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How Does a Cryptocurrency Exchange Work?

Basics of Cryptocurrency
Last updated May 27, 2020

Thanks to cryptocurrency exchanges we are not limited to using a specific cryptocurrency solely but trade for others. However, this does not mean that people trade some internet magical money for some other kind of magical money.

There’s no denying that the growing interest in cryptocurrency supported the mainstream adoption of what seems to be one of the best financial inventions of the 21st-century.

If you’re new in the crypto space, there is a lot to grasp: Cryptocurrency, Blockchain, Bitcoin, Ethereum.

But once you’ve learned the basics of all these concepts, your attention might shift towards learning how to earn your first crypto coins.

And while there are many ways to earn them, cryptocurrency exchanges remain one of the best.

In this article, we will go over what crypto exchanges are, how they work, their risks and benefits, and see what are some of the best crypto exchanges on the market.

1. What is a Cryptocurrency Exchange?

what is a crypto exchange

A cryptocurrency exchange is an online platform where you can exchange one cryptocurrency for another. On some exchanges, you can also trade for fiat currency, based on the market value of the given asset.

Furthermore, because today most exchanges have integrated wallets within them, it’s quite easy to send your funds from a platform to the other. So, you’re not limited to sticking only with platforms that provide fiat transactions.

Crypto exchanges work very similarly to regular stock exchanges. The main difference is that on stock exchanges, traders buy and sell assets to profit from their changing rates. But in crypto exchanges, traders use cryptocurrency pairs to profit from the volatile currency rates.

There are three types of crypto exchanges on the market:

  • Traditional Trading Platforms
  • Direct Trading Platforms
  • Cryptocurrency Brokers

In the case of traditional trading platforms, buyers and sellers can trade cryptos based on the current market price. The exchange acts as the “middleman” and, in most cases, it charges a fee for each transaction.

Direct trading platforms are peer-to-peer online ecosystems where buyers and sellers can directly trade. These types of platforms don’t use fixed market prices and sellers usually set their own exchange rates.

Cryptocurrency brokers are online platforms that allow buyers and sellers trade cryptocurrencies at a market price plus a small premium. The exchange takes place between the buyer or seller and the broker, not directly between the buyer and the seller.

2. Centralized vs. Decentralized Exchanges

centralized vs. decentralized exchanges

Many believe that the biggest threat to cryptocurrencies is the fact that most of the trading happens on centralized exchanges. This directly contradicts the philosophy of most cryptocurrencies  – decentralization.

Undeniably, it’s these centralized exchanges that have made cryptocurrencies so accessible. Centralized crypto exchanges also bring the much-needed liquidity to the fragile crypto markets.

However, these centralized exchanges don’t allow you to be in full control of your private keys. Over the past couple of years, centralized exchanges suffered various attacks, resulting in losses of billions of dollars’ worth of crypto.

In order to fight back, centralized exchanges adopted various KYC and AML procedures.

SIDENOTE. KYC = Know Your Customer. AML = Anti-Money Laundering

Decentralized exchanges (DEX), on the other hand, are also a lot more private. They don’t ask for personal information, proof of identity or other KYC/AML procedures.

This is why some traders might prefer decentralized crypto exchanges in favor of the centralized ones.

The main advantage of decentralized exchanges is the fact that they don’t need intermediaries for their operations.

An exchange platform needs to provide 4 main operations for it to function:

  • Capital deposits
  • Order books
  • Order matching
  • Asset exchange

The capital deposits, order books, and order matching operations are typically provided by a third party inside a centralized exchange. The assets are already decentralized, so, for a DEX to workout, it needs to provide the other three as well, in a decentralized manner. And that is achieved by code.

However, the user of a decentralized cryptocurrency exchange takes full responsibility for his actions and the security of his funds.

The absence of an intermediary allows for another advantage – low or non-existent trading fees.

It may sound perfect, but let’s not rush to conclusions. Decentralized exchanges come with their own set of drawbacks.

The DEXes are only accessible to the people who are already present in the cryptocurrency ecosystem. And since they cater to a smaller audience, their trading volumes are usually lower than those of centralized exchanges. This means that the liquidity levels are not as good (low trading volumes obstruct the selling of crypto and the liquidation into cash).

Decentralized exchanges usually don’t offer the same advanced functionalities such as margin trading, stop losses, etc., and they have less user-friendly interfaces.

