by Rohit 

October 26, 2020

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What Is a Cryptocurrency Exchange?

A Cryptocurrency exchange is an online platform to buy and sell Cryptocurrencies like Bitcoin (BTC), Ether (ETH) or XRP. Think of it as a stock exchange but specifically for Cryptocurrency. 

Cryptocurrency Exchange is also called a DCE which stands for Digital Currency Exchange. Through a Cryptocurrency exchange, you can buy coins like BTC or Litecoin using traditional fiat currency or paper money. In addition to that, you can also exchange one Cryptocurrency for another. For example, you can easily exchange BTC with Ripple’s XRP, Etherium’s  ETH. 

In order to buy or sell Cryptocurrency, you need to make an account online on one of the Exchanges. You will also need a Cryptocurrency wallet to make any kind of transactions. Let’s explain to you how cryptocurrency exchanges work.

How Do Cryptocurrency Exchanges Work?

Both trading Cryptocurrency (short term buy and selling) and investing in Cryptocurrency (long term buying and selling), require a platform to carry their operations. This is where a Cryptocurrency exchange comes into play. Just like the stock exchange, this is the platform for Crypto buyers and sellers to come and operate.   

Cryptocurrency exchanges provide a platform for two main operations – buying Crypto and selling Crypto. Crypto exchanges allow exchanging one cryptocurrency for another which involves direct buying and selling of coins, and the exchange of traditional fiat currency into Crypto. 

The only difference between a stock exchange and a Crypto exchange is that on a stock exchange traders profit from buying and selling assets — shares or derivatives — in order to profit from their changing rates, while on crypto exchanges, traders use Cryptocurrency trading pairs to profit from the highly volatile currency rates.

What are the Trading Pairs?

In the case of Cryptocurrency, generally, the trading happens in the form of pairs.

The term “trading pairs” describes the exchange between one type of Cryptocurrency and another. For example, the “trading pair” XRP/BTC or BTC/ETH. Many top crypto exchanges offer “trading pairs” that pair major fiat currencies with mainstream cryptos, such as BTC/USD, ETH/GBP, and LTC/EUR. 

Trades which include exchanging fiat currency to Cryptocurrency are alright but there are some Cryptocurrencies that can only be bought using another Cryptocurrency.

Bitcoin is easily the most common Cryptocurrency against which other Cryptos are traded. The whole point of this trade is to turn the difference in prices between the Cryptos to your advantage. 

For example, you have Bitcoin (BTC) and you wish to buy Litecoin (LTC) with it then you will have to spend a certain amount of BTC (as per the rates) to obtain a certain amount of LTC. Make this trade only when you are sure that the value of LTC will go up 10% as opposed to the value of BTC which will go up by maybe 2%. You really don’t want to miss out on that 8% profit margin. 

Now that you have got a bit of an idea on Cryptocurrency exchanges to work, let’s move onto how people use them to invest in Crypto.

How to Invest in Cryptocurrency?

Investing in Cryptocurrency means buying units of Crypto and saving them to sell over the long term when the prices move up. As per Investopedia, “the goal of investing is to gradually build wealth over an extended period of time through the buying of a portfolio of…. and other investment instruments.”

Investing in Cryptocurrency is a popular way to make your money grow. 

There is a small area where most people make mistake. Cryptocurrency markets are known for high fluctuations and will lure you into buying and selling impulsively.

You’ll very soon realize that you have started Cryptocurrency trading rather than the original idea of making a relatively longer-term investment. Don’t mix up Cryptocurrency trading with Cryptocurrency investing.

If you had meant to invest in cryptocurrency, you should just leave it alone for maybe 5 to 10 years. Depending on your investment horizon. Stop timing the market and being concerned about the fluctuations in prices. Take your Cryptocurrency off the exchange, and store it securely in your wallet to redeem it some 5 or 10 years later.

Types of Cryptocurrency Exchange

There are two types of Cryptocurrency exchanges in operation currently – Centralized exchanges and Decentralized exchanges.

When it comes to the basic differences between the two, the major one is that a centralized exchange is private companies where the whole amount of power is vested in one system. They don’t work on the principles of Bitcoin which works in a decentralized manner. 

Decentralized exchanges, on the other hand, work just like Bitcoin. A Decentralized exchange has no central point of control. Instead, think of it as a server, except that each computer within the server is spread out across the world and each computer that makes up one part of that server is controlled by an individual. Let’s delve deeper into both for more clarity:

Centralized Exchange

Centralized exchanges are private companies that offer platforms to trade cryptocurrency. These exchanges require registration and identification, also known as the KYC or “Know Your Customer”. These exchanges are more popular hence all of them have higher trading volumes and high liquidity. Few examples of centralized exchanges are Coinbase, Binance, Bittrex, Kraken, and Gemini. 

