What is a Cryptocurrency Exchange and How Does It Work?

A cryptocurrency exchange is an online platform where cryptocurrencies are bought, sold or exchanged for other cryptocurrencies or conventional (fiat) money. In other words, depending on your requirement, it can serve as a trading platform or a forex platform. To buy or not to buy cryptocurrency is entirely a private matter as the losses and the gains can be massive to the individual. So, choice of what exchange to use is entirely upon you as an individual.

Here are a few other things you should know about cryptocurrency exchanges.

Types of Exchanges

There are notably four types of exchanges. These are:-

  1. Trading exchanges

This is where buyers and sellers engage in their trading activity based on the current market prices. The trading could involve only cryptocurrencies or also incorporate fiat currency. The exchanges charge a fee for every transaction. Some of these trading exchanges engage the support of a middleman while others do it on a peer-to-peer basis, that is, directly.

  1. Brokers

These are exchanges that set their own prices. Sellers and buyers will use the brokers’ rates to trade and these prices are usually the market price plus an additional brokerage fee. This type of exchange is suitable for newbies due to its ease of use and simplicity although slightly higher in price.

  1. Direct trading

This is trading between buyers and sellers on a peer-to-peer basis. The seller sets their prices and the buyer has two choices:-

  • Buy at the seller’s pre-set price
  • State the rate they are willing to buy at and the exchange tries to match a seller at that price. This of course is not always instantaneous.
  1. Funds

A fund is a pool of cryptocurrencies where buyers can purchase shares and the trust speculates on their behalf. The trading volume is high owing to the fact that it is the only available bitcoin fund so far. The fact that you do not deal directly nor engage in direct purchase or storage or cryptocurrency makes it very ideal.

Choosing an Exchange

Before commencing to trade, it is prudent to undertake a study on the exchanges. Some things to look out for include:-

  • Reputation – It is important to go through reviews from actual users of the exchange. This can be got from discussion forums like Reddit and Bitcoin Talk where you can post questions and they respond. Reputable rating websites do also provide vital information as to the trustworthiness, reputation and legality of an exchange.
  • Verification – Some exchanges may require some verification of your identification before you can make a deposit or withdrawal. While this may seem inconveniencing and time consuming, it helps to avert possible money laundering rogues ‘hovering’ on the system for easy prey and all forms of scams.
  • Exchange rate – Do your due diligence by shopping for exchange rates that are fair. These rates vary from one exchange to the other and sometimes the deviations can amount to a difference of over 10%.
  • Fees – Ensure to carefully study the fee structure which will normally be indicated on the exchanges’ websites as pertains to any form of transaction you want to undertake.
  • Location – Before selecting an exchange, ensure that accessibility and all functions are compliant with your location or country of domicile.
  • Payment method – Run a check on the payment options available and whether there are suitable options for you. For example, this one will accept BTC or ETH when buying other cryptocurrencies.
  • Transaction limits – Check whether there are limitation as to the amount you can either deposit or withdraw and depending on whether you are a heavy trader or light trader you can decide accordingly on if to proceed or shop for a limitless platform.

How do Exchanges work?

  • To start using an exchange requires that you register or open an account with the given site/platform. You’ll be required to have a wallet. With that you then proceed to deposit funds/crypto.
  • Cryptocurrency exchanges are sustained by Market buyers and Market Takers. A market maker is one who provides liquidity to the exchange and a market taker is one who takes from the exchange. Both are important as they must co-exist for the exchange to remain relevant. However, market makers are charged a smaller fee to transact as an incentive to provide floating money to the exchange while the takers are charged a much higher fee so as to desist from draining the exchange of its liquidity.
  • Exchanges capitalize on Spreads. A spread is the difference between the highest asking price and the lowest bid price. To put it simply, the difference between the buying price and the selling price. The spread is usually ten times bigger compared to fiat currency.
  • Exchanges use leverage trading. This is whereby you can trade an amount you do not actually possess by paying a certain interest on ‘borrowed’ money and having it deducted once the transaction is finalized. Bid gains can be made but losses are equally possible.
  • So as not to be duped by the deliberate hype created by traders causing pump and dump in prices, determine what you hope to achieve with your trading, like say a 5% gain, and set a limit order such that when the target is attained, an order is executed.
  • Exchanges use Bitcoin bot which is an automated trader that follows and tries all indicators on all coins. You buy when the indicator crosses. It is excellent in that it does not miss out, captures every activity, and also does not halt to rest.

Advantages of using exchanges

  1. Availability of multiple digital currencies so the trading options are diversified.
  2. Secure purchase process. Most exchanges operate with the Escrow system which takes care of the interest of both the buyer and seller.
  3. It is a larger platform with more floating currency or liquidity. Exchanges make it impossible to get stuck with one’s coins.
  4. They give an opportunity to buy the newest coins through ICO’s which is only made possible by exchanges.

Disadvantages of exchanges

  1. They are very attractive to fraudsters because of the amount of cash traffic that flows through them.
  2. They are the perfect tunnel for pump and dump schemes.

To wrap up, exchange platforms are necessary for every serious investor or trader. It is, however, important to keep track of your trading activities. Fortunately, pulling out of an exchange is also not a long process. A few steps and you could convert your crypto into cash.

If you have any questions, please ask below!