Before we can take a closer look at how crypto exchanges work, we have to clarify what exchanges are. Exchanges, no matter if they are used for stocks, (crypto-)currencies or other financial instruments, are platforms for traders that bring together supply and demand.
Cryptocurrency Exchanges
For the rest of this article we will focus on cryptocurrency exchanges. Not all exchanges in this field work in the same way, but there are several characteristics most of them have in common.
Fiat to crypto exchange
Some crypto exchanges offer the option to trade fiat currencies (USD, EUR, RUR, etc.) into cryptocurrencies and the other way round.
Trading pairs
All crypto exchanges offer crypto trading pairs in some sort or another. Most common are trading pairs including Bitcoin. Trading pairs with other high volume coins like ETH, XRP or Doge are also very common.
Information and community
Aside the actual trade exchanges can offer information regarding their listed assets. This includes info pages, community forums and in some places even an academy where the user or trader can find educational material for several topics.
Technical indicators
This additional information can also come in form of technical indicators. While some exchanges just offer the price of the coins as a chart or graph over time, some also give the option to apply technical indicators like Bollinger Bands, Oscillators, Moving Averages and several more.
Advantages
Trading cryptocurrencies on exchanges offers several advantages. First of all they usually offer a high variety of different coins to trade with. This gives users the option to trade several coins in one place without having to transfer them between different wallets. Usually the bigger the exchange the more coins they offer for trading. The same goes for the trading volume. Because of their high volumes it’s easy for people to buy coins or to sell them without having to wait for finding a seller/buyer first.
Exchanges also offer security in the whole process of the trade. While people could also try to sell their coins to an unknown person outside a marketplace, there’s always the risk that one of the participants in the trade doesn’t fulfill his part. Exchanges will execute the trade for both parties and act as an intermediary to make sure the trade is executed as planned. They manage to do so as in most cases the traders have to keep their coins directly on wallets of that exchange. This gives the exchange the power to securely execute trades without any of the other two parties interfering. Having the coins directly there can also bear technical advantages for their users.
Traders that want to invest in several coins can store them directly there without having to install a wallet for each coin on a local computer. In addition most exchanges also offer to manage the private keys for their users, so instead of having to remember and secure several private keys for several different wallets, they usually just need to remember the login data for their account on the exchange.
Disadvantages
What’s easier for users is in some cases also easier for hackers. Storing high amounts of several cryptocurrencies makes crypto exchanges lucrative targets for attacks from hackers. From the traders perspective it’s always good to have some knowledge about how the exchanges used secure their assets. Having most of it in cold wallets and appropriate security measures (2fa, browser check, etc.) in place are important criteria when deciding for an exchange.
The disadvantage of offering a high variety of coins and tokens is that, especially among the lesser-known projects, users and traders can fall victim to pump and dump schemes. Here some users come together and increase the price of a project in some cases by several hundred percent. The high rise in price and volume attracts other traders that don’t want to miss out. That’s when the first group starts selling the coins again with high profit to the newly attracted buyers. The latter are usually stuck with the newly acquired coins and only manage to sell them again by taking a high loss.
In some cases traders might not see any negative aspects about exchanges until they try to withdraw their funds. Some platforms have very high withdrawal fees or in some cases even withdraw minimums that can prevent or stop users from withdrawing their funds. Here it’s always important to check those fees before depositing any coins on an exchange. In some cases high fees or minimums only apply to certain coins (usually BTC) and not to others. Apart from withdrawal fees there are usually trading fees involved as well. Here it’s always good to compare, as the differences can be very high among different platforms.