What is a centralised cryptocurrency exchange?

Centralised cryptocurrency exchanges offer familiarity and ease of use, but are they right for you?

Centralised organisations have become part of everyday life: our banking systems, governments, and nations as a whole are very centralised. Centralised cryptocurrency exchanges are the most commonly used form of exchange to control digital currency. However, what exactly does that mean? Is this a good thing? Or perhaps an area for improvement? Let’s have a look at what centralised cryptocurrency exchanges are and whether they’re the right choice for your needs.

Centralised cryptocurrency exchanges

A centralised cryptocurrency exchange is an exchange that acts as a third party to help carry out transactions. Traders must rely on the exchange to act as a middleman when handling their assets, much like a bank acts as a middleman when holding your money and carrying out transactions.

Centralised exchanges are therefore seen as a more reliable and familiar, especially for beginners. They can offer security and monitoring that you may not be able to do on your own, and traders are able to trust that the exchange will carry out requested transactions for them and can also utilize the network of connections on offer in order to trade more easily.

There’s always a concern that third parties may have security vulnerabilities, but they can also offer a less risky or more practical method of trading cryptocurrency. A completely trusted middleman—in charge of handling money from point A to point B or providing safe asset storage—can make transactions easier and reduce consumer risk.

On the other hand, having a third party involved in a transaction that could be handled equally as well—if not better—through a direct manner is usually unnecessary; it clogs things up and results in a more expensive experience for both the producer and the consumer. After all, the middleman needs to get paid, which ultimately ends up cutting into profits or increasing costs.

Pros and cons

A party that holds large amounts of meaningful data is a party with a great deal of control. Take traditional banks for example. Your account information—including your balance, transaction history, and personal details—is all contained within an internal, centralised database. The tech giants of today (Facebook, Google, etc.) are mostly all heavily-centralised institutions which hold massive pools of data. Your data. My data. Everyone’s data. This is centralisation at its finest, and if you’re not careful, it could become a problem.

In a similar way, centralised cryptocurrency exchanges can present problems to investors. This type of exchange stores your funds in dedicated, unique cryptocurrency wallets, but it holds the private key(s). Essentially, the exchange has all the control over your digital assets. This can be disconcerting for hands-on investors who prefer to be in complete control of their assets, and can also lead to security issues should the exchange be targeted by hackers.

Multiple centralised exchanges have been hacked in the past (and the cryptocurrency equivalent of billions of dollars have been stolen), so the bottom line is that storing your cryptocurrency on a centralised exchange can’t be considered 100% safe. It’s worth noting however that more established centralised exchanges are taking steps to increase security, with Coinbase also offering insurance of up to £250,000 in the event of a hack. This increased security does come with higher transaction costs, but if you’re particularly concerned about security you may think it’s worth it for peace of mind.

At their core, cryptocurrencies and blockchain were made for decentralisation, and that is probably the direction future exchanges will be heading. Nonetheless, centralised exchanges are widely used by investors; they can provide workable solutions that are simply good enough.

A positive aspect of implementing centralised practices in cryptocurrency exchanges is that it’s what people are used to. Given a similar process of signing up for an online account, logging in to make transactions, and seeing your balance stored on an app or website, users of centralised exchanges are likely to find the process easier and quicker to adapt to. This makes them especially appealing to beginner crypto traders.

The whole commotion surrounding private key storage and setting up different types of cryptocurrency wallets can be confusing, overwhelming, and deter potential investors from entering the crypto space. We live in the age of passwords, and that’s what people are used to. Using familiar processes is perhaps the easiest way for new exchanges to attract new customers.

Thankfully, new log-in methods extend beyond basic email/username and password combinations. Almost all secure exchanges now offer additional layers of account protection, such as email verification or Google Authenticator codes. The majority of cryptocurrency exchanges might still be centralised, but that is perfectly OK if your data is protected.

Some might say using a centralised cryptocurrency exchange leads to a more stressful experience. Centralised exchange hacks have happened, and people have lost all of their on-exchange investment funds overnight. However, having the ability to recover lost or forgotten passwords through an exchange can also save you a lot of hassle and pain. There is much more control in holding your own private keys, but simple storage on a centralised exchange is still the go-to method for many investors. As such, expect centralised exchanges to continue popping up. To successful founders who can eliminate security concerns, these exchanges are money printing machines.

Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.