Centralized Cryptocurrency Exchanges
The popularity of cryptocurrency is causing investors to make a beeline for buying into the cryptocurrency boom. The trading activity in these markets has increased manifold in the past few years. However, novice investors can find it difficult to understand how cryptocurrency is bought and sold. This is particularly important since there is more than one way to buy and sell crypto.
Traders often face the choice between centralized and decentralized exchanges when they first start investing in crypto. In this article, we will have a closer look at what centralized crypto exchanges are and we will also understand the pros and cons of investing via these exchanges.
What are Centralized Cryptocurrency Exchanges?
Centralized cryptocurrency exchanges are private corporations that facilitate trading in cryptocurrencies. They provide a platform wherein investors can buy cryptocurrency using fiat currency. Alternatively, they can also convert one type of cryptocurrency into another. These are licensed corporations that have a physical presence i.e., offices, employees, and other such infrastructure.
There are many advantages and disadvantages which need to be understood before deciding whether or not centralized exchanges are more preferable to decentralized ones. The details of these pros and cons have been listed below:
Advantages of Centralized Cryptocurrency Exchanges
- Protects against scandals: The entire world of cryptocurrency is online. Transactions often involve the use of complicated jargon which makes novice investors uncomfortable. Also, the absence of any centralized agency to provide legitimacy makes the transactions risky and even murky to some extent. The cryptocurrency investors have faced their own fair share of scandals. Conservative investors want to ensure that they deal with a reputable intermediary to protect themselves against such scandals. This is where centralized exchanges are viewed in a favorable light. Since these corporations have a physical presence and are regulated by the government, investors feel that they can avoid scandals by using the services of these exchanges.
- Can be Accessed by Institutional Clients: There are several institutional investors who want to invest in cryptocurrency for the sake of diversification. However, they are unable to do so since their bylaws require them to only deal with reputable parties. For such entities, centralized exchanges are very important since they provide the only mechanism to invest in the cryptocurrency markets.
- Service: Centralized exchanges provide a very important service to cryptocurrency investors. These exchanges have call centers where customer service personnel are trained to explain the nuances of cryptocurrencies to traders in an intuitive and easy-to-understand manner. Also, centralized exchanges provide custodian services. This means that they have a specialized infrastructure to store digital currency. These exchanges provide digital vaults which are highly secure. Some of these exchanges even provide services wherein the digital coins are stored offline in a special form of hardware. These services are very valuable for investors who are concerned with the security of their investment.
- Insurance: Cryptocurrency exchanges know that no matter how high-tech their security is, they will still be prone to digital attacks. It is for this reason that the funds at a cryptocurrency exchange are insured. Of course, an additional fee is charged to provide such insurance. However, it offers peace of mind to investors who may be constantly worried about the possibility of digital attacks.
- Investing Tools: Lastly, centralized cryptocurrency exchanges also provide value-added services. These services include charting tools that help the investors by providing information in an organized manner and aid in decision making.
Disadvantages of Centralized Cryptocurrency Exchanges
There are several disadvantages to using centralized exchanges as well. Some of them have been written below:
- Fewer Options: Investors on centralized exchanges end up trading variety for safety. In most centralized exchanges, only 40 to 50 types of cryptocurrencies are available for trading. This is a small fraction of the total number of cryptocurrencies in the crypto universe. Since these exchanges are very concerned about their reputation, they only allow reputed cryptocurrencies to list. However, this also reduces the number of trading options. Reduced options also have a financial impact since most of the growth in the past few years has come from newer cryptocurrencies.
- Strict Regulations: Centralized exchanges are licensed by the government. As a result, they have to follow strict government norms. The know your customer (KYC) norms at some of these exchanges are equivalent to those of big banks. Centralized exchanges deal with a wide variety of regional and federal government agencies. The data at these exchanges may also be accessed by these agencies. These strict regulations are a deal-breaker for many investors who prefer privacy.
- Risk of Bankruptcy: The centralized exchanges are also private corporations. Hence the money which is in their custody is in effect a loan which an investor has given to them. Wherever there is a loan, there is always a chance of default. Up until now, there has not been any news of the bankruptcy of any exchange. However, there is always a possibility that this might happen in the future. Investors who use these centralized cryptocurrency exchanges run the risk of losing money as a result of such bankruptcies.
The reality is that centralized cryptocurrency exchanges provide some legitimacy to the trading of these digital currencies. In the absence of these exchanges, entering and exiting cryptocurrency markets can be fraught with risk and uncertainty.
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The article is Written By Prachi Juneja and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
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