What is a Centralized market?
A centralized market is a financial market where all orders are routed centrally to one central exchange without any other competitor.
In layman terms, It is a type of market where financial transactions are made to and through one single exchange market.
To further help you understand, allow me to paint you a picture: You’re looking to buy a pair of Air Pods, a pair of Nike Air Jordan, and a Rolex watch. To get these items, you could go the centralized route like Amazon or Jumia where prices are controlled by the “central overlord”, or you could take a more decentralized approach and go to independent vendors to get your items possibly getting yourself better price offers in the process.
A more accurate example of a centralized market is the New York Stock Exchange(NYSE) as opposed to a more decentralized market like FOREX or NASDAQ where there are no intermediates between transactions.
How does a centralized market work?
Centralized markets simply reroutes all transactions and orders through a central channel.
A centralized market model offers transparency of prices to the buyer and seller— both parties have equal access to the prices. A centralized market simply shows you the price and lets you make decisions at your discretion without trying to subliminally influence you with competitive prices. Most times a centralized market are unique in the sense that purchases and offers found in a centralized market is exclusive to this market alone. As a result quoted prices found in a centralized market cannot be easily found in other markets.
On the other hand, In a decentralized market there are no intermediates, therefore buyer and sellers connect with each other directly and this leaves room for competition as quoted prices could vary greatly from one another.
Components of Centralized Markets
Transparency
As discussed earlier, Centralized markets offer buyers and sellers transparency. In addition, quoted prices are made known to both parties prior, so is any additional transactional fees that might be incurred. Additionally, prices in a centralized setting are usually fixed and less flexible as opposed to the decentralized model where buyers and sellers seek out one another and negotiate prices they are comfortable with. This transparency allows the parties involved to proceed how they see fit without hassles, it also helps to eliminate the incidence of any of the involved parties getting the “short end of the stick”.
Clearinghouse
A clearinghouse acts as an intermediary between buyer and seller to ensure both parties honors their full commitment. In a financial marketplace, An intermediate or clearinghouse acts as a sort of “conscience” in the trade ensuing both parties gets the security they deserve after the transaction has been made. It is important to note that clearinghouse is different from a broker as a broker does not ensure the integrity of the transaction but merely acts as a channel through which the financial market can be accessed and trades can be placed.
Advantages of a centralized market
Trades are kept fair: In a centralized market, intermediates are in place to ensure fair transactions. These markets have the equivalent of a “referee” to ensure the trade goes on without hitches.
Do more business: The regulated atmosphere in the centralized market means repeat business as more buyers and sellers would want to perform more transactions in this type of market due to the security it offers and its less risk model.
Transactions are made quickly: Due to it’s structure, centralized markets facilitate fast transactions as almost all “leg work” has been eliminated by the intermediary and the back and forth of negotiation is almost nonexistent. This in turn speeds up the rate of transactions between the involved parties.
Price consistency: In a centralized market, the price is often regulated and consistent leaving little room for a considerable rise or fall in quoted prices.