Centralized Exchange (CEX)

Understanding Centralized Exchanges (CEX)

Centralized exchanges, also known as CEXs, play a vital role in facilitating trades between users. They accomplish this by maintaining an order book, which is essentially a compilation of buy and sell orders posted by individual traders. These orders represent requests to buy or sell a specific amount of a particular cryptocurrency at a predetermined price. CEXs collect and aggregate these orders from their users and use specialized software to match and execute corresponding buy and sell orders.

It is important to understand that CEX users do not directly exchange cryptocurrencies or fiat currencies with each other. Instead, when users deposit their funds onto a centralized exchange, the exchange takes custody of these assets and issues IOUs (I Owe You) to the traders. These IOUs represent the corresponding amount of funds held by the exchange. The exchange internally tracks the IOUs as they change hands during trades and only converts them into actual currency when users withdraw their funds.

As of 2020, centralized exchanges (CEXs) are the most common mode of operation for cryptocurrency exchanges. The efficiency and speed at which CEXs process transactions, under the authority of a single entity, make them a convenient platform for day traders and crypto investors to buy and sell cryptocurrencies.

However, the reliance on a central entity also brings certain disadvantages. Centralized exchanges lack transparency as they do not disclose their internal operations to users. This lack of transparency creates an environment that enables malicious practices such as wash trading and price manipulation.

Furthermore, the fact that centralized exchanges hold custody over users’ assets makes them an attractive target for potential attackers, both from external sources and within the organization itself. In 2019 alone, the 12 largest CEX hacks resulted in the loss of over $292 million worth of customer funds.

Technical issues or coordinated attacks can also lead to significant downtime of CEX services, resulting in missed trade opportunities for customers. Lastly, centralized exchanges are vulnerable to government censorship, as regulators can freeze or seize user funds and compel the exchange’s parent companies to disclose customers’ personal information.