What is a Crypto Exchange and How Does It Work?

What is a Crypto Exchange?

Cryptocurrencies are digital coins that are issued by a blockchain. However, cryptocurrencies are not tangible and investors need to use digital wallets to store and trade them.

At the same time, investors need to access digital currency exchanges in order to purchase different types of tokens. There are thousands of cryptocurrencies present in the blockchain sector with new coins added to the mix with the passage of time.

Cryptocurrency exchanges work like traditional stock and commodity markets. They are a type of trading facility where investors can create an account and access different types of cryptocurrencies that are listed on the given platform.

According to an article published in Forbes, cryptocurrency exchanges work like digital brokerages. They allow investors to participate in spot trading and other financial instruments such as derivatives trading, lending, and margin positions.

How do Cryptocurrency Exchanges Work?

Cryptocurrency exchange lists a specified amount of cryptocurrency based on adding a given digital currency to the commercial reserves. The investors are able to access the digital coin on a trading platform by creating an account on the forum. Centralized cryptocurrency exchanges allow investors to verify their accounts by completing the account verification process.

Once an investor has created an account at the trading platform, they are able to purchase cryptocurrencies in exchange for fiat currencies or swap them with other digital coins present in their wallet accounts.

The cryptocurrency exchange charges a predetermined amount of trading fee from the investors. At the same time, the trading platform also provides various payment options for cryptocurrency investors in the region.

Investors can also access other trading options such as derivatives trading and margin trading options on a cryptocurrency exchange. Most exchanges also grant their users access to crypto market metrics to allow them to analyze a coin before purchasing it.

Types of Cryptocurrency Exchanges

Here are the types of cryptocurrency exchanges mentioned as under:

Centralized Exchanges

Centralized exchanges are regulated entities under the relevant financial regulators of the sector. Therefore, account holders on the platform have to complete account verification processes using a government issued document.

At the same time, all account holders must also complete the checks sanctioned by the regulators such as Know Your Customer and Anti-Money Laundering.

Advantages

• Centralized exchanges always maintain a healthy liquidity.
• Recovery for issuer funds.
• Ability to handle and process transactions.

Drawbacks

• Centralized exchanges are susceptible to hackers on account of user data placed on centralized servers.
• The potential of trading volume manipulation in some past incidents.

Decentralized Exchanges

Decentralized exchanges are based on the tenets of a distributed ledger. These exchanges allow investors to trade without the presence of a centralized authority.

Investors using DEX have full control over their private keys and digital asset ownership. At the same time, traders on the platform can trade currencies without a hefty account creation process.

Advantages

• The investors have full control and ownership of their cryptocurrency holdings.
• The investors can enjoy greater privacy and security.
• Data stored on a distributed ledger prevents the threat of cyber security attacks on the platform.

Drawbacks

• Investors can experience low liquidity on decentralized trading platforms.

Hybrid Exchanges

Hybrid exchanges incorporate some qualities from both centralized and decentralized exchanges. They offer investors the ease and convenience of trading on the decentralized trading platforms with the addition of the security that is extended on centralized exchanges.

Advantages

• They incorporated the best features from both centralized and decentralized exchanges.
• They maintain a high level of privacy for the investors such as transaction history and other user information.

Drawbacks

• This type of exchange trading platform is a new concept that has yet to gain popularity among investors.
• On account of the new idea, the platform has limited trading volume and liquidity.

Conclusion

Cryptocurrency investors must always keep in view some important aspects before creating a trading account on a given exchange such as regulatory status, liquidity, track record, CS support, funds disclosure, transparency, and customer reviews.