Cryptocurrencies have erupted into a $1.50 trillion asset class, sparking a wave of global disruption through the use of distributed ledger technologies. Like traditional stock and commodities exchanges, cryptocurrency exchanges are platforms by which participants can trade cryptocurrencies.
While certain exchanges allow for the purchasing of cryptocurrency using fiat, such as the Euro or U.S. Dollar, others require participants to strictly trade digital assets in pairs. Some reasons for buying cryptocurrencies include, but are not limited to:
- Paying network fees to power decentralized applications running on a public distributed ledger
- Participating in certain networks' governance
- Participating in certain networks' consensus via staking
- Speculating on price
To meet the growing demand for buying and selling cryptocurrency, many exchanges have emerged throughout the past five to ten years. They function similarly to e-brokerages that offer a variety of financial tools. They can offer trading of cryptocurrency between participants, trading cryptocurrency on margin, and even allowing for speculation on the price of certain cryptocurrencies through a financial contract called futures.
Throughout this article, we'll cover what cryptocurrency exchanges are, how they work, types of exchanges, and some of the most prominent exchanges today.
Types of cryptocurrency exchanges
Centralized exchanges (CEX)
A centralized exchange functions similarly to traditional brokerages or stock markets. The exchange is owned and operated by a centralized authority that maintains complete control over every account and those account's transactions. All transactions on a centralized exchange must be approved by the exchange; this requires that all users place their trust in an exchange operators' hands.
- Liquidity: Liquidity of an asset refers to its ability to be sold without causing much price movement and minimum loss of value. Liquidity is essential to ensure safety against market manipulation, such as coordinated "pump-and-dump" schemes. Centralized exchanges are known to have greater liquidity than other types of exchanges.
- Recovery possible: Most centralized exchanges offer the benefit of being able to verify a users' identity and recover access to their digital assets, should the user lose or misplace their login credentials.
- Speed: Transaction speed matters for certain types of cryptocurrency traders; it's of utmost importance in high-frequency trading, where milliseconds count. As per an analysis by bitcoin.com, relative to other types of exchanges, centralized exchanges handle transactions faster, with an average speed of 10 milliseconds.
- Honeypot for hackers: Centralized exchanges are responsible for billions of trades per day and store valuable user data across centralized servers. Hackers prefer them over other types of cryptocurrency trading platforms for this reason alone — the most notorious hacks have been aimed at centralized exchanges, including Mt.GoX, BitFinex, and Cryptopia.
- Manipulation: Certain centralized exchanges have been accused of manipulating trading volume, participating in insider trading, and performing other acts of price manipulation.
Decentralized Exchanges (DEX)
Unlike centralized exchanges, decentralized exchanges (also known as a DEX) act as autonomous decentralized applications running on public distributed ledger infrastructure. They allow participants to trade cryptocurrency without a central authority.
Centralized exchanges are often exclusive to participants within certain jurisdictions, require licensing, and ask participants to verify their identity (KYC: "know your customer"). In comparison, decentralized exchanges are fully autonomous, anonymous, and devoid of those same requirements. Several decentralized exchanges exist today, which we can categorize into three types: on-chain order books, off-chain order books, and automated market makers.
- Custody: There's a famous saying in distributed ledger communities, "Not your keys, not your crypto.": digital assets and cryptocurrencies are owned by whoever possesses the keys to an account that holds those digital assets. As DEXs are decentralized, and no single entity owns them, users control their private keys and their digital assets.
- Security and privacy: Since users are not required to go through KYC to create an account on a decentralized exchange, users can be more confident that their privacy is preserved. Regarding security, most DEXs employ distributed hosting and take other security precautions, thereby minimizing the risk of attack and infiltration.
- Trustless: A users' funds and personal data are under their own control, as nobody except the users has access to that information.
- Low liquidity: Even top decentralized exchanges struggle with liquidity for certain digital assets — lower liquidity makes it easier to manipulate markets on a decentralized exchange.
- Blockchain interoperability: Trading or swapping two digital assets that exist on the same distributed ledger is a relatively simple procedure using a DEX; trading two digital assets which exist on two different distributed ledgers can prove incredibly challenging and require additional software or networks.
A hybrid exchange combines the strengths of both centralized and decentralized exchanges. It facilitates the centralized matching of orders and decentralized storage of tokens — this means a hybrid exchange cannot control a users' assets and has no way to stop someone from withdrawing funds. Simultaneously, a fast centralized database manages order information and matching trades instead of using potentially slow blockchain infrastructure.
- Closed ecosystem: A hybrid exchange can work in a closed ecosystem. Organizations can be assured of the privacy of their information while taking advantage of blockchain technology.
- Privacy: Private blockchains are primarily used for privacy-related use cases in exchange for limiting communication with the public. A hybrid exchange can protect a company's privacy while still allowing it to communicate with shareholders.
- Low Volume: Hybrid exchanges have only been around for a short while. They don't yet have the necessary volume to become go-to platforms for buying and selling digital assets. Low volume makes them an easy target for price manipulation.
Prominent cryptocurrency exchanges
Binance is Changpeng Zao's brainchild, a developer with previous experience building trading systems used in the Tokyo Stock Exchange. Binance hosts mostly crypto-to-crypto trades, meaning only a limited number of cryptocurrencies can be bought using fiat currencies. Currently, Binance dominates the exchange space with over $72.63 billion USD of the daily crypto trading volume.
