Centralized Exchanges: Everything to Know

By  Beluga Research July 12, 2023

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Summary

  • A centralized cryptocurrency exchange is run by a single entity, typically a company or organization
  • This type of exchange will require a user to create an account, provide personal information and verify identity before trading
  • A centralized exchange offers more liquidity but perhaps less security than a decentralized exchange
  • Examples of centralized exchanges include Coinbase and Kraken

Overview

A centralized exchange is a cryptocurrency exchange controlled by a single entity. A centralized exchange allows users to buy, sell, and trade digital assets such as bitcoin, ether and other cryptocurrency. Centralized exchanges are more popular than other trading alternatives like decentralized exchanges. This is because they have higher liquidity, provide more user-friendly interfaces and allow for the trade of a wider range of cryptocurrencies.

Centralized exchanges are generally run by a company or organization. This entity acts as an intermediary between the buyers and sellers. The entity mandates that a user create an account, provide personal information and verify identity before trading. Centralized exchanges store user funds in a wallet that the exchange manages. This can be a cause for concern as such wallets are susceptible to hacks and other security breaches.

A Brief History

The first cryptocurrency exchange, BitcoinMarket.com, was launched in 2010. In 2011, the first centralized exchange, Mt. Gox, was created. At its peak, Mt. Gox was responsible for over 70% of all Bitcoin transactions. In 2014, Mt. Gox experienced a hack that resulted in the loss of over 850,000 bitcoins. This event highlighted the vulnerability of centralized exchanges. It also showed the need to improve exchange security.

Since then, companies have developed a number of centralized exchanges, which include Coinbase, Binance and Kraken. These exchanges have implemented various security measures to prevent hacks. Popular concepts include two-factor authentication, cold storage and regular security audits. Despite the risks associated with centralized exchanges, they remain the most popular way to trade cryptocurrencies. This is because they offer more convenience and ease than decentralized exchanges.

What Is a Centralized Exchange?

A centralized exchange is a cryptocurrency exchange controlled and operated by a single entity. This entity requires users to create an account. A user must provide personal information, including their name, address and phone number. Users must verify identity by sharing identification documents like a passport or driver's license.

After a user has created an account and verified their identity, they can deposit funds into their account and start trading. Centralized exchanges offer a wide range of trading pairs. Users can trade cryptocurrencies against fiat currencies such as USD, EUR and GBP and against other cryptocurrencies.

When a user places an order on a centralized exchange, the exchange matches the order with an opposite order from another user. The exchange then executes the trade, deducting fees from both users' accounts for the transaction. These fees vary depending on the exchange. They can range from a fraction of a percent to several percent of the transaction amount.

Centralized exchanges store user funds in wallets managed by the exchange itself. To mitigate the risk of hacking, many exchanges implement security measures such as two-factor authentication.

Getting Started

  • Create an account. A user must provide their name, email address and a password. Some exchanges usually require additional personal information, like government-issued identification or proof of address.
  • Deposit funds into an exchange wallet . A user can utilize a variety of payment methods, like a bank transfer, credit card or cryptocurrency transfer.
  • Start trading . Centralized exchanges offer a wide range of trading pairs. This allows a user to buy and sell different cryptocurrencies against one other or against fiat currencies, such as USD or EUR. Making a trade requires selecting the trading pair to use. The user should specify the amount they want to buy or sell and place their order. The exchange will then match their order with another user's order to execute the trade.

Unique Aspects

  • User-friendly interface . These exchanges are designed to be easy to use, even for people who are new to cryptocurrency trading. They offer a variety of tools and features that help you track trades, analyze market trends and make informed trading decisions.
  • High liquidity . Since centralized exchanges are owned and operated by a single entity, they can offer a high level of liquidity for a wide range of trading pairs. A user can buy and sell cryptocurrencies quickly and easily. They do not have to worry about finding a buyer or seller.
  • High level of security . These exchanges are responsible for storing a user's funds. They have a strong incentive to protect the accounts and funds from theft and hacking. The entities operating the exchanges use a variety of security measures, including Secure Sockets Layer (SSL) encryption.

Advantages

  • Liquidity . Centralized exchanges offer high levels of liquidity. Users can quickly buy or sell cryptocurrencies at market prices. The smooth trading experience is due to the fact that centralized exchanges have a large number of buyers and sellers.
  • User-friendly interface . Centralized exchanges have user-friendly interfaces. These make it easy for users to navigate the platform. This is helpful for new users who find it challenging to access complex platforms.
  • Security . Centralized exchanges have advanced security measures in place to protect user funds. This includes multi-factor authentication, cold storage and regular security audits. The security measures make it difficult for hackers to steal user funds.
  • Customer support . Centralized exchanges have customer support teams that are available 24/7 to assist users with any issues they may have. This is beneficial for users who have technical issues or questions about the platform.
  • Fiat currency support . Centralized exchanges support fiat currencies. This allows users to easily convert their cryptocurrencies into traditional currencies like USD, EUR and GBP. The support aids users who want to cash out their cryptocurrencies or use them to purchase goods and services.

Disadvantages

  • Centralized control . Centralized exchanges are operated by a single entity. The entity has complete control over the exchange. This can be problematic if the entity decides to freeze user accounts or delist cryptocurrencies without warning.
  • Lack of anonymity . A centralized exchange requires users to provide personal information to use the platform. Users' transactions are not anonymous. This can be a concern for users who value privacy.
  • Risk of hacking . Centralized exchanges are often targeted by hackers who attempt to steal user information and funds. Although centralized exchanges have advanced security measures in place, they are not foolproof. Hacks can occur.
  • Fees. Centralized exchanges charge fees for trading cryptocurrencies. The amounts are usually higher than fees charged by decentralized exchanges. This can be a concern for users who want to minimize the costs of their trades.