Generally speaking, there are three main types of crypto exchanges. But there are other ways to buy and sell crypto, including investing apps and P2P or peer-to-peer platforms where you can buy and sell crypto 1:1.
Learn more about the different types of exchanges, how cryptocurrency exchanges work, and how to decide which type of exchange is best for you.
What Is a Crypto Exchange?
A cryptocurrency exchange is simply where buyers and sellers can trade crypto. If you want to trade crypto, you need to do it via a crypto exchange because, at least for now, very few traditional investment firms offer crypto.
How Cryptocurrency Exchanges Work
When you set up an account with a crypto exchange, it enables you to buy and sell cryptocurrencies like bitcoin (BTC), ETHer (ETH), litecoin (LTC), polkadot (DOT), dogecoin (DOGE), and so on. Depending on the exchange, you can purchase crypto using a fiat currency like the U.S. dollar, or trade one form of crypto for another.
The bigger and more established a service is, the more likely it is to offer a range of cryptocurrencies. Still, you may want to check that your desired crypto is available before setting up an account.
On a crypto exchange, you can use ordinary fiat currency to buy crypto, or you may be able to trade one crypto for another. You may be able to convert your crypto back into regular currency, leave it in your account for future trades, or withdraw it as cash. Available services can vary, depending on the exchange or app you use. For example, some services don’t allow you to move your crypto off platform to your own crypto wallet.
Unlike traditional exchanges that have set trading hours, cryptocurrency exchanges are active 24 hours a day, 7 days a week.
How to Trade on a Crypto Exchange
To begin trading, you need to fund your exchange account – sometimes called a wallet. Note that a wallet provided by a platform or app is typically held on that platform. It’s generally recommended that you also set up your own crypto wallet for greater security.
You can then view the trading prices of different crypto. Note that the exchange doesn’t set the prices; they’re determined by the market, and most exchanges reflect up-to-the-minute pricing, although there can be slight differences among exchanges owing to the fact that cryptocurrencies are decentralized.
You can then place a buy order to purchase bitcoin, ETHer, etc., and your order is added to the order book along with other buy and sell orders. Depending on which type of platform you’re on (an exchange, investing app, or cash app), the view of Exchanges and online brokers generally charge fees for their services. Unlike traditional markets, where many fees have declined in recent years, crypto trading typically costs more. It’s not uncommon to see fees as high as 5% per trade or more, for example, although many can be much lower: 0.5% or less per trade.
What are the Three Main Types of Crypto Exchanges?
There are three kinds of digital currency exchanges: centralized exchanges, decentralized exchanges, and hybrids. Here’s how they shake out:
Centralized Exchanges
These exchanges have a third party that helps conduct transactions to make sure they go through as intended — similar to a brokerage.
This might seem counterintuitive since one of the founding tenets of cryptocurrencies is that they are decentralized — meaning they aren’t issued or regulated by a government or other central authority. But a centralized cryptocurrency exchange can make it easier to buy your intended crypto with regular currency.
The potential risk inherent in some centralized exchanges is that these exchanges, being held by a single entity, are more vulnerable to an attack.
Decentralized Exchanges
A decentralized cryptocurrency exchange, or DEX, operates without the third party commonly used centralized exchanges. You could say decentralized exchanges are closer to the spirit of the cryptocurrency world because they are open source and depend on users to trade peer to peer.
In theory, a decentralized cryptocurrency exchange could be more secure than a centralized exchange. Because there’s no central entity or server to hack, it might make it harder to steal cryptocurrency. Fees might be lower and your transactions might also process faster in a DEX.
A DEX might have some drawbacks compared to their centralized counterparts. You might have to be a little more skilled with tech because a DEX may not offer the easy transfers from bank accounts or debit cards to buy crypto.
Some DEX don’t offer fiat currency changes at all and your only option might be to trade one cryptocurrency for another. Your funds aren’t insured and there’s nobody to call if you run into a customer service issue, as there’s no central authority.
Hybrid Cryptocurrency Exchanges
Hybrid cryptocurrency exchanges are an attempt to blend the best of both worlds from centralized and decentralized into one exchange. Their aim is to give end users the convenience of a centralized exchange while also giving them the security and freedom of a decentralized exchange.
Hybrid exchanges have yet to see the adoption that centralized exchanges have realized, but they may be laying a roadmap for a middle ground that might keep consumers and crypto enthusiasts happy in the future.
Choosing a Crypto Exchange: 5 Things to Know
In order to pick a crypto exchange that meets your needs and aligns with your crypto plan or strategy, consider these five factors.
1. Where does the exchange do business?
Before you choose an exchange to trade on, make sure it covers your jurisdiction. Some exchanges are limited to specific locales. An exchange’s jurisdiction reflects not only their target market, but also where they’re allowed to do business due to certain cryptocurrency regulations. Some exchanges have website addresses specific to each country.
2. How much liquidity does it have?
Exchanges that have a higher volume of trades and more money changing hands tend to work in an investor’s favor. In order to access that higher liquidity, look for an exchange with many users, or users who hold large amounts of assets on the exchange and trade frequently. Of course, some cryptocurrencies tend to be more liquid than others.
If there are only a small number of orders, there might not be enough people willing to buy or sell the coins an investor wants to acquire or liquidate. Lower trade volume could drive prices up for buyers – or drive prices down for sellers.
Liquidity is typically important during times of high volatility (which is common to the crypto markets). Less liquidity can exacerbate volatility to the point where prices rise or fall even more dramatically than they would otherwise.
3. Which types of crypto can you trade?
In general, the higher-market-cap coins are more likely to be traded on most exchanges. Investors looking for more exotic, lesser-traded coins might have to search out smaller exchanges. It’s easy to find out what coins are available, so just check the list to find your desired crypto.
4. What are the fees?
As noted above, crypto exchanges and trading apps vary widely in terms of the fees they charge – but they all charge somETHing. Be sure to understand the terms and choose an exchange that makes sense for the types of trades you’ll be making.
In some cases, an exchange might have a native token that enables traders to pay lower fees. The Binance exchange has the binance coin (BNC), for example. Users pay fees in the form of BNC, rather than from the currency pair they are trading.
5. How secure is it?
While no exchange is 100% secure, you might consider those that have been around for the longest time, have the most customers, or have had the least amount of problems. You can usually find information about an exchange’s security practices on their websites.
Some exchanges insure some or all of user funds. An exchange that offers insurance could shield investors from losses should anything catastrophic happen, but such policies are not common and they’re typically not extensive. Be sure to do your research.
Closing Thoughts
A crypto exchange sounds simple – it’s a platform where you can buy and sell different types of crypto – but like most things in the cryptoverse, exchanges can be complicated and may require a little more scrutiny from users than traditional stock and bond exchanges do.
The main thing to remember is that this industry – the coins, the platforms, the blockchains, the exchanges, the wallets – is largely unregulated. That means the consistency you may be accustomed to in the ordinary financial world, in terms of how investments are structured and how investment firms work, is less common in the world of cryptocurrency.
Thus it’s important to invest some extra time to understand basics – like how cryptocurrency exchanges work, whETHer a certain exchange can do business in your state or country, and what fees they charge, etc.
