Centralized exchanges (CEXs) are a type of cryptocurrency exchange that is operated by a company that owns it in a centralized manner.
Centralized exchanges most commonly facilitate trades between users by maintaining an order book: a collection of buy and sell orders posted by individual traders. Orders are requests to buy or sell a certain amount of a specific cryptocurrency at a certain price. CEXs aggregate orders from their users and then use special software to match and execute the corresponding buy and sell orders.
CEX users do not actually exchange crypto or fiat currencies with each other. Instead, when they deposit their funds onto an exchange, the latter takes over the custody of those assets and issues a corresponding amount of IOUs to the trader. The exchange tracks every user’s IOUs internally as they change hands in trades and only converts them into actual currency at the moment of withdrawal of funds.
As of 2020, CEXs are the most widespread mode of operation for cryptocurrency exchanges. The speed and cost-efficiency of processing transactions by a single point of authority make them a convenient venue for day traders and crypto investors to purchase and sell crypto.
The reliance of CEXs on a central entity does lead to some disadvantages, however. Centralized exchanges do not reveal their internal operations to the users, leading to a lack of transparency that enables malicious practices such as wash trading and price manipulation.
The fact that they hold custody over users’ assets makes a centralized exchange a lucrative target for potential attackers both from outside and from within the organization: in 2019, over $292 million worth of customer funds have been lost in just the 12 largest CEX hacks.
Technical issues or coordinated attacks can lead to significant downtime of CEX services, leading to lost trade opportunities for their customers. Finally, centralized exchanges represent an easy target for government censorship, allowing regulators to freeze and/or seize user funds and force the exchanges’ parent companies to reveal their customers’ personal information.