX such as Uniswap, Sushiswap, or PancakeSwap will take one cryptocurrency, such as Ether, as an input, and quickly swap the value of Ether and return the output in the trader’s desired cryptocurrency. 

Decentralized finance may also refer to decentralized borrowing and lending platforms.  In decentralized borrowing and lending, DeFi platforms like Aave and Compound allow participants to deposit crypto assets to earn yield or to take loans using their digital assets as collateral.  While traditional banks are still largely hesitant to lend against crypto collateral, loans can be approved and processed in minutes in DeFi platforms.