What Are Crypto Exchanges And How Do They Work (2024)

The size of the cryptocurrency market is now worth more than one trillion, witnessing a craze for digital currencies and decentralized finance. Every now and then hundreds and thousands of virtual currencies are cropping up. The curious segment of crypto investors thus need to know more about a proper platform which allows them to trade swiftly in various digital assets.

Just like traditional stock and commodities exchanges, cryptocurrency exchanges are also kinds of platforms that facilitate its participants to trade in different kinds of cryptocurrencies.

Especially after the fallout of leading crypto exchanges of the world, FTX and now the Binance-SEC saga, there is a high level of curiosity to understand more about these exchanges.

To help, Forbes Advisor India has prepared a detailed guide on cryptocurrency exchanges, how they function, their types, pros and cons and most importantly listed all the red flags to watch out that a cryptocurrency exchange might possess for a potential customer.

Meaning of A Cryptocurrency Exchange

A cryptocurrency exchange works similarly like stock exchanges which helps the investors to buy and sell in digital currencies such as Bitcoin, Ethereum or Tether. These platforms work on digital marketplace such as mobile apps or via desktop functions similarly like e-brokerages. They also provide an array of trading and investing tools to its users.

The crypto exchanges also provide trading of various cryptocurrency such as margin or lending trading, and future and options trading.

To provide their users with these countless offerings, the crypto exchanges charge some type of fee for your transactions which can be either based on the volume of your transaction or dependent upon which kind of trade you carried out. Before crypto exchanges, investors were only able to receive crypto via mining or by organizing transactions in various online and offline forums. But now, there are hundreds of cryptocurrency exchanges operating worldwide and offering various digital currencies with varying levels of security and fees structure.

Unlike traditional stock or commodity markets, where fees have been reduced in the last few years, crypto trading generally costs more.

Note: The ideal cryptocurrency exchange will make it easy for you to trade the currencies you want with truncated fees structure and reliable security features.

How Does A Cryptocurrency Exchange Functions?

Cryptocurrency exchanges, whether centralized and decentralized, are very new as a concept. They work on the basis to provide a match for buyers and sellers. When you set up an account with any of the crypto exchange, it facilitates you to buy and sell cryptocurrencies such as Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), Cardano (ADA) or Dogecoin (DOGE), and so on.

So, if anyone wants to place trades on crypto exchanges in India, they have to first register and complete the Know-Your-Customer (KYC) process. Once the user’s account is opened and verified, then they can transfer funds in the form of fiat currencies such as INR or digital currency onto the platform, which can be further used to make purchases.

So, if suppose you want to buy your first cryptocurrency via crypto exchange, here are the basic steps:

Step 1: Explore and choose a trustworthy and sound cryptocurrency exchange.

Step 2: Register with the exchange and open an account with them.

Step 3: Fund your account or crypto wallet either by depositing fiat or digital currencies.

Step 4: Now, select the cryptocurrency you want to buy and how much. For instance, if you wish to buy Bitcoin worth INR 10,000.

Step 5: Follow the necessary steps to initiate and complete a transaction.

Step 6: Check your account to verify that the transaction was a success.

Pros and Cons of Cryptocurrency Exchanges

Pros

• Very easy and hassle-free for users to buy cryptocurrencies.
• Exchanges allow you to place a legitimate trade on cryptocurrencies.
• There are many exchanges which offer their users with tax forms, making it easier to compute crypto taxes.

Cons

• Too much vulnerable to hacks and cyber theft.
• If the exchanges go bankrupt, users will not be able to access their funds or place trades.
• In most of the exchanges, users do not have the right to hold their private keys.

Types of Cryptocurrency Exchange

Centralized Exchanges

These kinds of exchanges work on the same lines of conventional equity stock exchanges or full -time brokerages. As the name says, the centralized exchange is regulated by a single authority which keeps an eye on every account and maintains full charge on each and every transaction.

Pros

• Great liquidity.
• Recovery of the user’s fund is possible.
• Able to handle transactions faster.

Cons

• Easier for hackers as CEX stores valuable user data across centralized servers.
• Have been charged with manipulating trading volume in the past.

