If you’ve dabbled with investing in one form or another, you’re probably familiar with the concept of an exchange. Entities such as stock exchanges and foreign currency exchanges allow customers to trade their stock or currency for other assets. On stock exchanges, you typically have the opportunity to convert between shares of stock and fiat money. Through foreign currency exchanges, you can convert your money from one nation’s fiat currency to another. A cryptocurrency exchange works in a similar way.
A cryptocurrency exchange, or digital currency exchange (DCE), is an online platform that allows you to buy and trade cryptocurrency or digital currency, then sell it to convert it back to fiat money. These exchanges will either take a commission or simply charge usage fees for their service.
How an exchange works
Cryptocurrency exchanges don’t work in exactly the same way as stock exchanges and foreign currency exchanges. However, having a grasp of general exchange fundamentals and procedures will allow you to more easily navigate cryptocurrency exchanges.
If you’re familiar with placing buy and sell orders through stock brokers, you can safely assume cryptocurrency exchanges function in a similar, third-party manner to these brokers. Brokers take your desired cryptocurrency price and order quantity, wait for an order to be completed, and then typically collect a percent commission (plus an upfront fee) on your order.
Similarly, a cryptocurrency exchange is usually programmed to accept your digital buy and sell orders (along with price and quantity), waits in a similar manner for your order to be triggered (met by a buyer or seller on the other end), completes the trade, and then updates your on-exchange holdings, all without human brokers.
Another of the unique aspects of cryptocurrency exchanges is the ability to exchange one cryptocurrency directly with another. This is something you can’t do with stocks, where you’d need to liquidate shares to fiat money before using those funds to buy new stock shares. Be aware though that you won’t necessarily be able to trade one cryptocurrency with all other cryptocurrencies under the sun.
Typical pairings available on cryptocurrency exchanges
The types of conversions possible all come down to what pairings are available on the exchange you’re using. For example, an exchange may have multiple trading pairs for Bitcoin (BTC) such as: BTC to US dollars (BTC/USD), BTC to Ethereum (BTC/ETH), and BTC to several other altcoins. If you currently hold BTC, but actually want ETH, you can trade directly from BTC to ETH via the BTC/ETH pairing. This is more efficient and less costly than trading from BTC to fiat money to ETH. Altcoins typically have fewer trading pairs than the most popular cryptocurrencies (Bitcoin and Ethereum), but this level of flexibility is still a nice feature to consider when choosing a cryptocurrency exchange to use.
Cryptocurrency exchange nuances, such as the absence of human brokers and the ability to trade between small, relatively rare and unheard of digital assets, bring a unique flair to investing, but you shouldn’t be intimidated by them, because the overall structure is still very much the same.
Types of exchanges
Outside of the heavily used cryptocurrency exchanges themselves, brokers and more discreet exchanges provide opportunities to move from one store of value to another. These can be more risky to you as an investor, but can also allow you to dodge the fees involved with trading on exchanges. Those fees add up, but only if you’re a heavy trader. If not, it’s probably in your best interest to stick with the easier-to-use, higher-volume, and more thoroughly developed exchanges.
Aside from choosing a reputable, trustworthy exchange, one last factor to consider would be the exchange type itself. If you’re just getting into cryptocurrency investing and don’t hold any coins or tokens, you should look for a fiat-to-cryptocurrency exchange that allows you to purchase BTC or ETH by linking your bank account or some other payment method.
Your initial BTC or ETH can then be traded into other altcoins on a cryptocurrency-to-cryptocurrency exchange. From there, your portfolio will probably have such a wide range of cryptocurrencies that you’ll never look at investing the same way again. Have fun… and embrace the exchanges!
Check out our other cryptocurrency guides here.