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February072022

Cryptocurrency: The Pros and Cons of Centralized vs. Decentralized Exchanges

Lisa S. Goldman, CPA, TEP, M.TAX, Partner

02.07.22 | TAX Chat

If you’re in the business of cryptocurrency or are thinking about joining the ever-growing number of people who are, odds are you’re hearing the terms “centralized” and “decentralized” quite a bit. Centralized and decentralized currencies have stark differences in security, cost, oversight, and several other areas. Users should review all the options before putting their money into one or the other.

Here’s what you should know.

The Basics

Centralized and decentralized – what do they mean?

Centralized exchanges are operated by one central authority that manages a network of transactions. The company in charge is responsible for holding a ledger, executing transactions, securing user data, and the other responsibilities that come with managing a financial system. Good examples are traditional banks that most people use daily. Have a debit card in your wallet? The issuing bank is the centralized authority.

Decentralized exchanges are the animals of the blockchain and were first used with Bitcoin. They don’t rely on any bank, company, or other centralized authority, but instead use an interwoven system of users and their devices. By widely distributing the network, it gives each user an equal share in ownership and eliminates dependence on any third party.

Security and Hacking

Centralized exchanges are much more susceptible to hacks and data breaches than decentralized exchanges. To infiltrate the system, a hacker need only bypass the defenses of the company running the exchange to access users’ holdings, financial information, and other potentially damaging data.

Decentralized exchanges are nearly impossible to hack, as a person would have to hack every user. The system’s peer-to-peer model leaves little to no room to infiltrate or manipulate.

Privacy

Decentralized currencies give users far more privacy protections than their centralized counterparts. Instead of having to go through the Know Your Customer (KYC) process that centralized companies require for users, peer-to-peer transactions can be done with near-total anonymity, meaning that money can be transferred by virtually any person for any reason.

Usability

Centralized exchanges are drastically easier to use than decentralized exchanges. By entrusting transactions to a company and sometimes paying a small fee, users often get the benefits of easy access to their money (think debit cards and ATMs), tools that help visualize their assets (online banking and apps are great examples), all of which are typically done with easy-to-use and visually appealing platforms.

Liquidity

A major flaw of decentralized exchanges is that they make it very difficult to get cash quickly. Users are often limited on how much they can spend at once and must go through several steps to get from the value on their screens to fiat currency1, especially given that so few businesses accept crypto at the moment.

Control

Though there are benefits to centralized exchanges, they come at the cost of control. On several occasions, they have been accused of manipulating the prices of their currencies, and users oftentimes don’t have complete access. Withdrawal limits and market forces mean it is possible that users cannot access their money at once, and in the worst-case scenario, the money may not be there at all.

Which kind of network catches your eye? For many people, the security, control, and privacy of decentralized networks is paramount. For others, the financial inclusion and monetary stability they get from centralized currencies win the day.

Questions? Contact Lisa Goldman at 212.699.8808 | lgoldman@berdonllp.com or reach out to your Berdon advisor.

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1 Fiat currency – a government-issued currency that is not backed by a commodity such as gold

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