How Does a Cryptocurrency Exchange Actually Operate?
By: Nicholas Donahue
Tags: Social Media, Cryptocurrency, Blockchain, Bitcoin, Blogs

Whether you’re a first-time cryptocurrency trader or an expert, you rely on a crypto exchange to execute your trades. In most asset classes, like stocks, bonds, and commodities, there are regulators that set the guidelines. In the crypto world, the exchanges themselves often act as gatekeepers.

In this piece, we’ll walk you through what an exchange is, the differences between types of exchanges, and how they are able to complete your trades.

What is an Exchange?

In general, an exchange is where traders can exchange assets. To do so, exchanges provide information about the assets, including prices, price trends, news, and more. For example, in the stock market people can purchase stocks with currencies (e.g., an exchange of $500 USD for a set amount of AAPL stock). These traditional exchanges allow users to easily connect their bank account to fund the trades.

In the crypto world, most exchanges have digital wallets built in so that your crypto can be securely deposited. We can also separate crypto exchanges based on: 1) the assets you can purchase, 2) how the trades themselves are executed, 3) the fee structure, and 4) who is responsible for the funds.

As more and more people enter the cryptocurrency world, it’s important to clarify the differences between types of exchange. Let’s explore the differences in more detail below.

Differences Between Exchanges

The first difference is between the type of assets you can purchase on an exchange. For instance, Coinbase allows users to use fiat to purchase Bitcoin (BTC), Bitcoin Cash (BCH), Ethereum (ETH), and Litecoin (LTC). There are other exchanges, like Binance, that allows you to trade popular coins like BTC and ETH for altcoins, including Ripple, Stellar, Nero, Monero, and Metal. People often use these two exchanges in purchase — first trading fiat into Bitcoin, then trading that BTC into their altcoins of choice.

We can also separate exchanges based on their operating type. Some exchanges, called Regular Exchanges, act as middle man and actually hold reserves of different assets. When you want to trade, you are actually trading with the exchange itself. While other exchanges — known as Peer-to-Peer Exchanges — facilitate trades between two parties.

Moreover, different services charge different fees. In general, there are two common business models for exchanges. Exchanges generate revenue by charging a small fee per trade (a transaction fee) or by earning a margin on asset prices, called a bid/ask spread. For the latter type, exchanges will purchase an asset for slightly less than they will resell it for — the difference between the purchase price (“bid”) and sale price (“ask”) is what the exchange keeps.

Lastly, we will explore the differences between a custodial and non-custodial exchange. In a custodial exchange, the exchange itself holds your money and is responsible for it. Said differently, these services are in custody of your private keys. The trades on custodial exchanges are done “off-chain”, which allows transactions to happen faster but also lacks a level of transparency (source).

By contrast, in a non-custodial exchange, users are responsible for their funds. A non-custodial exchange allows the user to keep their private keys, and transact with fewer steps. Some non-custodial exchanges do not even require an account to be created. When a counterparty is found for your trade, the non-custodial exchange will immediately deposit funds into your account.

Conclusion

In conclusion, cryptocurrency exchanges are a key part of the crypto economy. They provide price quotes, historical data, and liquidity. Exchanges also different greatly in the number of assets you can purchase and the features that they have. For beginners, finding the right exchange may be hard to do.

That’s what the founders of Hilo.io thought, so they set out to solve this problem. Hilo is a social platform for crypto traders and enthusiasts alike. Their team set out to build a visual platform that makes cryptocurrencies more social and accessible — including the ability to comment on pricing charts and follow crypto influencers.

To learn more about Hilo, or cryptos in general, please visit the resources below: