Crypto exchanges - what are they and how do they work?

Cryptocurrency exchanges work analogously to stock exchanges where stocks or commodities are traded.

What should we know about them?
Why can prices on different exchanges vary greatly?
What to look for and is the stock exchange a safe place?

What is a crypto exchange?

A cryptocurrency exchange is a place where cryptocurrency exchange transactions are made. Although a market is a good analogy of how some financial instruments are traded, it's not a physical place like a market. Trade takes place in the virtual world, the exchange is made on the website. In short, a cryptocurrency exchange is an intermediary whose task is to connect two parties to the transaction, those who want to sell with those who want to buy. And this intermediary receives remuneration in the form of a commission for associating the parties to the transaction.

For example, let's go to the Binance exchange, to the tab of a specific cryptocurrency pair. We will see here, first of all, a chart, i.e. how the price of a given cryptocurrency pair has changed in the past, we are also able to see the last transactions that have been made between users and, of course, it is on their basis that the price chart is created, and finally what is most important from the perspective of people who want to make a transaction, i.e. current buy and sell orders. The more of them, the greater the liquidity and depth of the market. The price chart, price, current orders and volume are definitely the most important information, which also in a very blunt way inform us about whether a given cryptocurrency exchange is worth our attention.

Uses of crypto exchanges

On the cryptocurrency exchange, we can sell or buy a specific cryptocurrency, tokens for FIAT, i.e. fiat currency, or exchange it for another cryptocurrency. How extensive the offer of a given stock exchange is largely determined by the exchange itself, but also regulatory issues come into play, in particular when it comes to exchange for fiat currencies. Unfortunately, regulations are changing, and often they are simply missing.

In order to make transactions, you need to register, this process will be explained in detail later. After registration, we will get access to the functionalities that a given exchange offers us. And here an important note, in the world of cryptocurrencies, security is extremely important. The key is, among other things, how we store our cryptocurrencies. Generally, we should hold them on the stock exchange as long as necessary. Cryptocurrency wallets provide much more security. This does not mean that the exchange is a dangerous place in itself, but it is definitely more vulnerable to, for example, any attack than a hardware wallet. In addition, in the case of cryptocurrency exchanges, there is also the issue of trust. Of course, the level of security is improving, but the sheer size of the exchange does not guarantee full security.

It is necessary to cite the example of the Mt.Gox exchange , which was established before the creation of Bitcoin. Exchanges, this one in 2013 accounted for over 70% of the entire volume on the market! On February 24, 2014, the exchange completely suspended trading on the platform, and after a few more hours it disappeared from the network. As a result of the attacks, 850,000 bitcoins with a value of about $0.5 billion at the time disappeared from the exchange. Unfortunately, this is not an isolated case, you can read about FCoin, Bitmarket , Cryptopia. There is also the example of QuadrigaCX, an exchange about which Netflix made the documentary "Trust No One: Hunting the King of Cryptocurrencies", although this is a slightly different case because the owner was a fraud before establishing the exchange and the exchange itself was focused on stealing and cheating its users from the very beginning.

Price differentiation between exchanges

There are several hundred cryptocurrency exchanges, which brings a large selection, but also makes the competition on this market huge. With the rest, just like in normal business, there are bankruptcies, and here it is. Why can the prices on different exchanges of the same instruments differ from each other? First of all, because the price is decided by users when making transactions. For example, when, on the Binance exchange, we have a lot of investors making transactions in pairs with bitcoin on another exchange, these investors can be only a few hundred. The market is decentralized, there is no one place where all orders from each user land, and this means that differences must exist. This makes it possible to use arbitrage strategies that reduce these differences. Just a few years ago, these strategies were extremely profitable. Currently, due to the maturation of this market, we have fewer and fewer such opportunities.

Cryptocurrency exchanges are divided by the type of instruments offered and the ownership form. We have spot exchanges, derivatives exchanges and exchanges offering both spot and derivative instruments. Spot instruments are simply the purchase or sale of a specific cryptocurrency, a token. Derivatives are instruments that give us access to financial leverage and their price depends on the underlying instrument.

For ownership reasons, exchanges are divided into centralized and decentralized, i.e. DEX exchanges. In the case of decentralized exchanges, we do not transfer funds to the exchange, but the exchange takes place between users' wallets. Compared to centralized exchanges, their interface is usually less friendly, they have less liquidity, and they do not offer customer service. Their greatest advantage is the control of their own funds by users. The world of cryptocurrencies is changing dynamically and cryptocurrency exchanges are competing for users. More than 10 years after the creation of Bitcoin, we can see the trend of exchanges creating real ecosystems. The exchanges, as in the case of Binance , are accompanied by payment systems, payment cards, staking opportunities, cryptocurrency mining or the possibility of investing in another gold rush, which is NFT.