By now, most people are at least vaguely aware of the concept of cryptocurrency, or at least are familiar with one of the most popular cryptocurrencies, Bitcoin. While Bitcoin was not actually the first cryptocurrency, it was perhaps the first cryptocurrency to become a household name. While Bitcoin may still be the most recognizable cryptocurrency, it is by far not the only one. This is where cryptocurrency exchanges come in.
What is a cryptocurrency exchange?
Imagine you wanted to trade American dollars for Japanese Yen or Euro. You would need to go to either a bank or a currency exchange of some kind, where they would convert your dollars to the appropriate currency based on current exchange rates. Cryptocurrency exchanges also work much like currency exchanges do in real life, which means there are a number of different ways to exchange currencies. If you were to walk into a bank, you might pay one fee for exchanging your currency at one rate, while if you used a currency exchange in an airport you might pay another.
You can also just purchase something directly from a merchant or use a credit card where the exchange rate is calculated automatically. In those cases, however, you have very little control over what the rate of exchange is or what fees you will pay. If you go to a bank or currency exchange, they will tell you up front what the exchange rate and fees will be. This is very similar to the variety of ways there are to exchange cryptocurrency.
Types of cryptocurrency exchanges:
- Traditional Exchanges: Traditional exchanges work much like the stock market where buyers and sellers of cryptocurrency simply “exchange” currencies at current market values. Usually, the exchange platform charges a small fee for the transaction. Some platforms only allow for straight cryptocurrency exchanges, while others will allow users to trade fiat currencies like US Dollars, Euro or Yen for cryptocurrencies. Some exchanges are run by a third party or entity, while others utilize blockchain to create decentralized peer-to-peer exchanges. With exchanges run by a third-party, you may have some recourse if you feel there has been an error, but with blockchain technology there is very little error but also no recourse if you should happen to feel there has been one.
- Cryptocurrency Brokers: Brokers operate most similarly to a currency exchange you might find at an airport or shopping center. Brokers set an exchange rate that is often slightly in excess of the current market price in order to cover their costs. It is, however, possibly the simplest, fastest and easiest way to conduct an exchange, particularly for newer or infrequent users.
- Direct Trading Platforms: Direct trading platforms offer a place for peer-to-peer trades without the middleman or broker. These types of platforms do not use a fixed market price but instead set their own exchange rates. Conversely, OTC buyers can list a price that they are willing to buy cryptocurrency at and sellers can simply decide if they want to sell at that rate or not. Like all peer-to-peer networks, there can be some advantages to cutting out the middle man, but novice buyers and sellers can also make themselves most vulnerable to being swindled on these types of platforms as well, since there is no intervening authority.
- Cryptocurrency Funds: Cryptocurrency funds are simply a digital version of mutual funds, where a number of users all pool their cryptocurrency together to “invest” with a professional fund manager. This allows the public to buy, hold and invest in cryptocurrency without having to either purchase, store, trade or manage it themselves.