A cryptocurrency exchange is a service provider that allows customers to buy and sell digital currencies in exchange for other assets, such as fiat money or other digital currencies.
Cryptocurrency exchanges act as an intermediary between a buyer and a seller and make money through commissions and transaction fees. A cryptocurrency exchange typically works 24/7.
Most cryptocurrency exchanges can be funded via bank transfer, and they usually also accept credit card payments, wire transfers and postal money orders. The biggest cryptocurrency exchanges can have really high fees and their security measures can be really weak, so do your research before committing your cryptocurrency or cash. In April 2021, two Turkish cryptocurrency exchanges went down, leaving hundreds of thousands of Turkish investors unable to access hundreds of millions of dollars worth of digital assets.
Let’s look at how a crypto exchange works!
How do cryptocurrency exchanges work?
A crypto exchange works like a brokerage, where you can deposit money via bank transfer, wire or other common means of deposit.
These two are centralized exchanges, meaning that they act as a third party between buyer and seller; hence, they offer more reliability and are easier to use for the less tech-savvy trader.
There are also decentralized exchanges, where peer-to-peer transactions take place without a third party or central authority to facilitate them. These are less user-friendly, but allow greater anonymity. However, decentralized exchanges do not let you exchange your crypto assets to conventional currencies.
The steps to opening an account are quite straightforward. You go to the exchange’s website, sign up, validate your email address, take a picture of your ID and provide your credit card details or make a bank transfer. To withdraw conventional money, exchanges offer a variety of options, including bank transfer, PayPal transfer, bank wire, credit card transfer or cash delivery.
Keep in mind that at cryptocurrency exchanges, you don’t own the actual Bitcoins, or other crypto tokens. The private key - which allows you to access your coins [LINK TO what is a crypto wallet? satellite] - stays with the exchange. For instance, when you invest in Bitcoin on an exchange, you have an “I owe you” (IOU) from the exchange on your Bitcoins, but you do not get the private keys.
If you want to access your Bitcoins or other digital assets (rather than simply exchange it to conventional money), you have to transfer them from your account at the exchange to your personal crypto wallet. This way you can access your Bitcoin address and private key. Once you have a private key and address, you can access your coins. Keep in mind that some crypto exchanges do not allow users to withdraw cryptocurrencies to cryptocurrency wallets, they only let users purchase the coins, and withdraw conventional money. It means some exchanges only allow you to keep your crypto within your online account. It can be a good option for someone just getting into crypto trading and not being familiar with the technology. However, exchanges that only allow users to hold their own crypto bought on the platform means you can’t move your coins off the exchange, and somewhere else.
Check this before you sign up with an exchange!
Traditional exchanges match buyers and sellers. To get access, you, as a retail customer, need an account at a brokerage, which has membership in the exchange and is regulated by a financial authority. Crypto exchanges match buyers and sellers too, but in their case, you can use their services directly by opening an account with them. Crypto exchanges are therefore a mixture of traditional exchanges and brokerage firms.
Are crypto exchanges safe?
Because exchanges hold a massive amount of crypto coins, they attract hackers and thieves. They are attacked relatively often, which can destabilize them. In the worst case, an attack could result in you losing your coins if you kept them in the exchange’s account rather than transferred to your personal wallet.
Cryptocurrency exchanges are seldom regulated and therefore generally risky. Let’s say, you go to a crypto exchange, deposit €200, and you convert €100 to Bitcoin. How are you exposed? The specific crypto exchange could be a fraud or could default. In this case, all your Bitcoins would be lost, unless you kept them in a personal wallet. In the US, crypto exchanges are not currently regulated; some exchanges provide protection for cash, but none of them provide protection for crypto coins. To mitigate the risk, you should transfer your crypto coins to a personal wallet.
Another risk factor is the liquidity of the exchange; in other words, whether it has enough money on hand to pay you if you want to sell your Bitcoin or other crypto coins. There is currently no regulation on how Bitcoin exchanges should manage their liquidity.
Want to stay in the loop?
Sign up to get notifications about new BrokerChooser articles right into your mailbox.
The bottom line
The bottom line is that these risks are substantial, yet few regulators are looking into it. If you want just to try your hand at crypto trading, crypto exchanges can be an easy option. If you’re looking to make a larger investment, consider using a personal wallet. Researching cryptocurrencies and learning how to trade crypto is essential before you actually start trading in cryptocurrencies!