3. What are Cryptocurrency Trading Pairs?

what are cryptocurrency trading pairs

In the world of crypto, the term “trading pair” describes a trade between two types of cryptocurrency.

For example, one of the most popular trading pairs on all exchanges is the ETH/BTC trading pair. This pair will allow you to buy BTC (Bitcoin) using ETH (Ethereum), or sell ETH for BTC.

Other popular crypto-to-crypto trading pairs include BTC/LTC, LTC/BTC, BTC/ETH (but, of course, there are a lot more).

Crypto trading pairs allow users to profit from the currencies’ changing rates, and they are the primary source of profit for many crypto traders.

4. Basics of Cryptocurrency Trading

basics of crypto trading

Starting to trade is intimidating. But if you take it slow you can easily understand how it works.

Right off the bat, you’ll need to create an account on a crypto exchange. Afterward, connect it to your bank account, debit card, or credit card so you can make an initial deposit into your wallet.

SIDENOTE. If you don’t have a wallet yet, we covered pretty much everything you need to know about them here, including the factors to consider when picking one and our thoughts on the most popular crypto wallets.

Crypto trading is a speculative business, it’s important to remember that there’s always a chance you could lose your entire investment.

What we recommend is to never TRADE or INVEST more than you can afford to lose. It might sound harsh, but that’s the crypto world for the moment, a world where market volatility is a real thing.

Most of the risks associated with cryptocurrency trading have to do with two things: security and regulation (or lack of).

For example, you should choose a crypto exchange that keeps deposits in cold storage (offline, beyond the reach of potential hackers), has two-factor authentication, as well as email encryption and verification.

At the end of the day, there are a lot of inherent risks associated with trading cryptocurrencies. So it’s important to do your own research and learn as much as possible about the crypto exchange you plan on using.

5. Top Cryptocurrency Exchanges

1. Binance

At the moment, Binance holds the 1st spot on CoinMarketCap (by trade volume).

Binance is a somewhat newer crypto exchange, but it already has a lot of trading pairs. Moreso, it operates worldwide, offering some of the best trading fees (0.1% standard trading fee).

Binance also has its own native token, the BNB coin. The exchange is also available in an app version for both iOS and Android.

2. Coinbase

Coinbase is one of the most trusted cryptocurrency exchanges. It is regulated as a US financial institution, including FDIC insurance for US deposits of $250,000 or less, and is compliant with key EU financial regulations.

In terms of fees, Coinbase charges 1.49% for each cryptocurrency purchase or sale, and it can go up to up to 3.99% for trades made with a credit card. 

The platform offers advanced security, as well as a few staking options.

3. Kraken

Kraken is another top-tier cryptocurrency exchange known for high liquidity, low fees, and fast funding.

The platform also offers advanced trading features (such as margin trading), and advanced order types (stop-loss orders).

Although it doesn’t have as many trading pairs as Binance, you can still choose between 72 available pairs.

Kraken is currently ranked 13th on CoinMarketCap by trading volume and it’s available worldwide.

SIDENOTE. Here at Coinzilla we have taken quite a liking on Kraken, and we’ve been using it for more than a year now.

4. OKEx

OKEx is another DCE platform that provides its traders with a variety of trading pairs (415 at the time of writing), advanced trading features, top-notch security, and data protection.

SIDENOTE. DCE = Digital Currency Exchange

One of the main advantages of the platform is that it provides an excellent opportunity for traders to find future contracts.

It’s also one of the safest platforms of this type and it uses cold storage and SSL encryption to enhance the security of the funds.

5. Huobi Global

Huobi Global is one of the largest cryptocurrency exchanges with wide support for many altcoins and a large variety of stablecoins, offering 470 transaction pairs.

The exchange platform has its own token, the Huobi Token (HT), and also invented the HUSD, an ERC-20 token that is 1:1 ratio pegged with USD.

In terms of fees, Huobi is at a flat 0.2%. But your commissions may vary depending on two factors, the amount of HT you hold, and a certain trading volume over the past 30 days.

Final Thoughts

Choosing the perfect cryptocurrency exchange for your exact needs can be a difficult process. Especially considering the sheer amount of options to choose from, as well as the specific details that set them apart.

Apart from taking the time to read this guide, it’s also important to read in-depth reviews about crypto exchanges you’re interested in before fully committing your funds.

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