Cryptocurrency Exchanges: Everything to Know
By Beluga Research July 7, 2023
- Cryptocurrency exchanges are online platforms that operate much like traditional stock exchanges and allow users to trade cryptocurrencies
- Cryptocurrency exchanges are open 24/7, which makes it easy for investors around the world to engage with the cryptocurrency marketplace
- There are two types of cryptocurrency exchanges: centralized exchanges, which are operated by a single entity, and decentralized exchanges, which operates on a peer-to-peer model
- Decentralized exchanges (DEX) do not require a central authority to faciliate trades
Cryptocurrency exchanges are online platforms that allow users to buy, sell, and trade cryptocurrencies. These platforms behave similarly to traditional stock exchanges, but they deal only in crypto, providing a marketplace for crypto investors (buyers and sellers) to connect. Thanks to exchanges, users can participate in myriad trades including, crypto to crypto, crypto to fiat and fiat to crypto.
Cryptocurrency exchanges provide a range of services including order matching, order execution and storage of cryptocurrencies. Some exchanges also offer additional services like margin trading, lending and staking.
A Brief History
The first cryptocurrency exchange, BitcoinMarket.com was created in 2010, and allowed users to trade bitcoin for fiat currencies. The following year saw the launch of the first major cryptocurrency exchange, Mt. Gox. It quickly became the dominant player in the market, accounting for over 70 percent of Bitcoin transactions at its peak.
In 2014 however, Mt. Gox suffered a major hack that resulted in the loss of over 850,000 bitcoins. The incident highlighted not only the need for better security measures on cryptocurrency exchanges, but also the importance of storing cryptocurrencies in cold storage.
Further, in November 2022, cryptocurrency exchange FTX collapsed over a period of 10 days. Following a report suggesting potential leverage and solvency concerns, the exchange faced a liquidity crisis and tried to negotiate a bailout by its rival Binance. The deal quickly fell through and Sam Bankman-Fried, CEO of FTX, was later arrested, extradited to the U.S. and released on a $250 million bond to await trial.
FTX was the largest collapse in the short history of cryptocurrencies, and its negative impact was vast as many crypto and fintech companies relied on FTX for facilitating trades. The incident may further deter investors, who already are cautious because of concerns about stability and security. Customers on the FTX platform may not recover their assets, potentially triggering legal action. The U.S. Securities and Exchange Commission (SEC) and other regulators may see the collapse of FTX as justification for tightening regulatory scrutiny of cryptocurrencies, and Congress may be more inclined to step in and create new laws governing digital tokens and exchanges.
Since the Mt. Gox hack and closure and the FTX scandal, many new cryptocurrency exchanges have still emerged. Each has varying levels of security, liquidity and user experience. Today, there are hundreds of cryptocurrency exchanges with new exchanges continuing to launch on a regular basis.
What are Cryptocurrency Exchanges?
Centralized exchanges are operated by a single entity and are the most common type of exchange. These exchanges are similar to traditional stock exchanges and typically have higher liquidity than decentralized exchanges. One primary difference between traditional stock exchanges and crypto exchanges however, is that crypto exchanges operate on a 24 hour basis. They never sleep, so there is no closing bell, and there are endless opportunities for profit and loss.
As for decentralized exchanges, they differ in that they are not operated by a single entity. Rather, each DEX is built on top of a blockchain and uses special software called smart contracts to facilitate trades. These types of exchanges are sometimes considered more secure than centralized exchanges because they do not have a single point of failure.
- Select an exchange that meets the investor's needs. There are many different exchanges available, each with its own set of features and fees. Some exchanges are better suited for beginners, while others are more advanced and cater to experienced traders. It is important for investors to conduct their own research and a reputable exchange with a proven track record of security.
- Create an account. This typically involves sharing some personal information and verifying one's identity. Some exchanges also require investors to provide proof of address and a government-issued ID.