As said above, centralized exchanges don’t follow the principles of Bitcoin. They run on their own private servers that are highly secure. However, if the servers of the company were to be attacked or compromised, the whole system could shut down for some time or sensitive data could be leaked.

Note that Cryptocurrency purchased on these exchanges is stored within their custodial wallets and not in your own private Cryptocurrency wallet that you own the keys to. To safeguard the interests of their users, centralized exchanges provide some level of insurance in case their systems fail. 

Decentralized Exchange

Decentralized exchanges have no central point of control. In this case, each computer within the server is spread out across the world and each computer that makes up one part of that server is controlled by an individual. If one of these computers turns off, it has no effect on the network as a whole because there are plenty of other computers that will continue running the network.

With a decentralized network, the chances of a cyber attack are highly reduced since attacking something that is spread out is significantly more difficult. These types of exchanges are not subject to any rules and regulations, as there is no specific person or group running the system. The individuals make transactions anonymously. This means that these trading platforms can be used for both legal and illegal transactions.

Now, if you have decided to invest in Cryptocurrency and understand about the 2 types of exchanges, it’s time to move on how to buy Crypto. In order to invest in Crypto you need to buy Crypto from an exchange to own units of cryptocurrency, and store them in your wallet since it is a long term venture (unlike trading where you don’t need to actually “own” units).

How to buy Cryptocurrency from Cryptocurrency Exchange

Setup an account

You can buy cryptocurrency, or sell it via an exchange. This means you need to create an exchange account and store the cryptocurrency in your digital ‘wallet’. Choose an exchange where you set your account.

Pick the currencies you want to buy and sell

Since you won’t be able to trade all 1,500 cryptocurrencies you should select which ones you want in your wallet. There are many options including bitcoin, bitcoin cash, Ethereum, XRP and Litecoin with new currencies being added all the time. 

Transfer Fiat Money Or Cryptocurrency

You can easily transfer real money to buy cryptocurrencies such as Bitcoin or Ethereum. While popular cryptocurrencies, like bitcoin, are available for purchase with U.S. dollars, many of them require that you pay with bitcoin or another cryptocurrency. 

How To Pay For Your Cryptocurrency?

You can pay for Cryptocurrency using almost any kind of payment method. Most common and accepted payment methods to purchase cryptocurrency are credit cards, bank transfer, debit card, cash or some of them also accept PayPal. 

The payment method also depends on the exchange you are using. Different platforms accept different payment methods, so you’ll need to choose a website that accepts the payment method you want to use. Once you purchase the Cryptocurrency, you can easily store it in your wallet.

How to Trade Cryptocurrency?

Cryptocurrency trading involves speculating on price movements via a CFD trading account, or buying and selling the underlying coins via an exchange.

Cryptocurrency prices are highly prone to fluctuation.

This is what traders make full use of, through trading Cryptocurrency. As we have explained all about buying and selling coins and tokens on an exchange. Let’s shed more light on investing through a CFD trading account.

Crypto Trading Through CFD Trading Account

The contract for difference or “CFD” trading are derivatives that allow you to speculate Cryptocurrency price movements without actually buying the coins. Unlike an exchange, you don’t buy coins and store them in your wallet here. With CFD, you are not taking ownership of the underlying coins, however, you are full party to any gains or losses that Crypto makes.

CFD might allow you to buy Crypto worth $ 5,000, with just $ 500. All prices are quoted in traditional fiat currencies such as the US dollar, and you never take ownership of the Cryptocurrency itself.

You simply put up a small deposit known as “margin”, to gain full exposure to the market. Think of it as a downpayment you pay, before actually owning the property. However, in this case, you can sell the property further without technically owning it.

If the price of that cryptocurrency moves in a favourable direction, you will make a profit, but if the price moves against you, you will make losses. Technically, we call it going “long” or “short”. You can go long (‘buy’) if you think the cryptocurrency’s value will rise, or short (‘sell’) if you think it will fall to make gains (in both cases).

In order to trade Cryptocurrency, you will need to pay a small sum of money as a trading fee to the Cryptocurrency exchange.

What is a Trading fee?

Just like traditional stock exchanges, Cryptocurrency exchanges charge commissions from the traders in the market called “trading fees” to offer their services. This commission you pay ensures the trade facilitation between the buyer and the seller. Commissions can be as low as 0.1% per transaction due to low trading cost bringing in high trading volume from the traders.

What is Trading volume?

In the case of Cryptocurrency, trading volume is the total number of Cryptocurrencies that were traded during a given period of time. Trading volume is a technical indicator because it represents the overall activity of a security or a market. The high trading volume of an exchange is a good indicator, as it shows that enough people trust the exchange to make trades and transactions there. Low trading fees will accelerate the number of transactions, hence low trading cost ensure high trading volume

Other than the trading volume there are many other factors you can check before picking out a Cryptocurrency exchange of your choice. Here’s a list of factors you can check before choosing a Cryptocurrency exchange:

How To Choose A Cryptocurrency Exchange?

