What Are Centralized Cryptocurrency Exchanges?

What Are Centralized Cryptocurrency Exchanges?

Centralized cryptocurrency exchanges are regulated businesses that facilitate cryptocurrency buying, selling, and trading. They act as an intermediary, attempting to provide a safe way to connect users to each other and as a way to exchange fiat and cryptocurrencies.

History of Centralized Cryptocurrency Exchanges

The primary reason centralized cryptocurrency exchanges emerged is because, initially, cryptocurrency transactions were difficult to make. You needed to be familiar with the command line to use the programs, trust the person or entity you were transacting with, not make any mistakes while typing commands and long addresses, and much more. Investors became interested in the possibilities of returns and needed an easier and quicker way to buy and sell.

Entrepreneurs, seeing an opportunity, created business models for exchanges that stored private keys and connected buyers and sellers. This distinguished them from decentralized exchanges, which are not run or controlled by a single entity. Rather, they are controlled by a community that has governance rights over the exchange, voting on the way the exchange runs or changes being proposed.

Eventually, centralized exchanges began providing the same services that stock and commodities exchanges provide, which attracted the attention of regulators worldwide.

Key Elements of Centralized Crypto Exchanges

Centralized cryptocurrency exchanges are businesses. They operate for a profit while providing services that people demand or that make cryptocurrency transactions more simple.

Some of the other elements that make a cryptocurrency exchange centralized are:

• Ownership by a single entity or group
• Governed by this group or entity
• Provide security measures for users
• Manage user accounts and capital
• Settle disputes for parties
• Allow fiat currency and cryptocurrency exchanges
• Match buy and sell orders between customers
• Collect identifying information about users
• Place funds in escrow services to protect users

Centralized vs. Decentralized Exchanges

The most obvious difference between centralized and decentralized exchanges is ownership. However, there are many more elements that make them different.

Centralized exchanges can be used to conduct exchanges from fiat to cryptocurrency (or vice versa). Decentralized exchanges do not provide this service, only allowing crypto-to-crypto exchanges.

Decentralized exchanges are often thought of as a "trustless" environment, functioning as peer-to-peer exchanges. Assets are never held by an escrow service, and transactions are done entirely based on smart contracts and atomic swaps and only between users.

Centralized exchanges hold assets and conduct the exchanges for users, rather than users interacting directly with each other.

Decentralized exchanges are generally also not regulated and are similar to traditional over-the-counter markets, which are also not regulated.

Fiat/Cryptocurrency Pairs

It's common for a centralized exchange to offer cryptocurrency/cryptocurrency pairing. This allows customers to trade, for instance, bitcoin for ether. They also tend to offer fiat currency/cryptocurrency trading pairs, which allows cryptocurrency traders to take part in foreign exchange markets and other currency trading in addition to converting cryptocurrency to fiat.

Some of the largest centralized cryptocurrency exchanges in the world offer these fiat/cryptocurrency pairs; however, they are regulated more heavily in some jurisdictions than others.

Concerns About Centralized Crypto Exchanges

Cryptocurrency is relatively new, and there are many horror stories about exchanges shutting down, being robbed, or being scams. Centralized exchanges are generally a much safer choice for people getting started in cryptocurrency; however, this is not always the case. FTX, one of the biggest centralized exchanges, shut down in late 2022 after it was discovered its owners were running a fraudulent operation. Billions of dollars in cryptocurrency were basically stolen from its users.

The key lesson behind FTX's fraud and eventual failure is that even a centralized and regulated exchange can be risky for investors. But some exchanges have, so far, proven to be trustworthy, even though they have all had regulatory run-ins during their early years. Some of these exchanges include Coinbase, Robinhood, Kraken, Gemini, and Binance—but by no means are there any guarantees that your cryptocurrency is 100% safe with them because of hacks, theft, and even employee issues. When choosing a centralized cryptocurrency exchange, make sure you understand its policies and how your money is protected.

The Bottom Line

Centralized cryptocurrency exchanges are online trading platforms that facilitate cryptocurrency exchanges between customers who prefer a familiar trading environment. These platforms are often used to store cryptocurrency and expose traders and investors to assets that are otherwise difficult for many people to access.

The comments, opinions, and analyses expressed on Investopedia are for informational purposes online. Read our warranty and liability disclaimer for more info. As of the date this article was written, the author owns BTC and XRP.