In the early days, the only way to get a hold of cryptocurrencies was to mine it or get it from another person, willing to sell directly to you. That is why people started looking for a simpler and safer option to get cryptocurrencies. This is where early cryptocurrency exchanges come in.
We have come a long way since the early days. In the past decade we have seen cryptocurrency exchanges rising around the world, contributing to billions of dollars in trading volume.
What is a cryptocurrency exchange?
Ever since the first form of currency, man found the need to trade it. Whether it be to obtain something or for profit, trading has always been associated with money and is more commonly known as forex (foreign exchange). But the very nature of cryptocurrencies requires a special trading platform, something built especially for the complexity of cryptocurrencies.
A cryptocurrency exchange or DCE (short for digital currency exchange) is a service/platform that enables clients to trade cryptocurrencies for other resources, such as other cryptocurrencies, standard FIAT cash or other digital currencies. They allow trading one cryptocurrency for another, the buying and selling of coins, and exchanging FIAT into crypto. Different crypto exchanges may have different options and features. Some are made for traders and others for fast cryptocurrency exchanges.
Cryptocurrency exchanges are in some ways similar to regular stock exchanges, the difference being the way traders make profit. On a stock exchange, traders buy and sell assets to profit from their changing rates, while on crypto exchanges, traders use cryptocurrency pairs to profit from the highly volatile currency rates. While stock exchanges have set working hours, crypto exchanges are also open 24 hours a day, seven days a week, 365 days a year.
Cryptocurrency exchanges (especially centralized exchanges) require new users to complete a registration process before they can begin trading. The levels of verification may vary – in some cases, confirming an email address will be enough, while others require applicants to upload a photo of their passport. These KYC (“know your customer”) checks are in order to ensure that crypto businesses comply with anti-money laundering measures.
Centralized and decentralized exchanges
There are two types of exchanges when it comes to differing in the hierarchies of operation and governance, known as centralized and decentralized exchanges.
|Run by a profit-oriented company that
gets revenue from their platform’s fee structures.
|Doesn’t rely on a third-party service.|
|Exchange controls funds.||Users control funds -
less susceptible to price manipulation and
other fraudulent trading activity.
|Not anonymous - KYC needed.||Anonymous - no KYC needed.|
|Transactions are made through the mechanisms
provided and approved by a central authority
which oversees its day-to-day operations
like maintenance, security, and growth.
|Trades occur directly between users in
a peer-to-peer manner via an automated process.
|FIAT gateway.||Not a FIAT gateway.|
|Exposed to theft and server downtime.||Not exposed to theft and server downtime.|
|High liquidity.||Low liquidity.|
How do exchanges set their prices?
A common misconception is that exchanges set prices. However, this is not true. There’s no official, global price.
The exchange rate of a cryptocurrency usually depends on the actions of sellers and buyers, although other factors can affect the price. Prices vary depending on the activity of buying and selling on each of these exchanges.
Each exchange calculates the price based on its trading volume, as well as the supply and demand of its users. This means that the higher the exchange, the more market-relevant prices you get. There is no stable or fair price for Bitcoin or any other coin - the market always sets it.
How do crypto exchanges make money?
Exchanges make profit from different revenue streams, most popular four are: commissions, listing fees, market making, and fund collection for IEOs, STOs and ICOs.
Commission - trading fees
The most popular way to monetize exchanges (cryptocurrency and traditional exchanges) is to charge commissions in the market. This commission pays for the trade facilitation service between the buyer and the seller. Commissions can be as low as 0,1% per transaction and due to low trading cost bring in high trading volume.
Due to competition, newly created exchanges struggle with low volume during their early stages and therefore need another source of revenue. Many exchanges opt for token and coin listing services to drive revenues. By organizing Initial Exchange Offerings (IEOs), Security Token Offerings (STOs), and Initial Coin Offerings (ICOs), exchanges may collect a percentage of funds raised from these offerings.
Another large revenue stream for cryptocurrency exchanges is the creation of a market or the creation of liquidity for a given financial instrument. In its purest form, market creation consists of buying and selling a digital asset on its exchange at slightly higher prices than on another stock exchange. When a trade happens on the exchange, they swap the trade on another exchange that offsets the previous trade, and the differences in the profit an exchange makes. This technique works exceptionally well when automated and used in long-distance markets (i.e., the difference between the bid price and the bid).
Another method to increase revenue is to equip the platform with an IEO module, which allows other companies to organize the sale of tokens. In this context, your exchange serves as a storehouse for people who buy chips before they go on an exchange - sort of like Kickstarter works. In this case, however, the authors of the papers receive tokens in exchange for other digital assets such as BTC or ETH.
How does swapping in this process make money? When the exchange collects funds on behalf of the fundraising company, it charges a percentage of the total proceeds as a commission. Depending on the final amount, such a percentage could mean a large payout for exchanges.
Give it a try!
Would you like to start trading but don’t know how to go about it?
Firstly, choose the exchange you would like to exchange your currencies on. Before signing up check validity, exchange rate, reputation and safety of the particular exchange platform.
After picking your preferred exchange sign up and go through the registration process (usually includes KYC/AML verification).
To start trading, you need to transfer the initial amount of money to the account. It is very common for cryptocurrency exchanges not to accept FIAT as the currency you put into the account first. Some exchanges may accept credit card payments, wire transfers or other forms of payment in exchange for digital currencies or cryptocurrencies.
Alright, you can get started. Good luck!