What is a Centralized Cryptocurrency Exchange (CEX)?

By Gaurav Roy

If you want to buy and sell crypto, then you will need a crypto exchange, which comes in two main types: centralized and decentralized. Both types of exchanges are an essential part of the crypto economy and each has advantages, disadvantages and unique features. Put simply, they are necessary for accessibility and ease of use, making it possible for new crypto users to exchange their fiat currencies, such as dollars or euros, for crypto.

Many centralized cryptocurrency exchanges  (or CEXs) work much like banks. In short, they usually require users to forfeit custody of their keys.  However, not all centralized exchanges work in this way, and they do come with certain unique benefits.

But what is a CEX, what are those unique benefits and why are they important for the success of the crypto industry?

Let’s get started!

What is a Centralized Cryptocurrency Exchange (CEX)?

A centralized exchange is a platform owned and operated by a single entity acting as an intermediary between buyers and sellers. This middleman or third party helps conduct transactions by providing liquidity for supported tokens. 

The centralized platform uses an order book system to establish crypto prices, much like a traditional bank does. Here, a user typically deposits funds into an account held by the exchange, which acts as a custodian of those funds. 

Users trust the platform to handle their funds fairly and securely. The crypto exchange matches buyers with sellers, or vice versa, and executes trades on their behalf.

Features of a Centralized Exchange

So what features does an exchange need to have in order to be “centralized”? Well, most centralized exchanges follow a similar model. Let’s take a look at what makes them unique.

Governed by a Single Entity

The defining feature of a centralized exchange is that it is controlled by a single entity, allowing for faster decision-making and subsequent implementation of strategies. This means more streamlined and efficient services. 

As a result, CEXs can offer features like advanced trading tools, fiat currency support, simplified account management, and customer support. This allows them to attract a large number of users and offer higher trading volumes and increased liquidity which translates to faster trade execution and tighter bid-ask spreads.

But one organization in control means a single point of failure. Any issue on such a platform can have widespread consequences, be it a technical glitch, server outage, or financial difficulty. Plus, since centralized exchanges are governed by a single entity, it means they are subject to the regulations in a specific region. This can leave your funds vulnerable to regulatory action–which is especially worrisome in countries with draconian laws.

Not to mention, you are trusting the exchange to execute your trades fairly and honestly. If a centralized entity decides to mismanage your funds, there’s not a lot you can do. This creates a risk of front-running, market manipulation, or even insider trading.

Finally, centralized management means that company policy is often opaque–you don’t know the principles on which the exchange operates. That may be fine if you use an exchange purely for buying crypto, nd choose to store your assets elsewhere. However, most centralized exchanges don’t work like that. Let’s explore why.

Custodial Wallets

When it comes to security, centralized exchanges implement several measures to protect users’ funds and personal information: a password, two-factor authentication (2FA), cold storage, withdrawal restrictions, and regular security audits.

However, a CEX usually requires you to use their own custodial wallets. This means you are depositing your funds into accounts under the exchange’s control. You receive the login details to access the wallet, but you don’t actually own it. Instead, the exchange holds the account’s private key, and you are simply “borrowing” the wallet to transact and store your crypto. This lack of ownership comes with a risk: It means that the centralized entity that controls your funds may revoke your access at any point. 

For this reason, many centralized exchanges, such as Kraken, recommend that you transfer your funds to non-custodial wallets as soon as you’ve made your crypto purchase. Even centralized exchanges themselves acknowledge that managing your funds yourself is always the best answer.

Require KYC

Finally, CEXs also require official documents to verify your identity. That’s because CEXs are businesses and, therefore, subject to local laws. This means by using these sorts of exchanges,  you lack privacy, being forced to share your sensitive information with centralized entities.

How Do Centralized Exchanges Work?

A centralized exchange uses an order book system to facilitate crypto trading. The order book is an electronic list a CEX maintains. It lists all the buy and sell orders, displaying the price and quantity of each order. An order book records ongoing trading activity and allows the user to see the current market depth and liquidity.

The way it works is: users place a buy or sell order on the CEX, and when the order finds a compatible price, the exchange matches the orders and executes the trade for a fee.

For instance: If A wants to buy 1 BTC at $30k and B wants to sell 1 BTC for $30k, the exchange will match A and B seamlessly.

Centralized Vs. Decentralized Exchanges (CEX VS DEX): What’s The Difference?

As users seek greater control over their assets, the growing demand for self-custody has led to the emergence and popularity of decentralized exchanges.

The key defining feature of a decentralized exchange is that instead of an order book, it uses an Automated Market Maker (AMM) to eliminate all intermediate processes in crypto trading. 

AMMs use smart contracts to determine prices and provide liquidity. For this, users deposit assets into smart contracts called liquidity pools. These pools automatically execute trades based on predefined mathematical formulas rather than relying on individual buy and sell orders.

Unlike a CEX, a DEX does not support custodial infrastructures where the exchange holds all the wallet’s private keys; rather, it allows you to be in control of your funds. When using a DEX, you simply connect your non-custodial wallet to trade crypto and use your own private keys to manage your funds.

Examples of Centralized Exchanges

Today, there are hundreds of centralized exchanges operating in the crypto market. Some of the most notable include:

Binance: The largest centralized exchange in the world, Binance was founded in 2017. It is home to thousands of cryptocurrencies and millions of users. 

Coinbase: The most commonly used CEX in the US, Coinbase is a publicly-traded company founded in 2012. It’s easy to use but comes with high fees.

Kraken: One of the most trusted centralized exchanges, Kraken was founded in 2011 and is known for its low fees. It is a suitable option for intermediate and expert crypto users.

Do I Need To Use a Centralized Exchange?

If you want to buy crypto using fiat currency, say USD, you would have to use a centralized exchange, as most DEXs do not support fiat currencies such as dollars or euros. Instead, they only accept crypto. This means to buy crypto for the first time, and you will usually need to use a CEX and undergo the KYC process at some point.

So you might be thinking, “How do I go about buying crypto without forfeiting the custody of my funds?”

Using a Centralized Exchange Securely

Well luckily, there is a way to buy crypto without forfeiting the ownership of your private keys. But how? The answer is simple; Yes, you can buy crypto directly from a CEX using Ledger Live.

With a Ledger device, you can connect to Ledger Live and buy crypto via an on-ramp partner. This allows you to buy cryptocurrencies and protect them with your Ledger directly. Put simply, you don’t have to forfeit any ownership of your cryptocurrencies, plus you can buy and sell cryptocurrencies at will. So, if you really must interact with a centralized exchange, you don’t have to give up your ownership rights.

Your other option is to use a centralized exchange and then migrate your crypto assets to your Ledger. So how does this work? To learn more, check out our article on how to migrate your crypto to your Ledger. But essentially all you have to do is:

1. Set up an account on your Ledger device  for the crypto you want to send
2. Buy the asset on a centralized exchange using your bank card or fiat currency
3. Send the assets to your newly-created account for that specific asset
4. Let your assets enjoy the security of your Ledger device!

In conclusion, while crypto exchanges may seem overwhelming, both centralized and decentralized exchanges have their clear benefits and risks.  If you want to buy crypto from an exchange, it’s important to know how safe your assets are, and whether you even retain ownership of them. All in all, crypto security is in your hands, because that is what self-custody is all about.