Understanding Cryptocurrency Exchange
If you have read our previous posts, you already know that a cryptocurrency is a decentralized form of money. Cryptocurrencies such as Bitcoin can be traded like fiat currency in the traditional stock exchange. The stock exchange market acts as a platform that matches buyers and sellers. Similarly, in cryptocurrency trading, we need a ‘marketplace’ where traders can buy and sell their cryptocurrencies. Cryptocurrency exchange responds to this need.
What is a cryptocurrency exchange?
A cryptocurrency exchange or a digital currency exchange (DCE) is a digital marketplace that provides users with the opportunity to buy and sell their digital currencies using fiat currency or bitcoin and other altcoins. DCE acts as an intermediary between buyers and sellers of cryptocurrencies.
Like in a traditional marketplace, digital currency traders can buy or sell cryptocurrencies by placing either a market order or a limit order. If a trader selects a market order, they are authorizing the exchange to trade their coins for the best available price in the market. In a limit order, on the other hand, the trader directs the exchange to trade coin for a price above the current bid or below the current bid, depending on whether they are selling or buying.
Exchanges will require you to register with them (for identification purposes) before you begin trading on them. The registration process may require a series of verification processes. Registration requirements may vary from one exchange to another and the restrictions they put on different services. It can range from simply entering an email and a password to the most comprehensive Know-Your-Customer (KYC) verification.
Once the authentication process is passed, traders can deposit funds to their accounts before they buy or sell digital coins. Funds can be transferred in fiat or digital currency, or both, depending on the exchange. Different exchanges also offer different payment methods such as direct bank transfers, bank wires, bank drafts, credit and debit cards, and even gift cards. Exchanges also give different withdrawal options including credit card transfer, cash delivery, bank wire, and check mailing.
Decentralized Exchange (DEX)
Decentralized cryptocurrency exchange operates without a central authority. They allow a peer-to-peer exchange of digital currencies without the need for authority to see the transactions through. Decentralized exchanges are considered more transparent and free from market manipulation. They are also generally cheaper. DEX also requires less personal information hence maintains a high level of anonymity.
The major challenge with DEX is that there is a need to maintain a fundamental level of user interest in the form of trading volume and liquidity. Some DEX has not been able to achieve these primary qualities.
Special Factors to Consider
Just like in any other financial service platform, there are costs associated with exchanges. Making deposits and withdrawals comes at a price. Additionally, traders may also be subjected to currency conversion fees and trading fees. The fee may depend on the volume of transaction, type of currency transacted, and the policies of specific exchanges.
Cryptocurrency exchanges are different from digital wallets. Unlike exchanges that offer a platform for trading coins, wallets allow the users to send, receive, and store digital coins. Some exchanges have inbuilt wallets while other work with external wallets.
To be more technical, digital wallets store private keys that authorize the transactions and access the bitcoin address of a user. By now, you must have already realized that digital wallets do not work like your physical wallets where you keep your bucks. To understand more about Digital wallets, read our article on “What is Cryptocurrency Wallet?”
A cryptocurrency exchange is one of the fundamental components of decentralized finance (DeFi). It supports other DEX services such as cryptocurrency trading and staking. DEX is more preferred since many users feel it matches the decentralized structures of most digital currencies.