The Centralized Crypto Exchange or custodial exchange is referred to as a business that provides traders with a platform to trade crypto assets. It acts as an intermediary or a third party between the buyers and the sellers and makes a profit from the transaction and commission fees. After trading, the crypto assets are automatically stored in their built-in exchange wallets, which are controlled by the exchange itself. This signifies that the control of the private key is with the custodial exchange and not the traders until you transfer your assets to a decentralized crypto wallet.
Now, the question arises “how secure are the exchange wallets?”, as we daily hear about fake crypto exchanges. Several factors help the user to select a legit exchange wallet. The custodial exchange wallets are relatively secure but the traders shouldn’t be holding their assets there for too long. Moving ahead in the crypto ecosystem, we will be covering the centralized exchange wallets in this chapter. For better understanding, we will be covering the working of the centralized exchange, the risk, how to prevent them, and a comparison between top exchange wallets.
Centralized Crypto Exchange wallets:
The exchange wallets allow the user to store their crypto assets on the same platform where they can instantly sell or buy crypto. The users and traders can conveniently hold their crypto assets in exchange wallets after performing trade. This minimizes the cost to move funds from the exchange to the crypto wallet and vice versa.
The centralized or custodial crypto exchange wallets provide the user with both security and monitoring that an individual can’t achieve alone. These platforms are like online brokerage platforms, which provide users with services that help the user buy and sell the cryptocurrency that they want. Hence, the centralized crypto exchange provides the user with better usability and charges a significantly less fee for the transaction as compared to the decentralized exchanges. Custodial exchanges like Binance and Coinbase execute over centralized servers and provide a similar experience to traditional stock exchanges.
Why do you need Crypto Exchange Wallets?
Imagine that there are no crypto exchange wallets. Now, if you want to buy a cryptocurrency what would you do? You will have to find another person who wants to sell that kind of cryptocurrency. Then both of you need to agree on the exchange rate and then they will transfer you the cryptocurrency in exchange for the price which you agreed on. This of course is a more complicated process compared to what we do today. Nowadays, you can easily find a buyer or seller just by logging into your exchange wallet. The exchange will not only keep your crypto assets secure but will also invest its network energy in finding an adequate trader for the user. Hence, trading through exchanges is the easiest and most common way of buying and selling cryptocurrencies.
How does a centralized crypto exchange work?
In the front, the working of the centralized crypto exchange is similar to the traditional banking system. The exchange will act as a middle-man that holds your crypto assets like a bank. The user needs to complete KYC verification to access their crypto assets as we do in other banking applications. After complete identity verification, the user can deposit crypto and start trading.
However, in the backend, the mechanism is entirely different compared to the traditional banking system. Cryptocurrencies are virtual assets that don’t exist physically as compared to the money in a bank. So, securing them means a completely different network. In order to secure and store the private keys, exchange wallets utilize a different approach. They use three sub-layers that are cold wallet, warm wallet, and hot wallet.
The hot wallet, also known as the online wallet, is utilized to perform all the withdrawals of the users. The users can directly access the hot wallet to perform their daily transactions. However, here the security assurance is limited as it is connected to the internet. So, the exchange wallets only hold a fixed amount of crypto in these wallets which is sufficient for daily operations. Warm wallets are similar to hot wallets only, but in exchange, they work as an intermediary between cold and hot wallets. So, if a malicious attack infects the hot wallet, they shouldn’t be able to directly access or reach the cold wallet. The cold wallet, also known as the offline wallet, is utilized to store more than 90% of the total fund. It is responsible for maintaining a fixed fund threshold of the warm wallet. In case, the crypto in the warm wallet decreases, the cold wallet is utilized to transfer the required amount. In order to secure the private keys from any kind of security breach, the cold wallet is kept isolated from any link to the internet.
Illustration of how to exchange wallet works:
Is the exchange wallet safe?
Yes, the exchange wallets are secure for performing trades but they are not protected enough to store the crypto. Hackers don’t usually try to exploit vulnerabilities in wallets directly as it is very difficult. However, they are interested in crypto exchanges as they are centralized and have a single point of failure, which makes them a hot target.
There are the following risks that you should know before using the exchange wallet. The risks are listed below:
- Not secure from hackers: For a short time, the exchange wallets are secure to use and do trading. However, for a long time, exchanging wallets is not recommended. This is because the exchange wallets hold a lot of cryptocurrencies making them a hot target for hackers. In the second case, it is possible that the exchange gets shut down due to some reason that will also end up exhausting your cryptocurrency. Hence, the user should always transfer their cryptocurrencies into cold wallets to keep them secure.
- Mismanagement in exchange: It is possible that your exchange may lose or mismanage the user’s private keys. For an instance, in January 2019, the 30-year-old CEO died with nearly $190 million worth of private keys. Because of this many users from Canada and around the world faced a big loss. Therefore, the exchange wallets are just financial services that don’t guarantee high security to the funds.
