Centralized Exchanges VS Banks: More of the Same?

The world of blockchain brings several new ways of managing your assets.

One of them is centralized exchanges (CEXs), with different products both crypto and fiat money.

Another one is decentralized exchanges (DEXs), which follow the opposite approach of traditional banking.

But as more banks accept cryptocurrencies and CEXs broaden their services, the difference between CEXs vs banks becomes more unclear.

Especially with the fast-paced evolution of blockchain tech.

So, if you want to know the difference and when to use CEXs vs banks, read on.

Quick Takes:

• CEXs offer a wide range of crypto-fiat services around the world as well as faster transactions. Banks are more consolidated in security and regulation, but many don’t manage cryptocurrencies yet.
• CEXs focus on the speed and convenience of crypto-fiat trading. Banks expand on fiat financial products such as credit cards, loans, savings accounts, cash management, and insurance.
• Even though there are differences in security, fees, and features, CEXs and banks both share similar risks. DeFi platforms can offer similar benefits without delegating to a central authority. But there’s a lot left to improve in security, user experience, and liquidity.

Overview of Centralized Exchanges (CEX) and Banks

While CEXs seem to work similarly to traditional banks, they’ve only been around for over a decade. And while banks have thrived for centuries, it’s unknown how they’ll interact with cryptocurrencies. And to know what to expect after mass crypto adoption, we have to know how CEXs and banks work.

Definition of Banks and CEXs

Traditional banks are financial institutions that specialize in lending while offering many related services. Depending on whether it’s a retail, commercial, or investment bank, it may offer personal loans, mortgages, savings accounts, debit cards, deposit boxes, and ATMs.

Their biggest strengths are security and stability. In the rare event of bank failure, it’s likely that government agencies back depositors’ funds. Specifically, central banks are responsible for controlling interest rates and the money supply, thus regulating the economy of their country.

CEXs are regulated trading platforms that might be institutions. The name implies that a central authority or company controls both the services and client accounts. Those wallets can be both or and offline, and clients use them to exchange crypto and fiat currencies.

They’re the opposite of DEXs, where users connect their own wallets and share control over the platform.

Key Differences Between CEX and Banks

CEXs and banks can be confused for three reasons: they can both be institutions, are centralized, and offer broad services. But there are fundamental differences, like:

• Main services: When you remove all extras, a bank is still a bank as long as it accepts deposits and makes loans. As for CEX essentials, it’s the trading platform. 
• Main benefits: Banks are about financial stability, and CEXs, investment flexibility. The most successful banks tend to be more secure, liquid, and regulated. As for the best CEXs, it’s both the asset variety and their time-cost efficiency.
• Payment infrastructure: Except for online banking, banks have convenient ATMs, deposit boxes, and public offices for client support. CEXs aren’t as developed for fiat services, so they have to partner with payment companies to provide them.
• Deposit insurance: Banks are well established legally and insured by the government. Most CEXs aren’t FDIC-insured, and some are unlicensed or under investigation. One way to verify exchange liquidity is with up-to-date proof-of-reserves (PoR), although they’re still uncommon.

• Trust criteria: The way you unlock the best banking services is with an excellent credit score and proof of income. For CEXs, identity verification (AKA KYC) is enough to unlock most features. You unlock the best rates as you increase your trading volume and exchange balance.

CEXs vs Banks: History and Development

CEXs were originally called CCEXs to differentiate between fiat-only and crypto exchanges. They date back to 2010-2011 with Mt.Gox, BitcoinMarket, and Bitstamp. This last platform is one of the few early exchanges that still operate in 2023.

Fiat CEXs have existed since the Amsterdam Stock Exchange in the 17th century. While banking has ancient origins, modern banks appeared in the 18th century, then commercial ones in the 20th, and digital banking by the 21st.

The first bank to add Bitcoin balances and trading was the Swiss Falcon Bank in 2017. Since then, cryptocurrencies gained relevance for institutions like JPMorgan, Fidelity Investments, and Goldman Sachs. It also led to research on central bank digital currencies (CBDCs), the most successful one being the digital Yuan (e-CNY) launched in 2020.

Comparison of CEX and Banks

Now that you know the fundamental differences, let’s compare CEXs vs banks by security, fees, user experience, services, use cases, and accessibility.

The following description considers the most common CEX and bank type. It might not apply, for example, to central banks vs fiat-only CEXs. This comparison is about international crypto-fiat exchanges and traditional retail banks.

Security

There’s no point in showing prices and services if your money isn’t safe first. Security is largely responsible for the mass exodus from CEXs, and it’s the greatest quality of banks. Or at least, as much as centralization allows.

