If a person wants to buy cryptocurrency, one option is to buy them at a cryptocurrency exchange. This article will explain what cryptocurrency exchanges are and how they work. It will also list some popular cryptocurrency exchanges.
What is a cryptocurrency exchange?
A cryptocurrency exchange is a virtual platform where cryptocurrency holders can exchange different cryptocurrencies for another fiat currency like USD or EUR.
Why are cryptocurrency exchanges needed?
These exchanges are a practical way to gain cryptocurrencies. The other ways to obtain them is to mine or buy them from an individual. Mining requires a large capital outlay in the form of at least one mining computer and buying from an individual can be risky and would often be slower than using an exchange. Hence, cryptocurrency exchanges became the primary means for end-users to obtain them.
History of cryptocurrency exchanges
To further understand how cryptocurrency exchanges work, it’s best to learn more about how they started.
Before crypto exchanges
In the first year of the Bitcoin’s existence, there were no cryptocurrency exchanges. A Bitcoin user would need to find another willing buyer if he wanted to sell his Bitcoin. The best place to look for other users was the forums at Bitcoin.org. However, negotiating fiat payment schemes required a high degree of trust with buyers and sellers now knowing what a ‘fair’ price would be for Bitcoin since there was no published market price yet.
The first cryptocurrency exchange: Bitcoin Market
The first cryptocurrency exchange was created by a Bitcointalk.org user named ‘dwdollar’ in March 2010 and was called ‘Bitcoin Market’ . The website would display a graph that marked the price of Bitcoin based on how trades performed during the day. This graph helped users determine which Bitcoin prices were fair for the first time.
In June 2011, however, Bitcoin Market was embroiled in a widespread scam where buyers used PayPal account chargebacks to accumulate Bitcoin without paying for them. As a result, dwdollar eliminated PayPal as a deposit method. Nevertheless, trading volume began to decline and Bitcoin Market was eventually removed.
The second cryptocurrency exchange: Mt. Gox
In July 2010, Bitcoin caught the attention of a programmer named Jed McCaleb. He originally developed a website used as an exchange for players of the collectible trading card game, Magic: The Gathering. There was less interest in the exchange, however, so he developed it for Bitcoin instead which was becoming popular at the time. The exchange, which is now known as ‘Mt. Gox’, was opened on July 18, 2010. From then on, Mt. Gox rapidly gained popularity within the Bitcoin community. In March 2011, the exchange grew to a point in which Mark Karpelès eventually acquired it. By 2014, most Bitcoin purchases and sales took place on Mt. Gox servers.
However, the exchange’s popularity wouldn’t last forever. In June 2013, Mt. Gox suspended USD withdrawals. Furthermore, all Bitcoin withdrawals became suspended in the following year. It announced soon after that 650,000 of their customers’ Bitcoin were missing. It was suspected that the Bitcoin were stolen by hackers which led to Mt. Gox closing shortly afterward. The case is still undergoing litigation today .
Cryptocurrency exchanges after Mt. Gox
Newer cryptocurrency exchanges emerged both during Mt. Gox’s height of popularity and after its demise in 2014. Nejc Kodrič and Damijan Merlak founded Bitstamp in 2011 as a European alternative to Japan-based Mt. Gox. In the United States, Jesse Powell founded a cryptocurrency exchange named Kraken after visiting Mt. Gox’s headquarters and observing it was managed poorly. In 2012, Brian Armstrong and Fred Ehrsam found a new exchange named Coinbase based in San Francisco .
As the volume of Bitcoin transactions rose from 2013 to 2017, more and more exchanges continued to emerge. The year 2013 saw the founding of Canadian exchange Bitbuy and the London-operated CEX.io. In the same year, Eric Vorhees created the Swiss-based exchange Shapeshift, which featured a simple interface that allowed easy conversion between different cryptocurrencies. In the following years, prominent exchanges were created such as Coinsquare, Poloniex, Bittrex, Coinmama, and Binance among others.
Cryptocurrency exchanges, in recent years, have focused more on security than ever before. Many exchanges place the majority of cryptocurrency assets into cold storage, which better protected the funds against hackers. A variety of security features such as two-factor authentication became popular as well in order to protect its users from cyber-attacks.
Types of exchanges
There are two ways to classify cryptocurrency exchanges. It can either be fiat-based or altcoin-based and either be centralised or decentralised.
Fiat vs. Altcoin
A fiat-based cryptocurrency exchange deals in both fiat currencies and cryptocurrencies. In most countries, fiat exchanges must register as money transmitter services and must comply with ‘know your customer’ and ‘anti-money laundering’ (KYC/AML) rules. Under KYC/AML rules, fiat-based exchanges must collect their users’ personal information, including name, address, and proof of government-issued IDs with photo. Fiat-based exchanges usually offer a smaller variety of cryptocurrencies than altcoin-based exchanges.
On the other hand, an altcoin-based exchange, also known as a ‘pure’ exchange, allows users to exchange one cryptocurrency for another but usually does not allow cryptocurrency to be converted into fiat. In most countries, altcoin-based exchanges are relatively free of government regulation. Users who only make small withdrawals can often sign up and use altcoin exchanges for years without having to provide any identifying documents.
Centralised vs. Decentralised
Most cryptocurrency exchanges are centralised, and companies, who function as a “liquidity provider,” often run these exchanges. This helps buyers and sellers find others on the exchange who are willing to engage in trades with them. Also, they are easier to use and run faster than decentralised exchanges. Complex order types, such as limit orders and stop losses often used by professional traders, are usually offered on centralised exchanges. However, users of centralised exchanges do not possess the private keys of wallets that store their cryptocurrency on the exchange. Instead, these keys are either held on the exchange’s servers or held offline on a hardware wallet owned by the exchange. As a result, users do not actually control their own cryptocurrency unless it is withdrawn from the exchange. Moreover, these centralised exchanges are more likely to be hacked, which can then lead to the exposure of personal user information.
Decentralised exchanges operate differently. There are two types of decentralised exchange: order book exchanges and relay exchanges. Order book exchanges utilise smart contracts to execute orders submitted on a central server. On the other hand, relay exchanges, allow buyers and sellers to look through different order books hosted by “relayers” in order to find the best deals for them. These orders are also executed by smart contracts. Decentralised exchanges are safer and more secure for cryptocurrency users. Users of these exchanges own their private keys and have full control over their cryptocurrency, preventing central authorities from halting withdrawals or losing users’ funds through lax security. The lack of centralisation also protects users against the risk of loss due to cyber-attacks or fraudulent exchange operators. On the other hand, these exchanges are currently slower than centralised exchanges and often lack liquidity and volume. They are also difficult for beginners to learn and do not offer complex order types.
The best cryptocurrency exchanges
Here are links to the official websites of some of the top centralised-fiat, centralised-altcoin and decentralised-altcoin exchanges today. By browsing the information on these sites, users should be able to find a cryptocurrency exchange that is right for them.