What is a cryptocurrency exchange and how does it work?

What is a cryptocurrency exchange? 

A cryptocurrency exchange is an online marketplace where you can buy, sell and trade cryptocurrency. When using a cryptocurrency exchange, you can trade different types of cryptocurrency, for example Bitcoin and Ether. You can also trade cryptocurrency for fiat currency, like dollars.

You might think of a cryptocurrency exchange in similar terms to a stock exchange, where some traders buy, sell and trade in order to generate profit from their exchanges, while others hold their assets and hope that they increase in value steadily over time. However, unlike traditional stock exchanges, cryptocurrency exchanges are not universally subject to the same regulatory oversight, and trading digital assets carries unique risks, including high volatility, potential loss of principal and evolving legal frameworks.

There are lots of exchanges online. Some have better reputations than others. You can typically identify reliable exchanges in a few ways, including:

• User numbers
• Reviews
• Compliance with regulations
• Data and information security accreditations

Crypto.com is widely viewed as a reliable cryptocurrency exchange and has an array of regulatory and security accreditations.

How do cryptocurrency exchanges work? 

Crypto exchanges work by allowing users to deposit fiat currency or existing crypto into an account or wallet. They can use this asset to store, sell, trade or buy more crypto through the exchange. The exchange provides the infrastructure, security and governance that allows users to make transactions with confidence; however, users should be aware that crypto exchanges are not all subject to the same regulatory standards as traditional financial institutions and protections for investors may vary

The exchange manages buy and sell orders in a digital order book and arranges them based on their value. The order book is constantly being updated automatically as new trades take place. It’s a complex operation that requires advanced digital infrastructure.

A crypto exchange acts as an intermediary between two parties making a transaction. It will set and publish the exchange rate they’ll pay when making a transaction, normally advertised in what are called ‘trading pairs’. For example, Bitcoin to dollar or Ether to euro.

As well as setting the various exchange rates, the exchange will charge fees on some transactions. The fee covers costs like licensing, security, hosting, staff and other operational expenditure involved in owning and operating an exchange.

A reliable crypto exchange will have some of the following characteristics:

• Educational information for inexperienced users
• Safeguards and protections against cyber crime and fraud
• Cold storage for holding crypto
• Clearly published disclosures
• Clearly advertised fees and costs

How does buying and selling work on a cryptocurrency exchange?

Let’s say you have a certain amount of Bitcoin and you want to buy another cryptocurrency, like Ether. You place a buy order on the exchange. You’ll normally do this from your account, selecting ‘buy’ or ‘sell’ and then selecting your crypto currency.

Once you’ve selected your cryptocurrency and your transaction type, you select the amount of crypto you want to buy or sell.

You can place one of two kinds of order; a market order or limit order.

A market order means you’re buying now at the best available price on the exchange. You’re effectively authorizing the cryptocurrency exchange as the intermediary to trade your Bitcoin for Ether at the best current price in its order book.

A limit order means you set a desired upper or lower limit for buying or selling an asset and the exchange will only execute the transaction if and when those limits are met.

Order matching

This is fundamental to how crypto exchanges operate. The exchange will match your buy or sell or order with an order in its digital order book. The orders are matched based on price and time. Your order will be matched first based on price, then based on time. The typical rule applied may be  ‘first-in, first-out’ on matched orders.

So for example, if you choose to sell Bitcoin the exchange will match that order with the highest current buy order on the exchange. If you choose to buy Bitcoin, the exchange will match you with the lowest current sell order.

Liquidity

Liquidity describes to an extent the volume and availability of different crypto currencies within the cryptocurrency exchange. If volumes and availability are high, this is high liquidity. And the opposite is low liquidity. High liquidity is good because it means that users can trade without causing significant price changes.

As with all marketplaces, the prices in cryptocurrency exchanges are in part influenced by supply and demand. If supply is high and demand is low, prices go down. If supply is low and demand is high, prices go up. The extent to which they go up or down is affected by the liquidity in the exchange.

While cryptocurrency exchanges share certain functional similarities with traditional stock exchanges, but there are important differences too, such as operating under different models, standards, and regulatory frameworks. Let’s take a look at the ways these two types of market differ.

• Accessibility: Crypto exchanges operate 24/7. Stock exchanges operate during local trading hours and are closed on evenings, weekends and holidays.
• Asset type: Stock exchanges let you buy, sell and trade shares in companies. The price of shares is mainly influenced by company performance. Cryptocurrency exchanges let you buy, sell and trade digital assets. The price is mainly influenced by demand and availability.
• Availability: Most cryptocurrencies are capped, meaning there will only ever be a fixed number of coins issued. Companies can issue shares at will to raise cash. This can dilute the value of its other shares.
• Volatility: Both the stock market and crypto markets can be volatile. But the drivers of volatility may differ.
• Rules and regulations: The stock market is heavily regulated and people can go to jail for breaking those rules. The cryptocurrency market is regulated differently and continues to evolve in that there are currently fewer clearly defined rules for people to follow, but there are still some protections in place, particularly when using established exchanges that follow industry standards. 

