What Are Crypto-Currency Exchanges And How Do They Work?
In the functional aspect, crypto-currency exchanges are online hubs that let you exchange one kind of crypto-coins for others.
Many offer the service of exchanging crypto-currencies for fiat money and vice versa, but not every exchange lets you convert anything.
You can exchange one crypto-currency for another only if the exchange offers the corresponding currency pair. For example, the presence of the BTC/LTC pair means the exchange in question allows for converting Bitcoin to Litecoin. If the hub doesn't list this pair, you won't be able to perform such an exchange operation. The rules are the same when it comes to fiat money.
The principle of operation of crypto-currency exchanges is quite simple. It includes several stages:
- Registering an account. In most cases, this procedure isn't fundamentally different from signing up on other websites.
- Depositing the money for trading or exchanging. As a rule, it's free for crypto-coins, while placing fiat money may involve a fee (not always, though). The commission of the exchange sometimes reaches up to 8%, but it's usually within the 1-5% range. The size of the fee depends heavily on the chosen method of money placement. As a rule, exchanges do not want to pay the commissions of the payment systems. So, they include any fees of this kind into their commission, which increases its total amount to some extent.
- Placing an order for buying and selling of the currencies. Users themselves set the desired price, at which they are ready to buy or sell the desired currency. Then they enter the bidding by placing the order on the general list.
If the transaction is successfully concluded, the user can withdraw the funds from the exchange or leave them in the exchange wallet for other transactions.
Occasionally, crypto-currency exchanges and individual accounts get hacked. That's why it's not recommendable to keep large amounts of money on an exchange – only the funds you will need for trading. Sometimes, the owners of the exchange may suddenly freeze the account and/or 'borrow' the user's funds permanently. That's why you should choose the exchange very carefully. Do not succumb to the temptation to use a little-known exchange for the sake of immediate benefits (zero commissions, etc.).
Strictly speaking, crypto-currency exchanges make their profits mainly from the fees. The aggregate volumes of commissions can reach very high levels as their user base increases – and particularly as a result of attracting large-capital users.
The Purpose Of Crypto-Currency Exchanges
Crypto-currency exchanges are the hubs for traders, miners, investors, as well as ordinary people that need to exchange money. All of them use exchanges for the purpose of either earning money or exchanging funds.
Crypto-currency exchanges can be used in the same way as stock exchanges. Traders employ the same profit-making principles at hubs of both kinds. Since crypto-currencies are highly volatile, the corresponding kinds of exchanges are significantly more profitable than their more traditional counterparts. In the traditional market, a trader earns good money on the fluctuation in the share price, which increases by, say, 9% per annum (and this isn't a bad indicator). In the crypto-market, a currency can soar by 20% in a day, which leads to appreciable profits. Of course, the trader must have the necessary skills and experience.
Some traders do not limit themselves to just one exchange. This allows them to earn not only on fluctuating exchange rates of one currency in relation to others, but also on the difference between the exchange rate of the same currency at different hubs. However, there is nothing fundamentally new about this. In the traditional market, traders do the same thing.
The behavior of investors on exchanges is rather passive. They occasionally buy relatively large amounts of a currency and put them in their portfolios. Sometimes they study the fluctuations of exchange rates. Some crypto-currency exchanges provide convenient graphs that allow you to track fluctuations in the greatest possible detail. Investors use them to determine the most profitable investment.
Miners simply exchange the less popular currency for a more popular one.
The logic is simple: it's often more profitable economically to mine a less popular crypto-currency. However, Bitcoin and Ethereum are the reliable ones in which it's smart to keep and grow your savings. In addition, if a miner wants to use his funds to pay for something, ZCash or any other less popular currency isn't of great use. The miner will need dollars (yuans, euros, rubles) or at least Bitcoin. In that case, the miner uses a crypto-currency exchange to convert the mined ZCash for another, more popular currency.
Occasionally, exchanges are visited by people who want to do the same with their crypto-currency obtained as a result of trading operations rather than mining. Such visitors use exchange hubs for their intended purpose: converting one currency into another.
How Crypto-Currency Exchanges Differ From Each Other
In general, exchanges operate on the same principle. However, they often differ in terms of functionality and capabilities, trying to attract as many users as possible with the help of distinctive features.
From the user's point of view, the most important differences are as follows:
- The choice of crypto-currencies. Some exchanges have only the most popular currencies, while others offer tens and hundreds of currency pairs.
- Withdrawable crypto-currencies. At some exchanges, you can only withdraw Bitcoin, Litecoin and a couple of other well-known currencies. Others envisage this opportunity for dozens of crypto-coins, as well as a handful of varieties of fiat money.
- Depositing/withdrawal of fiat money. Some exchanges work only with crypto-currencies and do not offer such an opportunity.
- Commissions. Usually charged per transaction. Some exchanges charge only the taker. Others charge both the taker and the maker. Other fees may also be levied.
- User data. Some exchanges only request you to submit your e-mail address. Others require a verification procedure, which may include scanned copies of your ID and/or other documents.
- Account protection. Some exchanges let you access your account after you enter your password. Others require you to complete a complicated login procedure that may involve confirmations of various data.
- Depositing and withdrawal methods. Some exchanges recognize only a couple of payment systems as a withdrawal method. Others allow the possibility of bank transfers or crediting to/from a card.
- Daily trading volumes. They exceed $2 billion at some exchanges and stand below $10,000 at others.
- margin trading, margin financing;
- detailed charts with Fibonacci levels and other trading tools;
- accrual of interest on deposits;
- referral programs;
- mobile apps, etc.
Finally, there are other important user parameters, such as language (usually English, with occasional support for other languages), and the responsiveness of the support service (almost every exchange has a tech support team, but this service fails to work as expected at some hubs).
How To Choose A Crypto-Currency Exchange
Your choice of a crypto-currency exchange should be based on what you intend to use it for.
For example, if you're an investor, it's advisable to focus on the following indicators:
- depositing/withdrawal fees;
- withdrawal limits (if their maximum is less than the amount you need to withdraw, you may lose a certain amount paying withdrawal commissions);
- reliability – at the very least, there should be no feedback about someone's inability to withdraw their $20,000;
- availability of the necessary currency pairs;
- the complexity of the verification procedure.
On the other hand, investors can allow themselves not to be too worried about account protection, as they will not keep their money on the exchange.
In turn, the following aspects are what's important for a trader:
- trading tools and detailed charts;
- a large number of currency pairs;
- decent account protection, as the trader will always keep a portion of their funds on the crypto-currency exchange.
An ordinary user who just needs to exchange funds should pay attention to the following aspects:
- availability of the necessary currency pair;
- depositing and withdrawal speed;
- no feedback mentioning withdrawal delays and failures;
- withdrawal without a lengthy verification procedure or submission of all kinds of documents.
On the other hand, it won't hurt a miner to undergo verification, as he or she will perform the same transaction regularly. Miners should also pay attention to the cybersecurity of the exchange, so as not to have to look for a new one later.
And so forth. Of course, it's best to opt for exchanges that have the largest trading volumes. The more people have chosen this or that hub, the more reason for you to put your trust in it, too.
As practice shows, if the exchange offers a huge number of currency pairs and withdrawal opportunities, delays and failures happen once in a while. This is partly explained by the large number of people wishing to withdraw or exchange an unpopular currency. But it can sometimes be a 'bait' used by scammers.
Do not forget about the general rules either: look at the real facts (the trading volumes, the fluctuations in the trading volumes, reviews) and do not bite the bait when the owners of exchanges make sounding promises.