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The blockchains that cryptocurrencies are built on aren’t very good at communicating with each other. That means it’s difficult to exchange one token for another. As a result, exchanges popped up to help facilitate the buying, selling and swapping of cryptocurrencies. We explore how they work below.
What are exchanges?
Exchanges are sites that allow the buying and selling of different cryptocurrencies. Inside that definition, there are exchanges that are designed to offer different types of services.
🔀 Cryptocurrency Exchanges: Some exchanges are designed for financial traders who make money out of fluctuating prices between different types of currency. These can be best thought of as stock exchanges.
💁♂️ Cryptocurrency brokers - These specialise in helping people buy and sell crypto using fiat currencies. These can be best thought of as brokers of cryptocurrencies, like currency exchanges you’d use to buy foreign currencies for travel.
👬 Peer-to-peer trading exchanges - a slight variation on cryptocurrency exchanges in that the exchange doesn’t set the market price, the sellers do.
💰Cryptocurrency funds - a slightly less common type of exchange, but typically involve and investment group allowing traders to invest in a particular type of cryptocurrency. This is a type of exchange where a trader won’t actually hold any cryptocurrency.
Some exchanges offer all of these features on one site whereas others only specialise in one or two.
How do they work
These exchanges have slightly different functions in terms of features and functionality. For the purposes of this explainer we will focus only on the two most common exchanges, brokerages and exchanges.
Exchanges typically make a profit by charging a transaction fee in order to facilitate the exchange of one currency for another. These rates vary according to which exchange you are buying and or selling from.
A user or trader will either hold cryptocurrency - some exchanges don’t allow the use of fiat currencies - or buy currency directly from the exchange to begin trading. In both instances, the user will need to have a wallet.
To buy currency using fiat money, a user will also incur a charge there too.
When a user wants to cash out of crypto and convert to fiat currency, they traditionally sell off their currencies and the fiat value is then withdrawn into a regular bank account.
Why are prices of crypto different on different exchanges?
Cryptocurrencies are decentralised. As a result there is no central authority regulating the prices of crypto. Exchanges set prices based on a variety of factors, based around how popular - or unpopular - a currency is. Hence why there is a subtle difference in pricing of a certain asset depending on what exchange you’re on - which has lead to an emerging industry of traders taking advantage of the subtle differences.
How many exchanges are there?
The number is changing all the time, but according to CryptoCoinCharts, there are some 200 exchanges currently listed.
Exchanges are wildly popular when it comes to cryptocurrency trading. However, they aren’t without their issues. Many exchanges have been hacked, sometimes losing huge amounts of currency.
Exchanges are also coming under increasing pressure to know more about the identities of their users, which has lead to the rise of a new type of exchange, often referred to as decentralised exchanges. We’ll explore those in another post.