Guide to Cryptocurrency Exchanges and Its Types

Depending on the legality of cryptocurrencies in one’s state or country, traders trade cryptocurrencies in either of the two ways: through a contract of difference or by directly buying and selling cryptocurrencies on an exchange platform. Most traders, however, prefer to trade cryptos directly on a cryptocurrency exchange rather than investing in a contract through a forex broker.

What is a Cryptocurrency Exchange

Cryptocurrency exchanges are platforms that bring buyers and sellers of different cryptocurrencies on a single platform and help them execute their trades. Unlike traditional stock or forex exchanges that have a fixed opening and closing time depending on the market, cryptocurrency exchanges function 24x7 to adhere to the forever open cryptocurrency market. These exchange also allow traders to study the market through live price charts and technical and fundamental indicators

Initially, cryptocurrency exchanges did not require a KYC completion for users to start trading cryptocurrencies. But with financial regulators stressing upon strong KYC and anti-money laundering laws for cryptocurrency exchanges, most exchanges no more allow users to trade without completing their KYC.

Types of Exchanges

Depending on how they function, cryptocurrency exchanges are classified as centralized, decentralized, and hybrid. They can be further divided based on whether or not they allow the use of fiat currencies to buy cryptocurrencies. If they do, they are known as fiat-to-crypto exchanges and if they only allow using cryptocurrencies to buy other cryptocurrencies, they are called crypto-to-crypto exchanges. There are also exchanges that are a mixture of these two types.

Centralized Exchanges (CEX)

Most of the cryptocurrency trading volume today comes through centralized cryptocurrency exchanges. The concept of a centralized crypto exchange is drawn from that of traditional stock and forex exchanges, where a central entity headed by a few core team members control the activity on the exchange.

Whenever users transfer funds to their accounts, it actually gets stored on the company’s accounts and the balance is reflected on to the user profile. This means that centralized exchanges have control over their users’ funds.

These exchanges are more common due to the high trading volume which provides liquidity to the market, hence, allowing for instant execution of trades at desired price levels. They are also easy to use and understand as the exchanges themselves handle most of the complex process once the trade hits the market.

There are also downsides to centralized exchanges. These exchanges work centrally and every bit of information is stored on a central server. This highlights a central point of failure, which the hackers have exploited several times in the past. The most recent of such hacks was the Binance hack which saw the loss of more than $40 million of user funds.

Decentralized Exchange (DEX)

Decentralized exchanges are exchanges that were built keeping in mind the true ethos of the cryptocurrency market — decentralization. On a DEX, users are the sole owners of their funds and they can directly link their cryptocurrency wallets to these exchanges without requiring to move their funds on the exchange. Hence, the exchange platform does not exercise any control over user funds.

Trades take place using peer-to-peer transactions, where every trader lists their desired bid and ask price on the exchange. Other traders then independently choose from the list of prices to execute a trade. The whole process on a DEX is free of an intermediary.

Due to the lack of any central server or entity controlling a DEX, these exchanges are almost impossible to hack. And even if hackers somehow hack a DEX, no user fund would be compromised as they are stored in individual wallets of the users and not on a central wallet of the exchange.

These exchanges are free of any regulations or closure threats as decentralized exchanges only exist in the form of computer codes deployed on decentralized servers.

However, these exchanges are complex to use and provide only basic features. This results in lower trading volume on such exchanges, which further pushes away other users from adopting a DEX over a CEX.

Hybrid Exchange (HEX)

As can be seen, both a CEX and DEX come tagged with their own set of pros and cons. These drawbacks resulted in the creation of hybrid exchanges. A hybrid cryptocurrency exchange is a mixture of a centralized and decentralized exchange.

While still in their development phase and covering only a small portion of the crypto trading market, many key members in the crypto industry believe that these exchanges are the future of cryptocurrency trading.

Hybrid exchanges integrate the top-notch security of a decentralized exchange to the liquidity and ease of use of a centralized one.

Conclusion

Although cryptocurrencies were first developed to act as a decentralized and borderless currency, people today mostly use cryptos as an exchange asset for generating profits in the long and short term. And it is the cryptocurrency exchanges that facilitate this rising demand for trading cryptocurrencies.

People hold different opinions about CEX, DEX, and HEX, and as to which one would survive in the long run. But all three types of exchanges have their audience and it is most likely that they all will continue to exist parallelly.