What is cryptocurrency exchange? What do you think of when you hear of an exchange? A stock exchange? Well, it’s pretty much the same concept. Exchanges are like marketplaces where buyers and sellers do what they do best—buy and sell.
Okay, so now you’re wondering why do cryptocurrencies need an exchange? The answer is quite simple. We have currency exchanges if you need to exchange your local currency for foreign currency.
However, when we need to convert a couple thousand dollars for euros, we head on to our local currency exchange. More often than not, it is a business that will simply take your dollars for whichever currency you need. Despite the simple transaction, there is a complex 24/5 forex market. You just don’t need to personally interact with the forex market in order to convert your money.
The cryptocurrency market, on the other hand, is still in its fledgling state. Yes, businesses are cropping up to serve this new market, but it is still, very much, an emerging market. You might find some bricks-and-mortar businesses that will allow you to buy cryptocurrencies in exchange for cash but it is still rare.
If you want to buy cryptocurrencies, you will have to go through one of the cryptocurrency exchanges. There are ways to buy cryptocurrencies without using an exchange, but it is always advisable to go through an exchange, where you will get the best possible price.
What is Cryptocurrency Exchange?
Now that we’re talked about cryptocurrency exchanges in general, let’s look at exactly how they work and how you can utilize them according to your needs.
- Exchange Platform
As the name suggests, these exchanges facilitate the exchange of cryptocurrency for fiat currencies such as US dollar or Euros. Since the cryptocurrency markets are open 24/7, 356 days a year, these exchanges are operational at all times.
At any given moment, you can use the exchange to buy any of the cryptocurrencies listed on a particular exchange. For example, you can buy or sell bitcoin, litecoin, ether, dash and more. You can use the exchange to sell $100 and buy $100 worth of bitcoins. You can then withdraw the bitcoins to your cryptocurrency wallet.
- Trading Platform
Some cryptocurrency exchanges such as Bitfinex also have a dedicated platform for traders. These platforms cannot be used to buy cryptocurrency and withdraw it. Instead, you can buy (long) or sell (short) a derivative contract such as a swap.
This is also referred to as margin trading, where you don’t actually own the cryptocurrency. Instead, you buy a contract representing the underlying cryptocurrency. Trading platforms also offer the ability to leverage a position. The capital in your account, also known as margin, is used as collateral for borrowing.
Leverage essentially means taking a loan to make a trade. You have to pay interest to the lender. Leverage allows traders to increase the potential gains as well as their losses. It significantly increases risk. Hence, you should not leverage your trading positions unless you’re an experienced trader who properly understands risk-management.
- Lending Platform
Exchanges that offer trading platforms also offer lending platforms. Lending platforms allow cryptocurrency investors to lend their capital to traders in return for interest income. It is a low-risk way to earn a decent return on your capital without the added risk of margin trading.
In most cases, lenders bear the risk of default. Default refers to a situation where the borrower is unable to make good on their obligations or even the principal amount. However, the good thing about using these exchanges is that the risk of losing your capital is non-existent.
As you might know, these exchanges are completely automated. So if you invested $1,000 and are trading with 3x leverage, you can buy bitcoins worth $3,000 despite having $1,000 in the account This means, a change of price of one percent will result in a change of three percent in your capital.
Despite having a position worth $3,000, the moment you lose $1,000, the position will be liquidated. If you lose, let’s say, $800, you will receive something called a margin call. Margin call means you are required to either deposit more margin (collateral) or have your position liquidated.
This ensures that under no circumstances will the lender’s capital will be at risk due to losses incurred by a trader (borrower). Hence, lenders can lend their capital with an implicit guarantee that their capital is not subject to market risk.
This ensures low enough interest rates for short-term borrowing to be feasible while at the same time, the risk is low enough for lenders to lend their capital at affordable rates. Lastly, interest rates are determined based on the demand and supply of credit. If there are more lenders, interest rates fall. On the other, if there are more borrowers, interest rates rise.
How To Get Started with Cryptocurrency Exchange
If you want to buy cryptocurrencies, you will have to go through a cryptocurrency exchange. In order to use a cryptocurrency exchange, you need to create an account with one of the exchanges.
After you’ve created an account, most reputable exchanges will require you to verify your identity in order to comply with anti-money laundering laws. You can deposit money and even use the exchange without verifying your account. However, you must verify your account if you wish to withdraw your money from the exchange.
Verification is a simple process. You simply have to provide some documents that will allow them to confirm your identity. You can deposit money on a cryptocurrency exchange through bank wire, credit card, cryptocurrency, etc.
Credit card deposits are instantaneous. Bank wire is subject to clearing. Cryptocurrency deposits require six confirmation from the blockchain.
Types of Exchanges
All exchanges allow you to access the cryptocurrency markets. Some offer advanced features such as trading and lending platforms. However, aside from the functionality and features, there is another thing that differentiates exchanges.
Some exchanges do not accept fiat currency. These exchanges usually focus on small-cap cryptocurrencies also known as altcoins. In order to access these exchanges, you have to first purchase bitcoins from one of the major exchanges and then deposit the bitcoins to these altcoin exchanges.
You can then use the bitcoins to buy altcoins such as DigiByte, Nxt, ReddCoin, etc. However, you cannot sell any of them for fiat currency.
As you can see, using cryptocurrency exchanges is pretty simple. Most platforms are designed to be as intuitive and simple as possible. However, trading is not simple, and you should understand the risk involved in trading.
Aside from that, you should always opt for an established cryptocurrency exchange. The larger exchanges have the necessary resources to develop and maintain state-of-the-art cybersecurity infrastructure to keep your funds safe.