Choosing the right Cryptocurrency exchange depends on multiple factors like security, authenticity, geographical location, trading fees, trading volume, liquidity and many more. While there are over 3,677 Cryptocurrencies in the market, the number of Cryptocurrency exchanges is somewhere over 300. We can promise you that picking out the right Cryptocurrency exchange is the first step to doing trading RIGHT.

Reputation & Authenticity

When you were young, the first rule your parents taught you about money was that wherever you keep it, make sure it is safe and secure. Whenever you consider using any Cryptocurrency exchange to make any kind of trading transaction, verify its authenticity and reputation. There have been cases in the history of Cryptocurrency wherein exchanges have thugged people out of their money, done some fraud or cheated on investors. So make sure, whatever platform you use, it’s been out of any kind of scams and scandals. Frankly, a quick google search won’t go remiss here

Geographical Location

Most Cryptocurrency exchanges have a set geographical location of the people they cater to. For example, if you live in the USA, then it will be a better option to invest through an exchange running out of the USA only. An exchange you sign up for won’t do any good for you if you can’t legally trade on it. In addition to that, Cryptocurrency has not been legalised in many countries so you need to ensure that exchange is accessible from your country and legal.  

Secure Transactions

You need to make sure that the Cryptocurrency exchange you choose to trade on, adhere to the “Know Your Customer” or KYC guidelines and Anti-Money Laundering (AML) regulations. Each exchange has its own chosen methods of security to make sure that their system is not hacked or breached. 

Check to see if the exchange offers two-factor authentication (2FA). If not, then the Crypto exchange might not be very secure by today’s standards. In addition to that other security measures worth checking before choosing an exchange are cold storage asset reserves and custodial storage services. As per Timothy Tam, co-founder and CEO of CoinFi, “At least 95 percent of the exchanges assets should be offline…Coinbase, for example, says it keeps 98 percent of its customers’ funds off the internet.” (via cnbc.com)”. 

Trading Volume 

The trading volume on trading platforms can vary highly based on the number of active participants on them at any given time, as well as the amount of each asset being traded. Say, if a trader is looking to sell 200 BTC, he or she likely will not be able to do so on a low-volume exchange as not enough buyers may exist at the current listed market price, forcing the trader to sell to lower offers on the exchange. 

In order to check the trading volume of an exchange, instead of trusting their data (they might lie), you can go on different exchanges, to see the amounts of each asset that sit in the order book and how far the price levels are from one another. Also,you can check third-party websites like Coin360, CoinMarketCap and OnChainFX to verify the trading volume for an exchange.

Liquidity

High Liquidity in an exchange is a good sign. It shows that many people are crying trading on this exchange throughout the day.  In fact, the higher the trading volume is, the more liquid specific exchange is. High liquidity shows that an exchange has the capability to process a high amount of transactions smoothly without being volatile. 

You can check whether an exchange offers a “locked-in” pricing system, which makes sure you get the price at the time of your transaction even if it doesn’t settle immediately. Liquidity can be different for different trading pairs. For example, data shows that it can be high for BTC/EUR, but low for BTC/GBP. 

Trading Fees and Other Charges

In order to offer their services, Cryptocurrency exchanges charge a small amount of money called “trading fees”. Along with that, they can also charge money for withdrawal or depositing money. You can check multiple exchanges and their fee rates to go for the rates that fit your budget the best. 

Seasoned exchanges charge towards the higher size for their services while the new ones can charge lower, at least initially. Make sure that you find an exchange that offers relatively higher trust and lower fees. 

Insurance Policy

Insurance policies help people deal better with emergencies. Before choosing a Crypto exchange check if it has an insurance fund. An insurance policy ensures that fair compensation can be provided to customers if the exchange is at fault and in some other circumstances. 

For users from the USA, certain exchanges are covered under the Federal Deposit Insurance Corporation (FDIC) which can protect a specified amount of U.S. users’ funds.

Customer Support

Active customer support ensures that all your doubts and queries are instantly solved. In fact, a human customer support team shows great dedication on the part of the Cryptocurrency exchange since it means that they are attentive to the needs of their user base. 

In addition to that, since money matters are involved, a good customer support team is necessary to ensure all communication between the exchange and its customers is smooth and direct.

About the author 

Rohit

A trader and investor with over 11 years in traditional stock markets. Got introduced to cryptocurrencies in 2018 and got hooked. Now spend half of the day in trading cryptocurrencies and another half in researching/reading about the whole ecosystem and cryptocurrencies in specific.

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