Three different types of cryptocurrency exchanges and how they work

In this guide, we break down the different types of crypto exchanges available and take a look at how they work

Without knowing what an exchange is or how they work, the prospect of trading with crypto can be a nerve-racking experience. In this guide, we break down the three most common types of cryptocurrency exchanges and how they work.

An exchange, in the context of cryptocurrency, is often a web-based application or service that provides users with the ability to exchange crypto, such as Bitcoin, with other digital assets like Litecoin or Ethereum. There are three popular and common types of exchanges for crypto. The first and most popular type of exchange is a centralised exchange, or CEX for short. The second type is a decentralised exchange, known as DEX. The final type of exchange is a hybrid exchange, one that implements features that are typical of both a centralised and decentralised exchange.

How do they work?

Below is how exchanges typically work:

  • Users either transfer their existing crypto to their account on an exchange or use the exchange to buy crypto with fiat currency (note that not all exchanges provide the option to buy cryptocurrency with fiat currency)
  • The exchange then holds on to the cryptocurrency
  • The user then watches the prices of other cryptocurrencies available
  • Users then place their buy or sell orders once they have chosen the desired trade
  • The exchange finds a seller or buyer to match your trade
  • The exchange then completes the transaction

 

Centralised cryptocurrency exchanges

A centralised exchange, or CEX, functions similar to a traditional stock exchange. Buyers and sellers are able to use the service to buy, trade, or sell their crypto. The exchange then plays the role of a middleman – the party that brokers the deal. In this space, the term ‘centralised’ refers to an entity that has full control over a service (in other cases, it may refer to the banking industry or a government who have full power over finances or the nation).

Centralisation is often seen as an enemy in the world of crypto, because it requires an element of trust in a third party to handle your money which is otherwise not needed if you were to use a decentralised exchange. There are a number of other reasons why centralisation is frowned upon, but in the context of a CEX, it is because, as a user of the service, you are trusting the exchange with your crypto. Furthermore, a centralised entity is more vulnerable to a hack because it has a singular location, whereas a distributed and decentralised system is powered by multiple nodes across the world, meaning decentralised exchanges are less likely to be compromised.

Decentralised cryptocurrency exchanges

One of the leading principles behind cryptocurrency is decentralisation. In short, the purpose of decentralisation is to take away power from singular entities and to provide peer-to-peer networks that do not rely on a middleman to complete transactions. This is why decentralised exchanges are popular, because they hold true to the philosophy behind cryptocurrency. A decentralised exchange, or DEX, does not store your funds like a CEX does.

Since there is no middleman, a DEX facilitates peer-to-peer trades. Because they are not centralised and therefore do not have a central server/device running the operation, they are significantly harder to hack than a CEX. However, this does in turn mean users are more vulnerable to locking themselves out of their money. Another drawback for DEXs is that there may be periods of low volume and low liquidity if there is a lack of people using the exchange.

Hybrid cryptocurrency exchanges

With centralised and decentralised exchanges alike being massively popular but each bearing their own limitations, a new generation of exchanges are looking to gain wider acceptance in the world of crypto. A hybrid exchange would typically seek to blend the benefits of both centralised and decentralised exchanges together.

Hybrid exchanges look to provide the functionality and liquidity of a centralised exchange, but with the security of a decentralised one.

The need for hybrid exchanges arose following the realisation that neither a centralised nor decentralised exchange could provide complete functionality that allows for efficient trading within a market. CEXs had become a standard of sorts because they provide quick processing of orders, liquidity, and marginal trading tools. But, the lack of security has always been an issue, and full centralisation goes against one of the founding philosophies of cryptocurrencies.

This is not to say that DEXs are definitively better. Because of the push for privacy and anonymity on DEXs, it is difficult to regulate and collect necessary information from users of DEXs, and as mentioned earlier, there can be liquidity, volume, and human error issues.

One of the first companies to begin creating a hybrid exchange is Qurrex. Qurrex Ltd are a FinTech company based in the Cayman Islands and the Netherlands looking to “develop the most reliable and secure platform for trading cryptocurrency.” The team at Qurrex began drafting ideas in 2016, and in 2018, they launched. However, live trading is not available yet as it is still in development.

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