What is a cryptocurrency exchange? Holding and Trading Explained

The world of cryptocurrency may be a mystery for most beginners, but as long as you know how cryptocurrency exchanges work and how you can take advantage of them for holding (or “hodling”) and trading, then you are already on a very good path to making healthy profits.

What are cryptocurrency exchanges?

Cryptocurrency exchanges are platforms that facilitate the trading of cryptocurrencies (eg. Bitcoin, Ethereum, Cardano, Stellar, etc.) for other assets, including digital and fiat currencies. In effect, cryptocurrency exchanges act as an intermediary between a buyer and a seller and they make money through mostly transaction fees.

At common cryptocurrency exchanges, $/€/£100 can be exchanged for Bitcoin of equivalent value, and vice-versa. Similarly, Bitcoin worth $/€/£100 can be exchanged for Ethereum of equivalent value. The same concept can be applied to different assets based on what is offered by the exchange.

Cryptocurrency Wallets

Note that a cryptocurrency exchange is different from a cryptocurrency wallet. While an exchange offers a platform through which cryptocurrency buyers and sellers can transact with each other, a wallet is simply a digital storage service for users to store their coins securely. To be more technical, crypto wallets store private keys which are used to authorize transactions and access the address of a user. Most crypto exchanges provide free wallets for their users.

What are cryptocurrency pairs?

Trading pairs of cryptocurrencies allows you to profit from the currencies’ changing rates. This is the primary activity of crypto traders.

Keep in mind that the order of currencies in the pair always matters. For example, if you anticipate that Bitcoin (BTC) may increase against the U.S. Dollar (USD) in the near future, you should buy the BTC/USD pair (with BTC first place and USD second place). And vice versa, if you think that BTC may fall against USD, then in that case you should purchase the USD/BTC pair (with USD displayed first).

Why do crypto exchanges have different prices for coins/tokens?

Because exchanges are not connected to each other. Prices for coins and tokens vary depending on the buy and sell activity on each one on these exchanges. Every exchange calculates the price of Bitcoin based on its own volume of trades, as well as supply and demand from its users. This means that the bigger the exchange, the more close-to-market price you should get.

There is no such thing as a ‘stable’ or ‘fair’ price for Bitcoin or any other coin/token – it’s always determined by the market at each particular moment.

Can I profit from price differences at various exchanges?

A profit is possible if the price difference covers exchanges fees.

If you compare the price of Bitcoin from 5 popular exchanges during a regular trading day, you will most probably see a 1% or 2% difference. The difference may reach up to 5% on active days with higher trading volumes. Typically the volume goes up every time the prices rise or fall dramatically.

If you are going to sell your Bitcoin on one exchange at a higher price and buy it at another exchange at lower value, make sure that the transaction fees implemented by the different exchanges do not surpass the difference. Sometimes it is worth it, other times it is not.

However, there is plenty of software on the internet for arbitrage trading, which allows you to make small profits from the differing Bitcoin prices. Please be reminded that you do need some advanced trading knowledge before successfully implement arbitrage strategies.

Centralized vs. Decentralized Cryptocurrency Exchanges

Centralized cryptocurrency exchanges act as a third-party between a buyer and a seller. Since they are operated and controlled by a company, centralized exchanges offer more reliability. Today, approximately 99% of all crypto transactions go through centralized exchanges. Examples of major centralized cryptocurrency exchanges include:

• Binance
• CoinEx
• Kraken
• Huobi

Decentralized cryptocurrency exchanges (DEX) allow users to execute peer-to-peer transactions without the need for a third party or an intermediary company. Due to some of the issues associated with centralized exchanges, decentralized exchanges are preferred by some users, especially for more technologically-savvy users.

However, decentralized exchanges do not allow for the trading of fiat currencies for cryptocurrencies, and so the average user would be better off using a centralized exchange for day-to-day trading purposes.

Advantages of Centralized Cryptocurrency Exchanges

1. User-Friendliness

Centralized exchanges offer beginner investors a familiar, friendly way of trading and investing in cryptocurrencies. As opposed to using advanced crypto wallets and peer-to-peer transactions (which can be very, very complex), users of centralized exchanges can simply log into their accounts, view their wallet balances, and make transactions (buying/selling, plus trading) through smartphone apps and websites.

2. Reliability

Centralized exchanges offer an extra layer of security and reliability when it comes to transactions. By facilitating the transaction through a developed and secure platform, centralized exchanges offer higher levels of comfort.

Disadvantages of Centralized Cryptocurrency Exchanges

1. Hacking Risk

Centralized exchanges are operated by companies that are responsible for the holdings of their customers’ assets. Traditionally, large exchanges usually hold billions of dollars worth of Bitcoin, making them a target for hackers and theft.

An example of such an incident is Mt. Gox, which was once the world’s largest cryptocurrency exchange in 2014 before it lost 850,000 Bitcoin, leading to its bankruptcy. (However, in these modern times, almost all major crypto exchanges are safe thanks to world-class security measures and protocols.)

2. Transaction Fees

Unlike peer-to-peer methods, centralized exchanges will charge higher transaction fees in return for convenience and usability. Such fees can be especially high when trading in large amounts.

Advantages of Decentralized Cryptocurrency Exchanges

1. Mitigating Hacking Risk

Users of decentralized exchanges do not need to transfer their assets to a third party. Therefore, there is no risk of a company or organization being hacked, and users are assured of greater safety from theft and other nefarious activities.

2. Preventing Market Manipulation

Due to their nature of allowing for the P2P (peer-to-peer) exchange of cryptocurrencies, decentralized exchanges prevent market manipulation, thus protecting users from fake trading and wash trading.

3. Anonymity

Decentralized exchanges do not require customers to complete know-your-customer (KYC) procedures, offering complete privacy and anonymity to all users.

Disadvantages of Decentralized Cryptocurrency Exchanges

1. Complexity

Users of decentralized exchanges must safeguard the keys and passwords to their own crypto wallets, or their assets are lost forever and cannot be recovered. These exchanges require the user to learn and get familiar with the technology and the process, unlike centralized exchanges, which offer a more convenient and user-friendly experience.

2. Lack of Fiat Payments

Decentralized exchanges do not allow for the trading of fiat currencies for digital currencies, making them less convenient for users who do not already hold cryptocurrencies.

3. Liquidity Struggles

Some 99% of crypto transactions are done via centralized exchanges, which dwarfs the trading volume done on decentralized exchanges. Due to the lack of volume, decentralized exchanges often lack liquidity, and it can be difficult to find buyers and sellers when trading volumes are low.

So, centralized or decentralized, which one is best for me?

There is no clear answer to which type of exchange is best for you. However, if you are just starting out in your journey with cryptocurrencies (either you want to hold or to trade), then it is best to choose a trusted centralized exchange. In the end, the ultimate reasons are:

• Ease of Use – Easy-to-use interface, integrated wallet, easy payments (with fiat);
• Security – All modern exchanges are armed with the best anti-theft technologies; and
• Liquidity – There is almost always someone on the other side wishing to accept your trade.

Because of the overwhelming advantages for a user to choose a centralized exchange, we here at CryptoPlaygrounds.com provide detailed reviews of the major cryptocurrency exchanges. In the end, this is the easiest and most convenient way to start your journey in the world of crypto.

I want to purchase crypto or to trade, where do I start?

If you want to starting investing or trading right now, the best course of action is to: