The centralized cryptocurrency acts as the trusted third party between the buyer and seller. Both the parties trust the exchange with their funds, and they deposit their funds in the exchange’s wallet.
Though, the whole concept of cryptocurrency was to give an alternative to the centralized banking system. The point was to give investors an option where they do not need to go through the banking process which has control over their investments.
The reality, however, is that around 99 percent of trading occurs through these centralized exchange. It will not be an exaggeration to say that these exchanges are working as a backbone of the blockchain industry.
These exchanges store both the fiat and crypto assets of its clients. Hence, they also act as the custodian of funds. The centralized exchanges have become the conventional platforms to buy cryptocurrency in exchange for your fiat.
How centralized asset exchanges work?
The exchange gets all control over the clients’ money, one gives their funds to these exchanges. Once, an investor decides to deposit their money on an exchange, they transfer the amount from their bank accounts to the exchange’s bank account.
Even bitcoins from the client’s wallet goes to the exchange’s portfolio. When it comes to the client’s balance, the exchange is the only source, and in case of any doubt or confusion, you have nowhere to go and becomes dependent on the exchange’s database.
When you open an account with an exchange, though it appears on your name it’s the exchange that has all the power on your funds as the amount you have already transferred to the exchange’s bank account.
This entire system has a large bank account on the exchange’s name, a large wallet and an internal database that maintains the balance.
The centralized database is a huge component here as it maintains the records of balances of all the clients.
As a trader, you have no ownership of your funds. When you plan to leave an exchange and withdraw all your money, then the amount you can withdraw is the one you have as the balance with the exchange, if you think the balance amount is different than what you think it should be, you can’t do anything about this.
Hacking of a centralized exchange
When the hackers get access to the exchange, what they do is, they change the balance in the database and withdraw all the money. That’s a considerable risk for the clients, and one must be aware of all the risks.
One always have plenty of options for the new centralized exchanges. However, not all of them becomes successful, and the success and failure depend on many factors. One of the critical factors on which the success of a centralized exchange depends is the number of clients trading on it, that is, the volume.
Another critical factor is the security measures to protect investors. Here no one is entirely immune from hacking and fraud, but there indeed are factors which can be considered to choose a centralized exchange which is comparatively less risky.
Market research and thorough understanding of how this market works are fundamental before you do trading with the exchanges.
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