Hence, always choose a high-security, reputed exchange wallet for performing transactions. In case you need to hold funds for a long period, it is recommended to store them in crypto wallets. PrimaFelicitas is the top cryptocurrency wallet development company that offers exceptional features in cryptocurrency exchange development, such as High transactions per second, Multi-layer security, KYC, AML Compliance, Multi-Currency support, Digital Wallet, and Margin Trading.
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Preventions to be considered while using centralized crypto exchange wallets:
With the increasing value of crypto, there is a greater responsibility of both the exchange and the users to keep their crypto safe. As the exchange keeps on improving with the transforming crypto environment, it also becomes the user’s responsibility to ensure security from their end. The following are a few precautions to be performed while using the exchange wallets:
- Use a reputed exchange wallet: Before selecting an exchange, it is very important for the user to perform good research about different exchange wallets in the market. The user should look for security features that the exchange utilizes. Research the exchange wallet and whether it has already been compromised in history or not and select wisely.
- Regularly change passwords: In the era of security breaches, it is a good practice to regularly change your password. It is recommended to create a complex password, store it safely somewhere, and change it regularly.
- Use multi-factor authentication: The user can enable two-factor authentication for safeguarding it with an additional layer. The user can utilize biometrics or a one-time password to additionally secure their wallets.
- Be careful of phishing: It is a common way used by attackers nowadays to capture users’ sensitive information. Always check the websites before filling in any confidential information in them. The user should save the legit link in the browser and use it instead of using an invalid link sent to you via mail or SMS.
- Always use a secure network: While using any external internet connection, always ensure that it is not tapped or someone is not eavesdropping. The user should use VPN wherever possible to hide/cover their IP address. It basically encrypts your data and transmits it without disclosing your personal information like location or IP address.
Best ways to secure your wallets:
In the crypto ecosystem, the security of the crypto assets has always been the priority of the user. Although custodial exchanges are susceptible to government rules and regulations, still the question is how we can secure them from the user’s end.
There are a few points that users should know in order to secure their wallets.
- Utilize cold wallets for savings: Cold wallets are offline wallets that are not connected to the internet. This minimizes the chances of getting hacked or misused by any malicious person. The user can secure their cold wallets using a PIN and keep them somewhere safe.
- Keep your wallets up to date: Another way to minimize vulnerability is by keeping your exchange wallet up to date. Updating the wallet helps in avoiding zero-day vulnerability, which is as soon as a vulnerability is detected, software developers start mitigating it and hackers try utilizing it to hack into the user’s system. Hence, as soon as there is an update, the users should download and update their exchange wallet.
- Backup your wallets: In case of any computer failure or a human mistake, it is important that you keep a backup of the wallet. It helps in ensuring that the user can recover their wallet in case their phone is stolen or any problem occurs.
- Stay up to date with current crypto attacks: The crypto ecosystem is increasing at a high rate. With this emerging environment, there are also new emerging attacks that the user should be aware of. Hence, staying up to date will make the user aware of what’s happening around them.
Comparison between best crypto exchanges:
When choosing an exchange wallet, it is beneficial to look for various points like security, storage, and payment methods. These exchange wallets provide distinct types of transactions like sending, receiving, depositing, withdrawing, exchanging, etcetera. The following is the table for classifying the exchange wallets:
Future of centralized crypto exchange:
Decentralization has been the ultimate goal of cryptocurrency; moreover, it is becoming hard to obtain because of different factors like a high barrier to user interaction, cost of transactions etcetera. Due to these factors, the users are more comfortable with the centralized crypto exchange, which seems to be more affordable and usable than the decentralized exchanges. Moreover, the primary issue of custodial exchange is the security and privacy of the users. The users need to provide their personal information like mobile number and ID for background checking before registration. This violates the user’s privacy and increases the risk of being compromised in the future. Hence, we can say that in the future, combining the phenomena of centralization and privacy could be a challenge and a need for betterment.
The aim of a centralized crypto exchange has been to provide users with a cryptocurrency exchange platform where the users can reply to cost fluctuations instantly. In the custodial exchange, the user can perform trading in real time. This is implemented by connecting the user to the exchange server where they can place a bid and ask for cryptocurrencies. Here, the ownership of crypto funds is with the exchange itself until the user requests a withdrawal. So, in case the exchange runs away with all users’ cryptocurrencies or comes out to be fake, what will you do?
These platforms can be counted as beneficial only for trading but if the user wants to hold their crypto it is always recommended to store it in a crypto or cold wallet. Apart from centralized exchange wallets, the users should also know other types of wallets and what benefits they provide, such as, next we will be talking about multi-sig wallets. The user can utilize multi-signature wallets where more than one signature is required to perform the transaction, which eliminates the single-point failure.
Last modified on August 19th, 2023 at 12:31 pm