How cryptocurrency exchange works. Top basics to know

How cryptocurrency exchange works. Top basics to know

The cryptocurrency market is characterized by high volatility, but bullish periods generate an increase in value that significantly exceeds falls during bearish downturns. It is this circumstance that attracts investors and those who seek to receive speculative income in the niche of digital money. The corresponding infrastructure is also evolving, including cryptocurrency exchanges offering their clients a fairly large and constantly expanding list of services. New and new crypto exchanges appear every day, and crypto exchange is one of the top popular platforms.

If you belong to the number of people who decided to join the cryptocurrency community and start to trade currencies for the first time, it will be interesting and useful for you to know how decentralized crypto exchanges, which account for most of the turnover of digital assets, are arranged and function. And so, what is a crypto exchange?

Classification of cryptocurrency exchanges

All articles devoted to cryptocurrencies indicate that they have a decentralized nature and therefore do not need intermediaries. This is true, but there are two aspects that cannot be ignored:

– if you do not trust the counterparty, you cannot be sure that a transaction based on P2P principles will necessarily take place and no attempt will be made to deceive you;

– it is usually difficult for beginners to figure out how to make a cryptocurrency exchange on their own, and many experienced users prefer to use services that simplify the execution of such operations.

 It is not surprising that cryptocurrency exchanges that provide the opportunity to sell, buy, exchange cryptocurrencies, including using fiat money, have become popular quite quickly.

For this reason, currently the most common way to carry out transactions with all types of digital assets is the use of crypto exchanges.

Before proceeding to the consideration of how they function, let’s consider the advantages and disadvantages of the two main types of cryptocurrency exchanges, centralized and decentralized.

Centralized Crypto Exchanges (“CEX”)

If you understand what a classic stock exchange is, then you can also accept the concept of a centralized crypto exchange, since they are similar in many ways. CEX, like any stock exchange, is the intermediary between the participants of the transaction, which ensures the convenience of their conclusion and security. The fee for providing such services is usually small and is charged in the form of transaction fees.

An important point is the fact that the leading crypto exchanges (Coinbase, Binance, Gemini and many others) allow you to perform both crypto-to-crypto exchanges and fiat-to-crypto exchanges. If you wonder how to make a crypto exchange, you should first note that transactions can be carried out either at the spot price, or as a result of placing an order that will be executed when the price of the crypto asset is equal to the spot price (a limit order that is also in circulation on stock exchanges)

All buy and sell orders are entered into a dynamic database that allows you to sort them by price criterion. When an application for the purchase / sale of a token is received, the crypto exchange software compares such applications with the best prices in the corresponding orders, taking into account the desired lot volume. Thus, the use of this mechanism allows you to adjust prices when trading currencies or cryptocurrencies based on the results of current supply and demand

CEX independently determines which trading pairs can participate in the exchange, taking measures to identify unscrupulous crypto assets.

Advantages of centralized crypto exchanges:

– maximum convenience for customers. CEX provides users with a classic, intuitive interface and familiar ways of trading cryptocurrencies. You don’t need to worry about the contents of a cryptocurrency wallet and perform peer-to-peer transactions, it all comes down to logging into your account, where you can view your balance, transaction history and make new transactions;

– reliability. The spot trading mechanism assumes that you will not have unforeseen problems with the counterparty, and the transactions themselves are carried out automatically without your direct participation;

– CEX providing cryptocurrency loans to their clients is far from uncommon. Margin trading is in many cases the only way to carry out a planned transaction.

We note the existing disadvantages of the centralized variety of crypto exchanges:

– risk of hacking. Large CEX, managing large sums, are especially attractive to hackers. Theft, unfortunately, happens, often causing the bankruptcy of the crypto exchange;

– additional transaction fees. If you pay minimal fees for closing a transaction during a P2P exchange, then exchanges have to pay more for the service provided, especially if the transaction amount is high;

– in most cases, your digital money will be stored on an exchange wallet. This is convenient, but creates additional risks due to the centralized way of storing customers’ money.

Decentralized Cryptocurrency Exchanges (“DEX”)

The main difference between DEX and CEX is the ability to carry out transactions using a peer-to-peer cryptocurrency exchanger, that is, directly. Examples of such exchanges: Uniswap, PancakeSwap, Bit.Team.

P2P exchange is based on the use of self-executing smart contracts. You only need to specify the parameters of the transaction and choose a trader, guided by the placed buy/sell orders. Everything else will be done automatically.

Of course, such an exchange is not ideal, but peer-to-peer cryptocurrency trading has a lot of fans. Let’s list the main advantages of DEX:

– there is no risk of hacking the wallets of the exchange, since all operations are performed with the wallets of counterparties;

– spot exchange, based on a dynamic level of supply/demand, may try to manipulate market prices. With decentralized peer-to-peer execution of transactions, you are reliably protected from such attempts;

– legal licensed centralized crypto exchanges are forced to use the KYC principle (literally, “know your customer”), requiring customers to enter identification data when registering. DEX exchanges provide the same level of privacy that the use of blockchain provides. For the same reason, decentralized crypto exchanges allow you to trade more trading pairs than their centralized opponents. Many altcoins are traded exclusively on DEX.

P2P exchange also has its disadvantages:

– since counterparties’ crypto wallets are involved in direct exchange, this creates additional difficulties with entering passwords and keys to them. In principle, the exchange process itself requires more user participation and understanding of what he is doing. The exchange in CEX is much easier in this regard;

– many decentralized crypto exchanges, working with a large number of cryptocurrencies, do not assume the use of fiat money for their purchase/sale. However, there are exceptions. So, the Bit.Team not only allows you to use the main fiat currencies in transactions, but also offers a large number of payment methods when using fiat;

– CEX exchanges often suffer from a lack of liquidity, so it can be quite difficult to find a counterparty for some positions, especially if we are talking about exotic tokens.

A little bit about the regulation of crypto exchanges

So, we have considered what a cryptocurrency exchange is, how it functions, what are its main advantages and disadvantages. So, we casually mentioned that centralized crypto exchanges can be licensed provided that the KYC protocol is applied. In this case, the complete confidentiality of the client is not guaranteed, but there are opportunities to prevent the laundering of “dirty” money and conduct a successful fight against fraudsters. However, the number of licensed cryptocurrency exchanges is relatively small – about 14%.

The main problem lies in the fragmentation of national legislation and jurisdictions in relation to cryptocurrencies. And it is unlikely that the situation will normalize in the medium term: there are many countries that have a purely negative attitude to digital money. But even where there is an interested attitude towards the cryptocurrency industry, things are not as good as they would like with its legal recognition.

Web Tech Mantra

Web Tech Mantra website came up with a new helpful content update on finance, technology, business, health, and more topics niche. We studied, analyzed and presented on this platform. With all our knowledge, we established a platform to build a proper and trustful rapport with the internet world. We also covered the social media world through web tech mantra, so every social media user can access the informational world through the web tech mantra.