My first contact with cryptocurrencies in 2020 was with a centralised exchange. The process was as simple as making an online purchase, and I quickly got drawn into the crypto craze around the time.
I was constantly checking the price of cryptocurrencies I had spent my allowance on, hoping to become a millionaire overnight.
While that didn't happen, I made decent profits — most of which I lost in subsequent trades.
However, my little trip down crypto memory lane is to point out how vital centralised exchanges (CEX) are to crypto. Though I've used decentralised exchanges (DEX), most of my crypto transactions happen on CEXs.
But things have changed significantly since the FTX debacle. I've moved most of my crypto dealings to decentralised wallets and exchanges based on the advice of senior crypto experts.
In this article, I'll discuss how traders and anyone who plans to venture into the crypto world can use CEXs and DEXs favourably in 2023.
What is the difference between centralised and decentralised crypto exchanges?
The difference between a centralised and decentralised exchange (DEXs) is that the former is an intermediary between you and the blockchain, while the latter offers direct interaction.
A simple way to understand this is to know what crypto wallets are. A wallet is an essential part of any crypto activity, and its primary function is storing cryptocurrencies.
A centralised wallet is provided by third parties like Binance, Quidax, Coinbase, or Bundle. These companies interact with the blockchain on your behalf by carrying out your instructions.
To use such wallets, you create an account just like any other fintech application, complete with KYC protocols, username, and password.
On the other hand, a decentralised wallet is connected directly to the blockchain and does not require any KYC. Instead of a username and password, you get a wallet address and a private key.
Why I moved my crypto to decentralised wallets?
FTX caused many people to reconsider using CEXs. According to Bitcoin.com, $19 billion worth of bitcoin, Ethereum, and stablecoins have been moved from CEXs since the FTX saga.
The FTX collapse gave more meaning to the saying, “not your keys, not your coins,” which means if you are interacting with the blockchain through a central exchange, you can't control what they do with your crypto.
In a conversation with Micheal Ugwu, crypto expert, angel investor, and CEO of FreeMe Digital, he mentioned that self-custody is crucial because human error will always be an issue with CEXs.
With DEXs, protocols, aka computer code, call the shots. Ugwu believes in this model because you don't have to worry about a protocol diverting your funds to conduct illegal trades.
He admits that while protocols aren't foolproof, regular audits of codes will help them remain impenetrable.
How to switch to decentralised wallets and exchanges
For this article, we'll assume the MetaMask wallet is your choice. To get it, you need to visit the MetaMask website and download the Chrome extension. Setting up a MetaMask wallet differs entirely from what you get on Quidax, Binance, or any other central exchange.
You don't need to supply any personal details. However, you'll be instructed to write down a seed phrase which you have to keep safe.
Note: The seed phrase is your private key and your access to your wallet. You will bear the responsibility of keeping it safe; losing it means losing access to the wallet.
The next step is to put some crypto in your newly created wallet. If you have some coins in an exchange, you can send them to your MetaMask wallet by copying the address.
Note: By default, MetaMask is an Ethereum-based wallet and receives Ethereum-based tokens. However, customising it with these four steps will allow you to send other tokens to the wallet.
Beware of phishing scams, as connecting your wallet to a dubious website could lead to a loss
Decentralised wallets and exchanges also have their bad sides
While you can be sure that there’s no Sam Bankman-Fried to divert your funds into illegal trades, decentralised wallets and exchanges also have their risks.
- The safety of your wallet is your responsibility: Losing important data, such as your private key, could lead to loss of funds.
- Any coin can be listed on DEXs: Scam tokens are easily listed on DEXs, unlike centralised tokens. Before a token can be listed on a CEX, it has to go through some due diligence.
- Risk of smart contract exploitation: A DEX with a poorly written smart contract — computer code that ensures fairness — could be exploited by hackers.
- It’s not beginner friendly: DEXs are not easy to use, and you will require some practice before you get the hang of it.
Does this mean you'll never need CEXs again?
With features such as peer-to-peer trading, CEXs play an instrumental role in ramping and off-ramping users (changing fiat to crypto and back to fiat). However, the FTX mess has shown that something is fundamentally wrong with CEXs.
While Ugwu believes the ethos of cryptocurrency is rooted in decentralisation, he admits that some elements of centralisation are still necessary; however, CEXs will require heavy regulation to be trusted.