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How Does a Cryptocurrency Exchange Work?

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Whoever thought that one day we’d be buying and selling invisible currency on a thing such as a cryptocurrency exchange? Nobody, I can guarantee you that. Well, perhaps maybe the inventor of Bitcoin, whoever they are. Regardless, the rapid development of crypto coins and extraordinary prices surges has drawn a lot of attention. From financial advisors to tech enthusiasts to your average joe, everybody wants in on the game. Needless to say, the cryptocurrency world has exploded. Furthermore, since the development of Bitcoin, many other crypto coins have begun to surface. For instance, popular cryptocurrency such as Litecoin, Ethereum, Zcash, Dash, Ripple and many more. As a result of cryptocurrency price surges, many individuals have become self-made millionaires. Blindly betting on what the next big coin will be. However, not many individuals are interested in using the coins for commercial purposes.
Consequently, you get many individuals speculating large sums of cash on different cryptocurrencies. Similar to a stock exchange these individuals buy a particular type of crypto coin on a cryptocurrency exchange. As previously mentioned, many of these individuals speculating on crypto are just average Joes and are completely unaware of the process of buying and selling crypto coins. As a result, this article is mainly geared towards them and those who are unaware as to how a cryptocurrency exchange work. In the following passages will talk about;
  • What a cryptocurrency exchange is and how does it work

  • A brief history of the development of the cryptocurrency exchange

  • How to buy and sell on a cryptocurrency exchange

  • Advantages and disadvantages to using cryptocurrency exchange
By the end of this article, you will be completely aware as to how the cryptocurrency exchange work.
What a Cryptocurrency Exchange is and How Does it Work
Following the development of Bitcoin and many other cryptocurrencies came the creation of the cryptocurrency exchange. Traditionally, many financial exchanges are heavily legislated with many requirements to be met by all parties. Originally they would have operated in a “pit” but with the development of technology, they operate on a software similar to the way a cryptocurrency exchange work.
There are two types of crypto exchanges that offer various ways of asset exchanges;
Through a Decentralized Crypto Exchange (Pre-Programmed Software)
Digital currency exchanges are similar to traditional exchanges such as the Nasdaq in which you have buyers and sellers except there’s no brokerage intermediary and it’s completely decentralized. Decentralised exchanges allow buyers and sellers to directly trade cryptocurrencies with one another without any third party intermediaries to ensure all trades are processed correctly. Predominantly, these exchanges would operate solely with the exchange of just cryptocurrency.
Through an Intermediary (Cryptocurrency Company) – Fiat Exchange
However, there are some cryptocurrency exchanges that act as an intermediary between buyer and seller and collect fees in order to profit from these exchanges. These types of exchanges would operate as a fiat exchange. In which physical currency can be traded for the cryptocurrency. Both exchanges have their advantages and disadvantages which we will highlight later in this article.
A Brief History of The Development of the Cryptocurrency Exchange
The frustration that comes with many exchanges whether they be crypto or not are the fees charged for the transaction. Fees can eat up a substantial amount of your profits over time. Especially if you’re buying and selling on a consistent basis and getting charged a fee for each trade. Over time many people began to favor decentralized crypto exchanges due to their complete omission of fees. With the recent popularity of Bitcoin, many other individuals started creating their own crypto exchanges in order to profit from the mass volume of trades occurring on a daily basis. In addition, many exchanges were set up to facilitate the trading of cryptocurrencies as there use had not yet become mainstream.
However, that’s not to say that these exchanges don’t have a dark history. Back in February 2014 one of the largest cryptocurrency exchanges shut down and filed for bankruptcy protection in Japan. This was purely to do with a large theft of Bitcoins from a digital wallet in which the intermediary stored all the transactions of the buyers and sellers. As a result, these buyers and sellers soon became their creditors. In addition, many state-owned regulators in various parts of the world such as America (SEC) have begun to start regulating these exchanges in order to prevent this from happening on a mass scale.
How to Buy and Sell on a Crypto Exchange
As we mentioned earlier, all of the transactions occur over a software designed to handle digital currency trading.
The way a cryptocurrency exchange work, for individuals looking to sell crypto coins, is that they design an order. These orders specify the quantity and price at which the buyer would like to sell the coin at. All of these orders are then placed in a large ledger called an “order book”. On the other hand, you have the buyer. When this individual seeks to purchase crypto coin they will search through the order book for a price and quantity satisfactory to them. If they cannot find one then they create there own order. When they’ve submitted there terms then the exchange tries to match their order conditions with the order conditions of the buyer and then the exchange is made.
The problem most exchanges face is the time lag needed to complete the exchange. Sometimes it varies from a couple of minutes to several days to complete. There are two ways of speeding up this process. Using an intermediary or getting the software to match the buyer and seller physically as opposed to by there terms. It’s always preferred to use an intermediary in the case of disputes breaking out. At least the third party can act as an arbitrator.
Advantages and Disadvantages to Using Cryptocurrency Exchange
Advantages of Cryptocurrency Exchange
  • No concentration of power. They are completely run by people.

  • Low or no fees

  • No central point of authority with decentralized exchanges means no government interference

  • Decentralised exchanges have more privacy
Disadvantages of Cryptocurrency Exchange
  • Longer trade times

  • Lower liquidity (depending on the exchange)