Trading Cryptocurrency: Exchange Basics

This article details the basic functions of cryptocurrency exchanges: how they operate and what types of orders and trades can be executed.

Key Takeaways:

• A cryptocurrency exchange is a marketplace where traders come together to buy and sell digital assets at specific prices.
  
• Many exchanges and apps support crypto-fiat pairs. A trading pair shows which currencies can be exchanged for one another.
  
• Market orders are executed at market (i.e., immediately) at the price available at the time; limit orders allow traders to specify a price at which to transact and do not execute until matching with another order.
  
• An order book is a collection of limit orders at which traders are willing to buy or sell.
  
• Market makers compose the entire order book, which represents the state of the market; market takers agree with the prices listed on the order book and execute their trade immediately.

What Is a Crypto Exchange?

A cryptocurrency exchange is a marketplace where traders come together to buy and sell (e.g., trade) cryptocurrencies or other digital assets at specific prices. Exchanges exist as a location where traders can transact without the need to find a buyer or seller willing to trade with them.

On an exchange, a larger number of users gathered in one place allows for more liquidity and better prices. There are also other types of exchanges, called token swappers, where one can buy or sell at prices determined by an algorithm.

For more information on exchanges and how they work, read What Is the Crypto.com Exchange? An Overview for Beginners.

What Are Trading Pairs?

Many exchanges support crypto-fiat pairs, most often in US dollars. A trading pair shows which currencies can be exchanged for one another. For example, BTC/USD allows users to buy or sell Bitcoin with US dollars. There are also crypto-to-crypto pairs, such as BTC/USDT and ETH/BTC.

How to Execute an Order

Once a user has deposited fiat currency onto the exchange, they are ready to execute their first trade by placing an order to buy their preferred cryptocurrency.

Once submitted, the exchange automatically matches the order with the lowest-priced offer(s) in its system. It then subtracts the corresponding fiat currency from the user’s account and credits them with ownership of the token they purchased. Once the order is matched, it is considered filled.

Basic Order Types

When a trader wishes to transact on an exchange, there are two major types of orders typically used: a market order or a limit order.

Market orders occur at market price, meaning traders want to execute their trade immediately, at the price available at the time.

Limit orders, on the other hand, allow traders to specify a price at which to transact and do not execute until matching with another order.

In other words, the difference between market and limit orders is their level of urgency. Traders using market orders prioritise the immediacy and certainty of trade execution over the price, whereas limit orders allow traders to delay their order execution (accepting the risk that it might never be executed) in return for their desired price.

What Is an Order Book?

Most centralised exchanges use order books, a collection of limit orders at which traders are willing to buy or sell. Essentially, it lists the number of units bid on or offered at each price point. For example, say a user wishes to buy 4 BTC at market: The order book may require them to first buy a portion at a certain price, then the remainder of their order at another price.

Understanding the Bid-Ask Spread

A bid-ask, or bid-offer, spread is the difference between the lowest-quoted ask and the highest-quoted bid. Why does the bid-ask spread exist? Recall the example above, when the user bought 4 BTC at market: They had to buy the BTC on offer at the price that other traders had specified. If that same user had instead placed a limit order to buy 4 BTC, they might have specified a lower price at which to buy BTC.

We can see that market orders are used by traders who demand immediate liquidity, paying the difference between the bid and ask price. Thus, the bid-ask spread represents the price of liquidity. In financial markets, using a market order is called ‘crossing the spread’.

Watch Out for Price Slippage

Coming back to the above example, where our hypothetical trader bought 4 BTC: Let’s say the order book changed after the trade, since the limit order was filled. If someone else were to come along wanting to buy immediately, they would have to buy at the next-best offer. In other words, our trader has moved the market while buying. The price movement that occurs during order execution is called ‘price slippage’.

The Importance of Market Depth

What if there had been 5 BTC on the market instead? Our trader could have bought all 4 BTC at the lower price, limiting their price slippage. Conversely, what if there had only been 1 BTC on offer? In that case, the trader’s market order to buy 4 BTC would have been executed at a much higher price.

The effect of price slippage is why it is important for exchanges to have sufficient market depth; otherwise, it becomes very costly for traders to transact. The higher the market depth (i.e., the quantities on either side of the order book), the lower the slippage.

Market depth is typically represented by a chart showing the bids and offers at each price (see below). Charts like this allow traders to estimate how susceptible the price is to buy or sell orders and gauge likely support and resistance levels.

Market Makers vs Takers

If ‘crossing the spread’ means paying the bid-ask spread, then someone must have profited. But who? Very simply put, this profit goes to the traders who use limit orders, known as market makers. Conversely, traders who use market orders are called market takers, or price takers.

Market makers get their name from the fact that their combined limit orders make up the entire order book, which represents the state of the market. Market takers, on the other hand, agree with the prices listed on the order book and execute their trade immediately.

Crypto.com has a VIP tiering system that offers lower fees for makers at the first VIP level, where users can save on fees by using limit orders. Users can also move up VIP tiers by reaching monthly volume milestones. Additional discounts can be gained by locking up CRO tokens on the platform. The full fee table is on the Trading Fees page.

Apply the learnings from above on the Crypto.com Exchange, the world’s leading crypto trading platform. For additional trading insight, check out How to Automate Trading on Crypto.com.

Due Diligence and Do Your Own Research

All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, cybersecurity, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any coins, tokens, or other crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction. Any descriptions of Crypto.com products or features are merely for illustrative purposes and do not constitute an endorsement, invitation, or solicitation.

In addition, the Crypto.com Exchange and the products described herein are distinct from the Crypto.com Main App, and the availability of products and services on the Crypto.com Exchange is subject to jurisdictional limits. Before accessing the Crypto.com Exchange, please ensure that you are not in any geo-restricted jurisdictions. 

Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.