Both banks and CEXs include multi-factor authentication, multi-signature accounts, encryption methods, and audits from third-party agencies. But Banks excel at this feature because of physical security, backup systems, network segmentation, fraud detection systems, and if everything else fails, insurance. It’s worked for them for decades, although with cryptocurrencies that might change.

A secure CEX would assign most of your tokens to offline wallets, or cold storage. Exchanges share how much is online or offline, although in practice it’s not transparent.

Finally, CEXs have stricter (but faster) registration than banks due to risks like cyber-attacks, lack of insurance/PoR, or rapid changes in regulation.

Fees

Both banks and CEXs have complex fee structures. In general, banks have higher fees because of maintenance costs like the staff, ATM machines, or building security. Online banks can be cheaper than CEXs in main services (withdrawing, lending) but then overcharge on others like currency conversion.

It’s typical to charge for monthly maintenance (~$20/mo), overdraft (over $30), wire transfers ($10 - $50), out-of-network ATMs (over $2 each), foreign transactions (up to 3%), and savings account withdrawals (up to $5). It’s possible to waive most fees and only pay $0-$50 per transfer.

CEX fees can be broken down into:

• Trading fees, which can be fixed, percentage-based, or hidden (spreads).
• Payment fees when sending or receiving crypto or fiat

Payments always include external fees, which are blockchain networks or fiat payment platforms. Most actions also require a minimum balance.

User experience

User experience comes down to product variety, design, and how familiar users are with those platforms. CEXs used to be the least beginner-friendly because of the crypto learning curve and the many services they offer. It’s hard to find a CEX that only offers crypto-fiat trading.

Today, some exchanges have Lite versions that disable extra features by default. It’s also possible to trade without the KYC hassle up to a daily limit. And because they’re less established, exchanges offer more rewards to attract new users.

These make CEXs more user-friendly than banks— unless you’re unfamiliar with cryptocurrencies.

Banks have just as many services, except they don’t appear at once. The default product is a deposit account for payments/ deposits/ withdrawals, and as you open specific accounts, you unlock different loans, investment products, and others.

Customer support is the most neglected CEX feature. Traditional banks also have delays and hurdles, but at least it’s a personalized service that you can get in person. In case of emergency or fraud, banks are more diligent than CEXs.

Services

Both CEXs and banks offer countless services, one more than the other when it comes to crypto and fiat respectively. But because they’re better regulated, eventually banks will offer more services than CEXs. It’s easier for banks to include crypto products than for CEXs to include fiat ones.

Yet, the most novel services will appear on CEXs first. You can find all of these:

• Crypto-fiat and margin trading
• Derivatives trading
• Over-the-counter (OTC) trading
• Asset custody/ portfolio management
• Market data and analytics
• Staking rewards
• Crypto lending and liquidity services
• Debit cards
• Peer-to-peer (P2P) marketplaces
• NFT marketplaces

Traditional banks offer:

• Checking and savings accounts
• A broader selection of credit and debit cards
• Personal, business loans, mortgages, 
• Mutual funds, retirement accounts, currency conversions, stocks/ bonds trading, exchange-traded funds (ETFs)
• Certificates of deposit (CDs)
• Estate planning
• Wealth management and trust services
• Wire transfers, bill payments, direct deposits, cashier’s checks, ATMs
• Life, health, auto, property insurance…
• Safe deposit boxes

A crypto bank would also offer wallet custody, trading, conversions, and loans.

Versatility

Exchanges aren’t as versatile as banks for different target audiences. That’s because they’re limited by crypto mass adoption, innovation, and regulation. But banks offer more relevant services whether you’re an institutional investor, business owner, or the average Joe.

CEXs do specialize in different profiles:

• “The best place to buy crypto.” Create the simplest trading platform with many payment options to attract new users.
• “The everything crypto platform.” Add as many features as possible to increase its value for experienced investors.
• The “institutional-grade exchange." Appeal to larger investors by offering deep liquidity, dedicated asset management, or high trading limits.

Business owners can use dApps and crypto payments, but CEXs aren’t a top choice. Individuals find the most value as well as institutions, although those still prefer the traditional banking system.

CEXs vs Banks Pros and Cons

Now that you know the general and specific differences, it should be clear that neither CEXs nor banks can replace each other. Depending on the situation, each one’s pros and cons have different weights. The best you can do is to strategically switch using this knowledge.

