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What are Cryptocurrency Exchanges?

What are Cryptocurrency Exchanges?

What are Exchanges?

Exchanges are sites that allow the buying and selling of different cryptocurrencies. Inside that definition, there are exchanges that are designed to offer different types of services.

  • Cryptocurrency Exchanges: Some exchanges are designed for financial traders who make money out of fluctuating prices between different types of currency. These can be best thought of as stock exchanges.
  • Cryptocurrency brokers - These specialise in helping people buy and sell crypto using fiat currencies. These can be best thought of as brokers of cryptocurrencies, like currency exchanges you’d use to buy foreign currencies for travel.
  • Peer-to-peer trading exchanges - a slight variation on cryptocurrency exchanges in that the exchange doesn’t set the market price, the sellers do.
  • Cryptocurrency funds - a slightly less common type of exchange, but typically involve and investment group allowing traders to invest in a particular type of cryptocurrency. This is a type of exchange where a trader won’t actually hold any cryptocurrency.

Some exchanges offer all of these features on one site whereas others only specialise in one or two.

How do they work?

These exchanges have slightly different functions in terms of features and functionality. For the purposes of this explainer we will focus only on the two most common exchanges, brokerages and exchanges.

Exchanges typically make a profit by charging a transaction fee in order to facilitate the exchange of one currency for another. These rates vary according to which exchange you are buying and or selling from.

A user or trader will either hold cryptocurrency - some exchanges don’t allow the use of fiat currencies - or buy currency directly from the exchange to begin trading. In both instances, the user will need to have a wallet.

To buy currency using fiat money, a user will also incur a charge there too.

When a user wants to cash out of crypto and convert to fiat currency, they traditionally sell off their currencies and the fiat value is then withdrawn into a regular bank account.

Why are prices of crypto different on different exchanges?

Cryptocurrencies are decentralised. As a result there is no central authority regulating the prices of crypto. Exchanges set prices based on a variety of factors, based around how popular - or unpopular - a currency is. Hence why there is a subtle difference in pricing of a certain asset depending on what exchange you’re on - which has lead to an emerging industry of traders taking advantage of the subtle differences.

How to find the proper exchange for your investing needs?

1. Be Cautious

The first thing to keep in mind when searching for digital currency exchanges—and when considering any aspect of cryptocurrency investing—is that scams and frauds are out there, and they can have a very real impact on individual investors. Mt. Gox, one of the earliest digital currency exchanges and one of the most popular, collapsed. Others have been hacked or otherwise comprised.

How does one make sure that a particular cryptocurrency exchange offers a legitimate service?

First, look for the physical address associated with the exchange. If there is no address readily available, you should not use the exchange.

There are many reasons for this. First, transparency is often a sign of legitimacy. Second, without knowing where the exchange is based, you won't have a good sense of the often-thorny legal ramifications of your investments. And third, if your account should get hacked, it is much easier to address these issues with the exchange and any regulators that may need to be involved if you have a physical address for the exchange itself.

2. Do Your Research

When it comes to cryptocurrencies and exchanges, reputation counts. Before you even go so far as to create an account (which should reflect a high level of trust, as it entails a user passing over private information of various types), take time to thoroughly research the exchange you're considering. What do other users say about the exchange?

What does the exchange say about itself? Have there been issues with security in the past? If so, how has that exchange addressed those problems? In your search, dig deep; look for potential negative stories that the exchange development team would not want potential customers to see.

3. Go With Higher Security

The harder it is to create an account at a particular exchange, the better. If it's too easy to generate an account, that suggests that an exchange is not particularly trustworthy. What happens, then, if your digital assets suddenly disappear? You may have a much more difficult time tracking down and retrieving your money in those cases.

Regardless of the exchange that you choose, it’s a good idea to keep the large majority of your digital assets in an offline storage service like a cold wallet, which is often even an option for staked coins. Exchanges should do the same with their assets that aren't required for liquidity.

4. Beware of Fees and Pairs

You've sifted through the pool of potential exchanges and found some that appear to have excellent reputations, stellar histories concerning security, and no backgrounds of hacks or scams. That's a great start, but now you'll need to consider how each exchange will impact your investing daily.

Two major factors that distinguish different exchanges are the fees and the currency pairs they offer. Most exchanges will include some type of fee for your transactions; these can be based on the size of the transaction, or they may be dependent upon your level of activity, or, in some cases, they may be unrelated to either of those factors.

Learn about the fees and consider how they would impact your investing based on your style; do you plan to be highly active, making some transactions every day? If so, perhaps consider an exchange with a lower per-transaction fee. If you’re considering transacting ether, you will want to be aware of the gas fees you’ll need to pay that are associated with various transaction types.

Another important consideration is the cryptocurrency pairs that your exchange offers. Coinbase, one of the most popular and successful exchanges in the world, only offers a relatively small selection of digital currencies for its users. If you're looking for obscure altcoins, you may want to look elsewhere, although Coinbase is considered to be excellent about security, user experience, and so on. Make sure you're keeping in mind how your own investment practices will relate to the features (and limitations) of any exchange you might use.

The Future

Exchanges are wildly popular when it comes to cryptocurrency trading. However, they aren’t without their issues. Many exchanges have been hacked, sometimes losing huge amounts of currency.

Exchanges are also coming under increasing pressure to know more about the identities of their users, which has lead to the rise of a new type of exchange, often referred to as decentralised exchanges.