The exchange has a separate branch for U.S. customers, called Binance U.S. It allows U.S. citizens to make trades for certain approved cryptocurrencies. Binance also has a native $BNB token that's used for transactions on the platform, which can significantly lower the cost of trading.
Binance Fee: Binance charges a maker and taker fee between 0.015% to 0.75% and a trading fee of 0.1%
Bittrex is a small to mid-sized exchange based in Washington State of the USA, which allows for fiat withdrawals and deposits. The platform is touted for its security. This is attributed mainly to the founding team's experience with Information Technology, including Bill Shihara, Richie Lai, and Rami Kawach. Bittrex has partnered with Jumio, an identity verification solution provider that supports over 200 countries.
The exchange is among the top platforms in terms of cryptocurrency asset support, as it enables users to convert fiat currency into a wide variety of cryptocurrencies. In addition to operating as an exchange, Bittrex also features an online wallet that supports multiple cryptocurrencies.
Bittrex Fee: The exchange charges a maker and taker fee, which is between 0.08% - 0.20%.
Cash App is a part of Square, Inc. It started as a money transfer platform similar to PayPal or Venmo. The platform evolved into offering financial services, which allowed users to invest in stocks, ETFs, and cryptocurrencies. Cash App is available in two countries, the U.S. and U.K., and supports only Bitcoin.
Due to its easy-to-use interface, Cash App is ideal for beginners and first-time investors. Cash App allows users to withdraw crypto investments to their wallet — a functionality that isn't available on platforms like Venmo or Robinhood.
Cash App Fee: The platform charges a service fee for each transaction and an additional fee determined by price volatility across U.S. crypto exchanges.
Robinhood is known for offering commission-free trades of stocks and exchange-traded funds via its mobile app.The company's name comes from its mission to "provide everyone with access to the financial markets, not just the wealthy". On January 25, 2018, Robinhood announced a waitlist for commission-free cryptocurrency trading and now allows trading on the platform for over 5 cryptocurrencies, including Bitcoin, Ethereum, Dogecoin, and others.
Robinhood Fee: The platform does not charge a fee for buying and selling cryptocurrency.
A crypto brokerage and trading platform, OKEx is a Malta-based exchange that allows users to buy and sell cryptos. It also offers multiple cryptocurrencies for trading across different spot and derivative markets. The exchange also provides crypto lending and borrowing and even has its staking services and mining pools.
OKEx supports major countries with some notable exceptions, including Hong Kong, the USA, Malaysia, and ten other countries. OKEx also runs a C2C (Customer to Customer) trading system to enable users to trade with one another.
OKEx Fee: The platform works on a maker and taker fee that fluctuates between 0.060% and 0.100%
Coinbase and Coinbase Pro
Coinbase is one of the most popular and widely used exchanges in the United States. It is a fully regulated and licensed crypto exchange with the ability to operate in over 100+ countries. Coinbase offers a user-friendly interface and dramatically lowers entry barriers, confusing and convoluted for beginners and professionals.
While the crypto industry has been fraught with fraudulent exchanges and Ponzi coins, Coinbase has avoided controversy. The platform also offers insured custodial wallets to protect the investment of traders and investors.
Coinbase Fee: Between $0.99 to $2.99
Coinbase Pro Fee: It uses a maker-taker fee model. For makers, the fee is anything between 0.00% to 0.50%. For takers, the fee is between 0.04% to 0.50$ of the order.
Safety when using cryptocurrency exchanges
Trading cryptocurrency comes with risk. Reports of scams, phishing, and vulnerabilities are expected. As a user, it's essential to keep spammers and hackers away from funds and preserve digital wealth by implementing these fundamental safety measures:
Perform research: Listed above are some of the more prominent exchanges for digital asset trading; however, Hedera does not recommend specific exchanges or wallet providers. Everyone must perform research to find an exchange that best fits their situation and requirements. The choices made in selecting a crypto exchange may have substantial implications down the line.
Bulletproof passwords and use 2FA: Security measures upholden by a user make a significant difference in the risk they take on. It's recommended to use a unique, multi-character, multi-case, and hard-to-predict password for every online login. Two-factor authentication should also be set up, using Google Authenticator or another password manager of choice. Everyone must take every security measure to ensure access to their digital assets remains secure.
Avoid phishing: Many of us have a habit of visiting the same website multiple times a day and being required to re-enter password credentials regularly. The web is rife with constant deception attempts to get users to give up their credentials. Remain vigilant by clicking on authentic links only; always double-check the URL bar of the websites used to buy, sell, or trade cryptocurrencies to avoid disclosing sensitive information.
Do not store cryptocurrency on an exchange: Most exchanges store users' data and keys on a centralized server; therefore, they become a preferred target for hackers. Unless necessary, store digital assets in a cold-storage, mobile, or desktop wallet. For maximum security, users should ensure they are the only ones who maintain ownership of an account's private key.
Keep mnemonic seed phrases intact: Securely document mnemonic seed phrases — these phrases are typically 12, 22, or 24 words that offer the same access to an account on a public distributed ledger as holding the private key. Instead of keeping them on a computer, write them down on paper and keep them somewhere hidden.