Pros: CEX Benefits Over Banks

These are the 5 biggest CEX benefits:

• CEXs offer more competitive crypto services. International exchanges offer the best rates. National ones offer the most convenient payment methods (crypto on-off ramps). Banks are jack-of-all-trades, and cryptocurrencies aren’t their strength.
• CEXs are more accessible than banks. Besides having great rates, they offer a wide range of crypto services (and tokens) that banks don’t. And anyone that passes KYC can unlock the full exchange features. Bank verification is more complex and slower.
• CEXs have more liquidity than banks (in cryptocurrencies). Exchanges are designed for convenience. They’re open 24/7 and are available worldwide, so there’s more trading volume and potential buyers. Banks have neither as much crypto liquidity nor demand.
• CEXs offer higher risk-reward. Investing with banks can be slow and not enough to offset dollar inflation. CEXs offer margin trading and advanced tools, so you can adjust leverage to your risk tolerance.
• CEXs are faster than banks. CEXs can instantly execute orders because of their many active users. As for fiat, note that bank account/card spending is far faster than bank account transfers. CEX deposits and withdrawals (via CEX debit cards) are considered purchases and only take minutes. And so does crypto depending on the network.

Cons: Biggest CEX Limitations

These are the 5 worst CEX cons:

• CEXs have the most security problems. Being the best CEX in the world puts a target on your back. You get attention from hackers trying to break the platform, regulators investigating potential charges, or other exchanges looking to borrow. CEXs have little margin of error and can go out of business at the most unexpected time.

CEXs bring up regulation concerns. Most banks don’t offer crypto services because of the unclear, ever-changing regulations. When they’re too restrictive, CEXs can just relocate to neutral countries. At least banks can guarantee consumer protection and legal compliance.

• CEX customer support is too limited. Some international CEXs aren’t even five years old. They have millions of clients, not enough support staff, and too little control over on-chain actions. Banks might be slower in solving problems, but they’re faster to contact than CEXs.
• CEXs are less stable than banks. In a bear market, CEXs are a bad place to hold crypto. Any black swan event can lead to mass withdrawals and company loan defaults. Cold storage doesn’t help in a collapse, and there’s no deposit insurance.
• CEXs are easier to manipulate. Because of those consequences, CEXs want to appear as trustworthy as possible. Even if that means faking trading volume or using borrowed crypto for PoR. Even the most blatant manipulation can be blamed on cyber-attacks.

Pros: Bank Benefits Over CEXs

These are the 5 biggest bank benefits:

• Banks favor financial protection. Both banks and regulators make efforts to ensure stability via security audits, FDIC insurance, or payment reversals. And whether there’s a bank run, dollar crash, bankruptcy file, or cyber-attack, you’re still better off with a bank than a CEX account.
• Banks have a better physical structure. Offices, ATMs, deposit boxes, sometimes precious metals. If for whatever reason Internet services are unavailable, you still have access to in-person support and untraceable cash. In contrast, a country can restrict CEXs by limiting the Internet infrastructure or prosecuting blockchain users.
• Banks have more product variety. You’re more likely to find relevant products on banks than CEXs whether you’re a retail investor, institution, or business. Eventually the same should happen to crypto services, although without the best rates.
• Banks have a better reputation than CEXs. If you have* to use CeFi, would you rather trust centennial banks or CEXs that get hacked every few years? If you ask regulators, banks. The earliest crypto exchanges are either shutdown or, at best, secondary options. 
• Bank payments are more accepted. If we picked a random person or business, chances are they have a bank account or accept card payments. It’s easier to trade than cash. In comparison, crypto payments are still uncommon.

Cons: Biggest Bank Limitations

These are the 5 worst bank cons:

• Crypto banking isn’t as developed (yet). 2023 Crypto banks look like 2013 exchanges. You can buy Bitcoin/Ethereum, five other coins, maybe convert, stake, and that’s it. CEXs still offer the most trading/investing tools.
• Rates and services are locked behind credit scores. One reason banks are stable is that they protect their assets from unreliable clients. You start with the “worst” rates and services and qualify for better ones as you improve your credit score over the years.
• Banking rates are rarely the best. Because most banks are NOT fiduciaries, it’s not in your best interest to choose their recommended products. 
• Full-featured banking isn’t worldwide available. It doesn’t mean you can’t open an account in a US-based bank. But whether it’s physical or online, international clients will find restrictions. No emergency support, fewer ATMs, and different transaction limits.
• Banks are less efficient than CEXs. Banks have a complex bureaucratic process and outdated technology compared to exchanges.

CEXs vs Banks: Illusion Of Choice?

CEXs offer better crypto services, rates, and liquidity, but your funds might not be there tomorrow. Banks are versatile and stable, but they’re limited and not so competitive. Whether you prefer one or the other, neither banks nor CEXs can prevent the dangers of centralization and trust.

• Lack of transparency
• Single point of failure
• Reduced innovation
• Clearer target for attackers
• Feature restrictions
• Manipulation and censorship 
• No control over custodial funds

DeFi proposes a third solution where trust isn’t necessary. 

It’s a borderless, inclusive financial system that leverages blockchains like Ethereum, Pulsechain, and Polygon. That’s not to say DeFi has fewer risks than CeFi, but at least they’re within each user’s control.