Working of cryptocurrency exchanges in detail

The stereotypical decentralized nature of crypto in contrast to the well-regulated stock exchange is a huge incentive for investors: they can operate free of regulatory rules that is the hallmark of stock exchanges.

But how do crypto exchanges work? Here are some of the main features of crypto exchanges.

A crypto exchange is simply a platform that pairs up sellers of crypto with buyers. It is an online platform where individuals exchange their fiat money (government-issued currency) into cryptos and vis-à-vis. These platforms support the trading of cryptos for other assets including digital currencies. In effect, these exchanges make money through transaction fees and commissions.

Crypto exchanges can be of 3 types depending on the competitive pricing, customer’s ease and government regulation.

  1. Decentralized Exchange

Abbreviated as DEXs, Decentralized Exchanges are a peer-to-peer marketplace that straightaway links sellers and buyers or the investors for conducting dealings without any intermediary. DEXs operate on the key principles that cryptos were developed for no regulations and controls from the authorities.

The trading is done here on the blockchain which provides the following advantages:

  • Offer transparency, investors security and greater control over trading. They also facilitate privacy to the users.
  • DEXs can’t be closed or hacked by the government easily.
  • These exchanges have an automated procedure that monitors all the transactions and doesn’t rely on a firm to control investors’ assets.

However, because of the absence of government controls and their restricted functionality, they are not much recognized. They thus have less liquidity, lower trading volumes and slower transactions. Here are some other limitations of these exchanges.

  • They only support crypto-to-crypto trading.
  • Due to the lack of regulation, the funds sent to the wrong wallet can’t be retrieved or canceled.
  1. Centralized Exchanges

Centralized exchanges or CEXs are the most highly used and accepted form worldwide. As the name suggests, they are fully controlled and regulated by a central authority. A CEX is just akin to the stock exchange. These exchanges are governed by a firm that provides crypto trading for crypto to crypto or fiat to crypto. KuCoin, Huobi and Binance provide crypto to crypto matching whereas Kraken, Bitterex and Coinbase proffer fiat to crypto matching.

Here are some characteristic features of CEXs.

  • The exchange, in CEX acts as an investor’s custodian or intermediary, which holds the money of investors like a bank.
  • CEXs enable faster transactions and have high liquidity.

Where do CEXs lack behind?

  • Trading in these exchanges is done on the database of exchange like Binance or Coinbase’s database. That’s why they are more vulnerable to cyber-attacks.
  • They don’t offer private keys to access wallets. They need KYC verification and regulations.
  1. Hybrid Exchange

The third category is said to be the next generation crypto trading marketplace as it overpasses the disadvantages of both forms of exchanges by integrating the security and privacy of decentralized exchanges and high liquidity, the regulated framework of centralized exchanges and quick transactions.

Some of the advantages are as follows:

  • Funds of investors are stored in cold wallets. This makes them less vulnerable to cyber heists.
  • Hybrid exchanges include solutions to blockchain technology.
  • These exchanges provide user custody of their funds even if a third party is included in the trading.
  • They guarantee agreement to digital laws and offer real-time access.
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