Types of cryptocurrency exchanges

There are effectively three types of currency exchange; centralized, decentralized and hybrid. Let’s dive in and explore the different types and the relative strengths of each.

1) Centralized cryptocurrency exchanges (CEXs) 

A centralized cryptocurrency exchange is a marketplace where exchanges, like buys, sells and trades, are managed by an intermediary. The intermediary is the central authority and to an extent it controls the movement of digital assets. The presence of an intermediary makes centralized exchanges similar to traditional stock exchanges.

Centralized exchanges take custody of your digital assets. They don’t own the assets and you can withdraw or move them. Because of this custodial approach, centralized exchanges implement a range of security measures and checks, including Know Your Customer (KYC) to reduce the potential for things like money laundering.

Strengths

User-friendliness is generally higher on centralized exchanges. This is because they’re aimed at all levels of expertise and need to make their services accessible to people who are new to cryptocurrency. Because they’re aimed at a broader market, centralized exchanges tend to have higher liquidity. They also use a central order book, which can make transactions quicker.

Drawbacks

Centralized exchanges by nature are a unified entity with custody of high volumes of digital assets. This means that if something goes wrong with the exchange, for example a server outage or a hack, all users may face a level of disruption. 

So, it’s really important for users to identify an exchange that they can trust, with strong information security standards.

2) Decentralized cryptocurrency exchanges (DEXs) 

Instead of a central intermediary managing custody of assets and trades, decentralized exchanges operate entirely on a blockchain. Transactions are facilitated by smart contracts, which authorize, define and execute transactions automatically. The absence of a centralized custodian is a defining feature of a decentralized exchange.

These are peer-to-peer networks that use blockchain technology and smart contracts to govern and manage all transactions. At no point does a decentralized exchange assume custody of your assets. 

Strengths

Decentralized exchanges are non-custodial and popular with people who want a high degree of autonomy and privacy. All transactions are anonymous and verified only by smart contracts written into the blockchain. There’s also a degree of community governance. Users can acquire smart tokens to vote on protocols and processes. 

Drawbacks

Decentralized exchanges are not suitable for beginners due to the complexity of the processes and interfaces. Liquidity tends to be lower in decentralized exchanges because they have lower user numbers and fewer assets in circulation. Lower liquidity can lead to price volatility.

3) Hybrid cryptocurrency exchanges 

A hybrid cryptocurrency exchange combines some of the elements of decentralized and centralized exchanges to deliver some of the respective strengths of each. Many hybrid exchanges operate on the blockchain but the front-end user interfaces emulate those of centralized exchanges.

Strengths

In theory this approach creates an exchange that combines the convenience and security of centralized exchanges with the autonomy and privacy of a decentralized exchange.

Drawbacks

This type of exchange remains in the emergent phase, so it has less of a proven record of success. And while hybrid exchanges may look and feel like centralized exchanges to the user, they’ll still have some of the limitations of decentralized exchanges, like lower liquidity and back-end complexity.

Cryptocurrency exchange comparison table

How to pick the best cryptocurrency exchange 

The first step is to decide whether you’d be more comfortable using a centralized or decentralized exchange. A hybrid exchange might be a good option if you’re relatively comfortable trading crypto but appreciate the user-friendliness of centralized exchanges.

To get a solid understanding of which type is right for you, consider which of these factors matter the most:

Security

All reputable crypto exchanges will disclose their security standards and procedures. It’s wise to avoid any crypto exchange that is vague or evasive about how it handles security. And although reputable exchanges will have specific robust security standards, that doesn’t mean they are infallible. 

So, decide if you’re more comfortable with a centralized exchange that takes custody of your assets and administers transactions centrally, or if you’d prefer to manage your own transactions on a decentralized blockchain based exchange.

Ease of use

centralized exchanges tend to have more intuitive and familiar user interfaces. These will be modelled on technology you already have and use, so there will be less of a learning curve. If you’re new to crypto trading and want an intuitive platform that emulates familiar products, a centralized cryptocurrency exchange may be most suitable.

If you’re familiar with blockchain technology and understand the associated interfaces well enough, a decentralized platform might be appropriate for you. This way you are able to manage your own transactions on the blockchain using smart contracts, with no need for any other entity to take custody of your assets.

Range of supported crypto currencies

As a general rule, decentralized exchanges will have a larger range of currencies. Because the open architecture of a decentralized exchange allows new tokens and coins to be listed without approval from a centralized authority, it’s generally easier for users to buy, sell and trade more types of crypto.

That doesn’t mean that centralized exchanges don’t have a diverse range of cryptocurrencies. Crypto.com for example lets you buy, sell and trade more than 400 cryptocurrencies using the App. Crypto.com users can also access a tiered reward program called Level Up*, which offers crypto rewards and lifestyle perks.

Fees 

Fees are perhaps one of the most pressing considerations. centralized exchanges are more likely to charge fees because they need to cover the costs of security, system management and governance. Most users can look at the fees as the cost of accessing a user-friendly system with reliable, recognizable security standards. 

Fees vary between platforms and you should look for exchanges that charge competitive fees that are described clearly. Crypto.com’s fees are tiered and depend on trading volumes and the types of trades you make. If you’re adding more liquidity to the exchange the total fees you pay may be lower as a result.

