Cryptocurrency exchanges are platforms where users can trade digital assets like Bitcoin, Ethereum, and many others. Like a traditional stock exchange, crypto exchanges offer a marketplace where users can buy, sell, swap and participate in advanced investment strategies.
Types of exchanges
There are two main types of crypto exchanges: centralised exchanges (CEX) and decentralised exchanges (DEX).
Centralised exchanges (CEX)
Centralised exchanges (CEXs) are the most common. They are managed by a central authority or company that oversees transactions and holds users’ funds, acting as intermediaries between buyers and sellers. As such, CEXs are subject to intense regulatory oversight, requiring users to complete Know Your Customer (KYC) and Anti-Money Laundering (AML) checks.
While most centralised crypto exchanges in Australia use the liquidity of other providers to satisfy market orders, a select few operate an order book to give traders more flexibility and deeper liquidity. Independent Reserve is an example of a centralised exchange that utilises an order book to facilitate user trades.
Decentralised exchanges (DEX)
Decentralised exchanges operate without a central authority, using blockchain technology and smart contracts to facilitate trades directly between users. Users typically do not have to verify their identity to interact with a DEX. However, because DEXs do not maintain custody over a user’s digital assets, participants must maintain and have access to their crypto assets, often through a software or private hardware wallet.
Many DEXs, like Uniswap, Jupiter, and SundaeSwap, use Automated Market Makers (AMMs) and pre-funded liquidity pools to facilitate asset trades between users. These AMMs utilise the power of smart contracts to satisfy trading requests without the intervention or oversight of a third party.
What is the difference between an exchange and a crypto wallet?
Two main differences exist between a crypto exchange and a private crypto wallet.
Functionality: Crypto exchanges are trading platforms (to buy/sell crypto), whereas wallets are primarily designed to store and transfer cryptocurrencies.
Exchanges simplify the process of buying and selling digital assets. They often feature individualised portfolio monitoring, real-time price data, and advanced tools for experienced traders. While some crypto wallets have begun to include buy/sell functionality, the most common application of crypto wallets is for storing, sending, and receiving cryptocurrencies.
Custody: Centralised crypto exchanges traditionally hold all deposited funds and digital assets their users have purchased. Crypto wallets, on the other hand, allow users to have direct and autonomous ownership of their funds and digital assets. This is often referred to as “self-custody.”
Types of orders (Trading mechanics)
Exchanges offer different types of orders to execute trades. These include:
- Market orders: These orders are executed immediately at the current market price.
- Limit orders: These orders are executed only at a specified price or better.
- Stop orders: These become market orders once a specific price is reached, allowing you to either limit your losses or take profit. For the same asset, you can have a stop-loss and a stop-buy price.
How do exchanges set the price of each asset?
The price of a specific cryptocurrency offered on an exchange is determined by supply and demand dynamics within the platform. Prices can vary between exchanges due to differences in liquidity and trading volume.
How do exchanges make money?
Crypto exchanges generate revenue through several methods:
- Trading fees: Most exchanges charge a small fee for each transaction, typically a percentage of the trade amount.
- Spreads: Spreads represent the price difference between the highest buy order (bid) and the lowest sell order (offer). Some exchanges may add an additional spread (i.e. 0.5% above or below the market price) and pocket the difference. Independent Reserve does not add a spread to its order book.
- Withdrawal fees: Fees are often charged for withdrawing funds from the exchange to cover the crypto network or bank fees.
- Premium services: Some exchanges charge a fee for advanced trading tools, leveraged trading, and other premium features.
- Interest and lending: Platforms may earn interest by lending users’ funds or offering staking services.
- Listing fees: Exchanges may charge cryptocurrency projects a fee to list their tokens on the platform.
Security considerations
Security is a major concern for crypto exchanges. Centralised exchanges implement advanced security measures, including two-factor authentication (2FA), cold storage solutions for funds, and regular security audits.
Pros and cons of crypto exchanges
Pros
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- Convenience: Crypto exchanges offer a convenient and accessible platform for buying, selling, and trading a wide range of digital assets, making it easier for individuals to diversify their investments.
- Trading tools: Many crypto exchanges offer advanced features that are usually reserved only for experienced traders. These include margin trading, stop-loss/stop-limit functionality, technical analysis tools and real-time market monitoring.
- Security: Exchanges employ state-of-the-art security measures to protect your investments from loss, theft and unauthorised access.
Cons
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- Sovereignty: Crypto exchanges store the cryptocurrencies purchased by their users. From a certain perspective, users don’t have direct custody of their digital assets – unless they withdraw them.
- Regulatory uncertainty: The regulatory environment for crypto exchanges is constantly evolving, leading to potential legal challenges, fines or shutdowns.
- KYC and privacy concerns: Many exchanges require identity verification, which may be a privacy concern for users who prefer to remain anonymous.
- Risk of insolvency: Users may lose access to their funds or assets if an exchange becomes insolvent or bankrupt.
How to select the right crypto exchange for you
There are many variables to consider when choosing a cryptocurrency exchange. These can include:
- Reputation and track record: Research the exchange’s history, user reviews, and past security breaches.
- Security features: Look for strong security measures, such as two-factor authentication, cold storage, and 1:1 reserves of customer assets.
- Regulatory compliance: Check if the exchange complies with local regulations and has a licence to operate in your jurisdiction.
- Trading pairs: Ensure the exchange supports the fiat/cryptocurrency pairs you intend to trade.
- Fees: Compare trading, withdrawal, and other charges across different exchanges.
- User interface and experience: Evaluate the platform’s ease of use, available tools, and overall user experience.
- Liquidity: Consider the exchange’s trading volume to ensure you can execute trades quickly and at your desired price.
- Deposit and withdrawal options: Check the available methods for depositing and withdrawing your money, such as bank transfers, credit cards, PayPal or crypto transfers.
- Customer support: Investigate the quality of the exchange’s customer support.
- Geographical restrictions: Verify that the exchange is accessible in your home country.
- Transparency: Look for exchanges that provide clear information about their team, operational processes, and the security of users’ funds.
How to register with a crypto exchange
Independent Reserve is a cryptocurrency exchange that enables clients from Australia, New Zealand and Singapore to buy, sell and hold crypto. Whether you’re an individual or representing a company, a trust or an SMSF, we can cater to your needs. Click here to register.
