Who is starting to look for more information about crypto, certainly must have come across the expression “exchange”, right? But, after all, do you know what cryptocurrency exchanges are?
Just like the Stock Exchange, which trades shares, in the world of cryptocurrencies there are also those responsible for trading digital currencies. And in this case, those responsible are the exchanges, which act as a kind of cryptocurrency broker, trading Bitcoins, and several other altcoins.
Want to better understand how an exchange works and see tips for choosing the ideal one? Read on!
- What is a crypto exchange?
- How to choose the best exchange?
- How does an exchange work?
- Direct selling of cryptocurrencies
- Cryptocurrency trade
- Cryptocurrency storage
- How to trade on an exchange?
- Market trading
- Trading-with-limited-orders
- Leverage Trade
What is a crypto exchange?
An exchange is a crypto broker. It works as an electronic platform that facilitates the purchase, sale, and exchange of digital currencies and tokens. These exchanges just connect buyers and sellers, ensuring a practical and secure transaction.
There are some exchanges that only trade Bitcoins and others that have a wide range of cryptocurrencies.
To start buying or selling, in general, it is necessary to complete registration and, in some cases, send some requested documents (known as KYC).
Nothing prevents a person from buying such cryptocurrencies and tokens directly from another holder. The problem is the need for trust in the seller, especially when sending the amount in fiat currency or other cryptography is done in advance.
When making a sale in the p2p mode – directly between users – it is impossible to know the origin of the funds that were transferred to this buyer’s account, especially when it comes to fiat currency. However lawful its counterpart may be, these funds may have an origin considered dubious by the bank, the Federal Revenue Service, or some government agency.
In order to avoid such risks for both parties, it emerged the figure of exchanges, who copied the model of traditional brokers by charging fees in exchange for this intermediation and settlement service.
How to choose the best exchange?
To choose a good exchange, you need to pay attention to some essential points, such as:
- find out who owns the exchange and search for them on the internet, analyzing what other positions they have held, companies they worked for, and their track record;
- evaluate the exchange on complaint sites, such as Trust Pilot, and also on internet forums, such as BitcoinTalk, evaluating the experience of other users with the exchange, the most common problems, and the way the company deals with these issues;
- learn about the history of the exchange, analyzing when it was founded, who are its partners, VAT Number, and other essential information about a company;
- analyze the fees charged and what services are offered, in addition to the commercialized cryptography; check if the exchange operates in your country and is under the laws of our country;
- analyze the volume of trades (a good indicator of the company’s liquidity) and the ability to meet users’ requests at any point of the day;
- evaluate the security issue, preferring those that offer two-factor authentication options, complex captchas, and anonymous registration.
How does an exchange work?
In general, cryptocurrency exchanges work in the same way as traditional financial market brokers.
They do not need to follow any specific regulations to operate, but the IRS started to require, since 2019, a monthly declaration of investments for each client.
Exchanges can also charge brokerage, custody, deposit, and withdrawal fees, and the incidence or otherwise of these charges and their amounts vary from company to company – just as with traditional market brokers.
One of the few differences is that, in the digital assets market, cryptocurrency exchanges are not mandatory intermediaries. In this market, they function only as facilitators of the negotiation process.
Direct selling cryptocurrencies, cryptocurrency trade, and storage, market trading are just some examples you can learn further in this article.
Direct selling of cryptocurrencies (P2P)
It is the simplest operating model, in which the exchange accumulates different cryptocurrencies bought at low cost and sells them at the current market price plus service fees.
In general, cryptocurrency exchanges accept fiduciary currencies (dollar, euro, etc.) as payment for cryptocurrencies, payment by banks, online payments (such as via PayPal), or payment by credit card;
Cryptocurrency trade
In this case, the exchange works as a kind of “Free Market”. That is, the exchange does not sell cryptocurrencies directly, but works as an intermediary, helping buyers to find sellers and carry out transactions with each other. Therefore, for each transaction, a fee must be paid to the exchange.
Cryptocurrency storage
This is a very common service provided by exchanges that offer the possibility for users to create local wallets to store their cryptocurrencies.
However, these wallets are not always the safest storage options, because if the exchange ends up going bankrupt, it will take all your money along.
Many, even, indicate that users keep cryptocurrencies in these portfolios only for a short period, transferring the amount to a more secure wallet and leaving only small amounts in the exchange’s wallet for next transactions or purchases.
In order to operate, exchanges do not need to follow any specific regulations, however, the IRS requires a monthly statement of investments from each client.
The fees charged on cryptocurrency exchanges, may vary depending on the company, for example, with a brokerage, deposit, and withdrawal fee.
How to trade on an exchange?
After choosing the best exchange for your needs, you will need to register, send some documents and confirm your identity. From there, you can choose to buy or sell crypto.
Most exchanges work as a cryptocurrency trade, that is, making the connection between buyers and sellers. So it is this method of negotiation that we will explain.
If you want to buy cryptocurrencies directly from the exchange, the process will be simpler, just reach an agreement regarding the values and carry out the transaction.
If the idea is to negotiate with other sellers, there are two possibilities: negotiate on the market (that is, buy and sell directly) or with limited orders. Let’s see each one.
Market trading
After depositing money in your exchange account, it will release this amount into your account balance on the platform and you will be able to compare cryptocurrencies offered by the exchange based on the market price.
Then, just choose the crypto that you want to buy, the price and the quantity, confirming the transaction.
Trading with limited orders
This mode of operation is a little different, so it deserves a more detailed explanation:
- The user can place a purchase order for a cryptocurrency at a lower price than the current quote.
- The system will wait until the price reaches the value of your order and only then will it make the transaction. Or you can place a sales order with a higher price and the same will happen.
It is worth noting that if you place a purchase order with a price above the current quote or a sales order with a price below the current quote, the order will be executed automatically at the price of the best sellers or buyers, taking into account the quantity of the crypto you want to buy or sell.
So, let’s assume that you place a purchase order of US$5000. You will be telling other users of the exchange that you are willing to pay US$5000 for 1 Bitcoin, for example.
If, at some point later, another participant places a sales order for 49 thousand reais, it means that he is willing to sell 1 Bitcoin for 49 thousand, but would accept to sell for the 50 thousand that you want to pay, then the transaction is closed in 50 thousand and orders are withdrawn from the exchange.
This dynamic changes the brokerage fee charged by the exchange. Usually, the user who places the first order pays a lower fee (or can receive a percentage of the brokerage, depending on the exchange policy) than the user who “withdraws” the order from the exchange.
After all, it is understood that the first will provide liquidity to the exchange, while the second will remove liquidity. In addition to buying crypto and paying with fiat currency, it is possible to trade cryptocurrency pairs. For example, buy Bitcoin and pay with Litecoin or buy Ethereum and pay with Bitcoin.
This, of course, as long as the exchange offers this alternative.
Leverage trade
Leverage in trade refers to the share of capital in a position that represents a credit. It is also known as margin trading, as it gives a greater margin to your initial investment.
This is a new model and has been adopted by some exchanges. These companies borrow cryptocurrencies that they own from users, similar to a bank. The exchange gains through the payment of a fee for the loan.
Yes, you can win more, however, if the market goes against you, your losses will also be amplified and you could lose more than you invested. Therefore, we recommend that you do not ignore the risk management rules.
What you think about this article about cryptocurrency exchanges? Tell us below in the comments below.