Many centralized exchanges, including Crypto.com, use the maker-taker fee model. Users pay a fee when removing liquidity from the exchange, for example by exchanging assets for fiat and then making a withdrawal. 

Users may earn a fee, often in the form of a rebate, when they add liquidity to the exchange, for example by paying into their account and buying crypto. This fee model incentivizes users to help the exchange maintain high liquidity.

Decentralized exchanges often charge fees to cover the cost of operating on the blockchain. These are variously referred to as network fees, gas fees, miner fees or simply blockchain fees. Both centralized and decentralized exchanges may also charge withdrawal fees. These are either calculated as a percentage of the amount being withdrawn or they’re a fixed fee within certain ranges. 

Liquidity

Larger, centralized exchanges tend to have higher liquidity. This can mean that asset prices are less volatile as large buy or sell orders won’t create a significant corresponding drop or increase in price. 

Smaller decentralized exchanges may have less liquidity, which can create more volatility and result in price drops or spikes.

Security considerations when choosing an exchange

Cryptocurrency exchanges use an array of security measures to protect user data, privacy and assets. The types of security used may vary according to the size of the exchange and whether its centralized or decentralized.

centralized exchanges use more traditional forms of information security to protect users. These include two-factor authentication (2FA); to protect user accounts from unauthorized access and cold storage; where digital assets are stored offline, away from The Internet. This protects them from the risks associated with having assets online.

Crypto.com is a good example of an exchange with best-in-class security practices. User accounts are protected by passkeys, hardware security modules (HSMs) and Fast Identity Online 2 (FIDO2) authentication standards, as well as multi-factor authentication methods like password, biometric, and authenticator codes.

It also has a rich resource of educational and instructional content designed to help users of all experience levels gain a deeper understanding of crypto trading and the underlying ecosystem. 

Decentralized exchanges that use blockchain technology tend to have fewer security processes, but this doesn’t necessarily mean they are less secure. It’s a different type of security because blockchain-based exchanges don’t need to store any user data like names and financial data. 

These exchanges foster a culture of personal responsibility, encouraging users to protect their own assets from fraud and scams. The biggest risks associated with decentralized exchanges are linked to human behavior, such as loss of private security keys and hacking.

Cryptocurrency exchange vs crypto wallet 

Exchanges are marketplaces, while wallets are storage. A cryptocurrency exchange is where you go to buy, sell and trade crypto. A crypto wallet is a place to store your own crypto. Some wallets allow you to trade crypto directly using the blockchain. This is often called ‘onchain’.

Wallets can be digital or software based, like crypto apps or browser extensions. Some wallets are offline, like hardware wallets. Regardless of wallet type, every wallet contains private keys, which are what you use to move crypto.

If you want to sell or trade crypto, you might use an exchange. If you have crypto and want to keep it securely for a long time, you might use a wallet.

Many people use an onchain wallet, like the Crypto.com self custodial wallet, for storage. And when it’s time to trade crypto, they’ll move crypto from their wallet to a crypto exchange, like the Crypto.com App.

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5. Securely trade and manage your crypto portfolio today.

FAQs about cryptocurrency exchanges

What is the safest cryptocurrency exchange?

It depends on how you measure safety. For inexperienced crypto users, the safest exchanges are the ones with intuitive user interfaces and easy-to-follow safety protocols that make it hard for them to put their assets at risk by accident.

These tend to be larger centralized exchanges with high levels of data and information security and a commitment to regulatory compliance, like Crypto.com.

More experienced users may prefer a blockchain based decentralized exchange where users take a degree of collective responsibility for security and safety. These exchanges rely on blockchain technology for security and validation and can be suited to people who value privacy and autonomy.

Can you lose money in a cryptocurrency exchange?

No marketplace is free from risk, including highly secure and well regulated marketplaces. You can lose money in a cryptocurrency exchange. 

For example, the value of your crypto assets may drop over time, meaning they are worth less in fiat currency than when you bought them. This is a risk associated with almost all types of currency or stock exchanges.

Do I need an exchange to buy cryptocurrency?

Not necessarily, but it can be very useful for a number of reasons. In theory, you could send cash directly to a cryptocurrency holder who then sends crypto to your wallet in return. But without an exchange to manage the process, you could be a victim of a scam or fraud.

Exchanges set prices, manage transactions and provide liquidity to the market. In return, they charge fees to cover the costs of providing those services.

What makes Crypto.com one of the best cryptocurrency exchanges?

Crypto.com is regulated and licensed in a number of territories for a range of financial activities. The company also complies with a number of important security standards. User accounts are protected by passkeys, hardware security modules (HSMs) and Fast Identity Online 2 (FIDO2) authentication standards, as well as multi-factor authentication methods like password, biometric, and authenticator codes.

Important Information: This is informational content sponsored by Crypto.com and should not be considered as investment advice. Trading cryptocurrencies carries risks, such as price volatility and market risks. Before deciding to trade cryptocurrencies, consider your risk appetite. Services, features and other benefits referenced in this article may be subject to eligibility requirements, token holdings, and may change at the discretion of Crypto.com.