How does a crypto exchange work – and what are the differences between the types?

In the modern age, cryptocurrency is all the rage – and, given the potential profits on offer and the unique nature of the asset class, it’s little surprise. Everything from Bitcoin to Shiba Inu has taken center stage in crypto-land at some point in recent years, and it’s unlikely that the crypto train will stop any time soon.

Most people who have some experience of the financial sector will know that cryptocurrencies are bought and sold on an exchange. But these exchanges operate in very different ways to traditional financial exchanges. Not only that but there’s also a whole host of different types of crypto exchange to choose from. This blog post will look at how crypto exchanges differ, and what their overall functions are meant to be.

Traditional definitions

Before looking at what the word “exchange” means in a cryptocurrency context, it’s important to first understand what it means in a wider financial sense. The most widely recognized type of financial exchange is, in fact, a stock exchange, which is known for its grandeur and physical presence. Stock exchanges tend to be actual buildings rather than just websites, and they are often located in national or provincial capitals: the New York Stock Exchange, for example, occupies a large and impressively-fronted building on Wall Street.

In terms of function, exchanges are there to facilitate the purchasing and selling of a particular asset. In the case of stock exchanges, it tends to be the stock only of companies that are “listed” on the exchange that can be bought or sold there. These are companies that have made a distinct decision to sell shares to the public in order to raise funds. It’s not possible to buy shares in privately held companies on stock exchanges.

Crypto exchanges

Crypto exchanges are different in several ways, but in one key sense in particular: they are based almost entirely online. There’s no physical building that a person can go to in order to trade.

There is some inevitable real-world evidence of crypto exchanges in the form of servers and other key technological infrastructure – but for the end user, it’s only possible to get to them through the web.

In some senses, this isn’t too different to a traditional exchange. If you wanted to buy shares, for example, it’s unlikely that you’d need to go to the actual stock exchange – at least not in this day and age. But the lack of a physical building in the case of crypto exchanges is symbolic more than anything: it reflects the fact that crypto styles itself as democratic, and that the asset itself can be traded easily by anyone with some start-up capital and a computer. Purchasing a stock, on the other hand, often takes far longer – and comes with much more complexity.

Crypto exchanges are also far more anonymous. In some cases, it’s possible to turn up to decentralized crypto exchange and complete a transaction without having to provide much information about yourself at all – or at least not nearly as much as you’d need to provide if you were purchasing stocks. Depending on the jurisdiction, there may sometimes be a higher level of information needed due to “know your customer” regulations – but, on the whole, it’s a fairly anonymized process.

The different varieties

But as cryptocurrency grows in popularity and recognition, it’s also become clear that there’s a real diversity of crypto exchange options out there. As a trader, it’s vital to know what the differences are – because it’s the main way of working out the trading and exchanging approach that is right for you and your needs.

The most famous variety of crypto exchange models is the decentralized one. A decentralized crypto exchange is one in which the transaction is just between the buyer, the seller and the blockchain. When someone liquidates their crypto-asset on a decentralized exchange, they don’t receive the cash via a third party: instead, they use something like an escrow service to protect the money while it remains on the blockchain. This is a highly secure way of doing it, and there are often lower fees. Liquidity and popularity, however, can below.

The opposite of a decentralized exchange is, predictably, a centralized one. In this model of crypto trading, there’s much more oversight: you’ll probably need to verify your identity, so there’s less privacy. But the upside is that the involvement of a third party can provide a little more stability and ease of use. Common centralized services include Coinbase and, as this article from respected site AskTraders shows, a number of Coinbase Alternatives.

Sometimes, it’s possible to access the best of both worlds through the use of a hybrid exchange. In this instance, some of the features of a decentralized exchange will be melded together with features of a centralized one, and you’ll be able to reap the benefits of both. You might, for example, use a more active escrow service which takes a bigger role in protecting money. This third party has some power, but they don’t have nearly as much as a full-service centralized exchange that calls all the shots on trading conditions.

Ultimately, cryptocurrency has exploded in recent years – and most people in the financial sector now know the basics of the trading process. But as a crypto investor, it’s vital to know how the key node in the system – the exchange – really works. There’s no use in confusing the traditional exchange with a crypto exchange, as the two are radically different. As this article has shown, crypto exchanges are much more anonymous – and arguably democratic, too. It’s key to remember that they vary in nature depending on how centralized or otherwise they are, though – and it’s wise to do your research and pick a type that suits you best.