How do crypto exchanges work?

Crypto exchanges are platforms that people can use to buy and sell cryptocurrency. For instance, someone may use a US crypto exchange to trade traditional dollars for cryptocurrencies or to trade one cryptocurrency for another. Some crypto exchanges may also offer custody — meaning they secure private keys needed to prove ownership of one’s cryptocurrency — and other services.

This article explores how crypto exchanges work, types of crypto exchanges, and potential considerations when using these platforms.

How crypto exchanges work

Crypto exchanges can help facilitate the crypto trading process, matching the right bids to the right orders for the right prices. These exchanges may provide tools and resources to make trading convenient and accessible. There can be exchanges where the seller of the cryptocurrency is the exchange itself, while other exchanges operate as the intermediary between two entities (a buyer and a seller) on the exchange.

The different elements of a crypto exchange include:

Order books

An order book is considered a crypto exchange's running list of buy and sell orders made by traders. This list is commonly sorted by price and may be used to determine when to execute orders for an optimal outcome.

Types of orders

There are generally two main types of crypto exchange orders:

• Market orders trade funds at the best available price in the market right away.
• Limit orders trade funds at a specific price. If the desired price isn't available, the order won't be executed until the price becomes available or the order expires.

Types of exchanges

There are two main types of crypto exchanges:

• Fiat-to-crypto exchanges. These may be used to trade traditional currencies for cryptocurrencies and vice versa. They may also support crypto-to-crypto trades.
• Crypto-to-crypto exchanges. These may be used to trade one cryptocurrency for another.

Crypto exchanges can also be categorized by their level of regulation, including:

• Centralized exchanges. These exchanges may be managed by third-party companies that can monitor transactions and set fees and standards.
• Decentralized exchanges. These exchanges typically have no third-party intermediaries and are instead run by peer-to-peer computer networks.
• Hybrid exchanges. These exchanges blend elements of centralized and decentralized platforms. The focus of these exchanges is generally to combine security features of decentralized exchanges with the order execution speed of centralized exchanges.

Exchange wallets

An exchange wallet is considered a digital hub or account where someone can store their cryptocurrencies for buying, selling, or safekeeping. Exchange wallets can be kept secure with private keys or alphanumeric passwords. People may set up their own wallets or use a wallet provided by a crypto exchange platform. On centralized exchanges, keys are often not shared with the wallet holder.

Exchange wallets are considered either “hot” or “cold”. Cold wallets can be used to store cryptocurrency offline, such as on a USB drive, where it can be kept secure until it's ready to be traded. Hot wallets are used to store cryptocurrency online, where it can be traded in the crypto market.

Considerations when exchanging crypto

Trading crypto can be complex, especially for those just getting started. Once someone understands the way crypto works and its volatile nature, there’s still the matter of navigating exchanges. Consider these notes when looking for an online cryptocurrency exchange:

• Be wary of scams and fraud. Cryptocurrencies exist in digital form, so they can be vulnerable to hacking. Scammers may also attempt to solicit private keys from a user to access their accounts and cryptocurrency. It’s important to remain aware and cautious with any unsolicited or suspicious communications.
• Make sure the exchange is legitimate. Research the platform and ensure that it's trustworthy before using it to buy, sell, or store cryptocurrency. Search for other signs of legitimacy, such as transparent contact information, a physical address, licensing information, and regulator oversight.
• Consider the exchange's pairs. “Pairs” are assets that can be traded for each other on the same exchange. Look for what cryptocurrencies can be traded on the exchange. Is there a wide array of options to buy and sell? Ensure currencies the user uses most are supported.
• Look out for fees. Crypto exchanges charge fees for transactions made on their platform. Be sure to evaluate potential fees, such as transaction fees or setup costs.