Decentralized Exchanges or DEX

These kinds of exchanges are completely opposite of centralized exchanges. They run on the basis of distributed ledger infrastructure. These kinds of exchanges allow trading of cryptocurrencies without any authority.

Decentralized exchanges are fully autonomous where the users control their keys and their digital assets. Moreover, the users are not required to go through any kind of KYC formalities and thus have more privacy in securing their transactions.

Pros

• Full custody of their funds.
• More security and privacy.
• Distributed hosting reduces the risk of cyber attacks.

Cons

• Low liquidity.

Hybrid Exchanges

A hybrid exchange is a mix of both CEX or DEX exchanges and has been designed to offer the best of both the worlds. They assist in providing the ease and convenience of the centralized exchange and also offer the benefit of privacy and security of a decentralized exchange.

Pros

• Provides the strengths of both DEX and CEX.
• Provides a high level of privacy.

Cons

• Relatively a very new concept.
• Do not have much volume till date.

To know more about the prominent exchanges of India, Forbes Advisor India has prepared a list of the best of the exchanges operating in India. Read our article on Best Cryptocurrency Exchanges In India to gather more information on specific exchanges and their key features.

Things to Check Before Selecting a Crypto Exchange

Always be cautious while selecting the crypto exchange which might put you in trouble, if not chosen wisely. A cryptocurrency exchange sounds simple — as it is just a platform where you can buy and sell different types of crypto. But, as most of the things in the cryptoverse are complex, exchanges can be complicated too and may require a lot more scrutiny than traditional stock as it is largely unregulated.

Here are few of the important points which could save you big time from a fraud or cryptocurrency exchange which might poses a significant amount of risk:

Check whether a particular firm is registered as a securities broker.

Choose the exchange which is incorporated or registered in India. This could make it very helpful if any concerned authorities investigate the exchange.

The exchange must notify or inform you what it does with your funds. So, if the exchange is manipulating or commingling your funds, it could be very difficult or impossible for you to recover your funds if the exchange enters bankruptcy. For instance, bad lending practices led to the demise of FTX and proved very risky for its users across the globe.

The exchange should have a legit presence on social media channels such as LinkedIn, Twitter or Facebook.

Always check the customer support system of the cryptocurrency exchange, before selecting the exchange, try to contact them via toll free numbers or via chat system.

Before selecting the exchange, also locate the exchange’s wallet. A fully operational exchange generally discloses their cryptocurrency reserves. But, if an exchange is trying to keep this information hidden, then it could be a sign of undercapitalized or illegitimate exchange.

How is a Cryptocurrency Exchange Different from a Cryptocurreny Wallet?

People often get confused between crypto exchange and crypto wallet. As they both are used extensively for the safe storage of cryptocurrencies — although how a crypto wallet functions is a little bit more complex. Here’s a quick rundown of some of the notable differences between crypto exchanges and crypto wallets:

How to Select the Proper Exchange for Your Investing Needs?

Do Proper Research: When it comes to selecting the best crypto exchange then its reputation and past records really matters a lot. Thus, it is very important for the users to do proper research about the exchange, its founders, legitimacy, security issues, and how exchange addresses any customers related issues.

High Level of Security: The cryptocurrency exchange should have proper and high level of security features. As these exchanges are not regulated, therefore only tight security features are a must.

Always Check Pairs and Fees: If you are satisfied with the exchange’s background and its security features, then the next important thing to consider is the pairs and fees, as it might affect your daily investment needs. Fees and pairs vary from exchange to exchange and totally depend on your on-investment requirements.

Withdrawal and Deposit Options: Select that exchange which offers multiple and convenient ways to withdraw and deposit your money such as bank transfers, credit and debit card payments, peer-to-peer lending etc.

Bottom Line

The most easy and hassle-free way for buying and selling of cryptocurrencies is via cryptocurrency exchanges. While it may sound very convenient \there are more than 200 exchanges, which are operating across the globe, and choosing the best one that suit your needs could be daunting.

So, when you are in the process of deciding which crypto exchange to choose, kindly keep in mind all the above-mentioned points such as its types, pairs, fees structures. location and other guidelines before you begin placing transactions in digital currencies.

Frequently Asked Questions (FAQs)