- Fund an account with fiat currency or cryptocurrency. Funding an account can typically be done via bank transfer, credit card, debit card or a cryptocurrency deposit. Once an investor has funded their account, they can begin buying, selling and trading crypto on their chosen exchange.
- Buy, sell, and trade cryptocurrencies. Most exchanges have a user-friendly interface that makes it easy to place orders and track a portfolio. However, even with an easy-to-use platform, it's important for investors to develop a solid understanding of the market and the risks involved before investing. Like traditional stock markets, the crypto market is volatile and can change drastically in mere minutes.
- Variety of cryptocurrencies available for trading. Unlike traditional stock exchanges, cryptocurrency exchanges offer hundreds of different digital assets from which to choose. These include well-known cryptocurrencies like bitcoin and ether as well as lesser-known altcoins such as Cardano and Solana. This array of options allows traders to diversify their portfolio and take advantage of different market conditions.
- Volatility of the market. Cryptocurrency prices can fluctuate wildly in a short period of time, which can offer opportunities for profit or scenarios for loss. For any investor, it's important to assess one's own risk tolerance, and never invest more funds than one can afford to lose.
- Security . Since cryptocurrencies are digital assets, they are vulnerable to hacking and theft. As a result, exchanges need to have robust security measures in place to protect users' funds. These can include two-factor authentication, cold storage of funds and regular security audits.
- Convenience. Unlike traditional stock exchanges, cryptocurrency exchanges are available 24/7. They allow users to buy and sell cryptocurrencies at any time of day, offering investors more opportunities to profit from trades, and enabling the facilitation of financial trades even outside of normal banking hours.
- Liquidity. Exchanges provide a high level of liquidity, which allows investors to trade more quickly and easily given there is a large flow of assets occurring 24 hours per day. This liquidity also allows users to buy or sell cryptocurrencies at the current market price.
- Security. Reputable exchanges implement robust security measures to protect user funds from hackers and other malicious actors. Given the history of early crypto exchanges and the lessons learned from them, today's exchanges have stepped up their security measures and have taken extra precautions to protect customer funds.
- Variety. Exchanges offer a wide range of cryptocurrencies that enable investors to access many different crypto projects and investment opportunities. This variety makes for a more diverse crypto portfolio, reducing reliance on a single cryptocurrency or project. Via portfolio diversification, investors become less vulnerable to volatile market conditions and have more opportunities to profit from various trades.
- Trading Tools. Exchanges often offer advanced trading tools, such as charts, order books and trading bots. These aids help users make more informed trading decisions and maximize their opportunities to profit and avoid loss.
- Fiat On-Ramps. Many exchanges allow users to deposit fiat currency, such as USD or EUR, which can then be used to purchase cryptocurrencies. This makes it easier for crypto newbies to enter the crypto space and educate themselves about all the opportunities it has to offer.
- Centralization. While centralized exchanges facilitate crypto trades and grant access to financial opportunities for the unbanked and underbanked, they also have one major detrimental attribute: centralization. Given a single party controls the flow of funds, CEX have a single point of failure, which makes them more vulnerable to hacks, fraud and other security breaches.
- Regulation . Exchanges are subject to regulations. Rules limit functionality and make it difficult for users to access certain cryptocurrencies.
- Fees. Exchanges charge fees for their services, including trading, withdrawal and deposit fees. All of these add up over time to cut into an investor's profits.
- Custody. Using an exchange, while sometimes beneficial, also comes with risk. An investor's funds are only as safe as the exchange's custody is secure. Should an exchange suffer a hack, breach, or financial failure, users' funds may be lost or stolen and irrecoverable.
- KYC/AML. Many exchanges require users to go through a Know Your Customer (KYC) and Anti-Money Laundering (AML) process. Such processes can be time-consuming and invasive.
- Price Fluctuations. The price of cryptocurrencies can be volatile. The changes can lead to sudden price swings and financial losses.