Entities such as stock exchanges and foreign currency exchanges provide services that allow for inter-conversion between assets of a particular class. A cryptocurrency exchange works in a similar way. 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.
For example, if I conclude an upscale safari with a stack of Tanzanian shillings that I’ll be unable to spend in my homeland, I can walk into the airport’s foreign currency exchange and trade these shillings for a more widely-accepted currency (like US dollars or British pounds), based upon a pre-set exchange rate for that moment in time.
How an exchange works
Stock exchanges and foreign currency exchanges don’t operate in exactly the same way as the “new kid on the block” cryptocurrency 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 anticipate cryptocurrency exchanges to 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.
One unique cryptocurrency exchange aspect is the ability to exchange one cryptocurrency directly into another. This is something you can’t do with stocks, where you’d need to liquidate shares to USD or some other fiat money before using those funds to purchase new stock shares. You won’t necessarily be able to trade one cryptocurrency into any other cryptocurrency under the sun, however.
Typical pairings available on cryptocurrency exchanges
The types of conversions possible all come down to what pairings are available on the exchange. For example, a single exchange may have multiple trading pairs for Bitcoin (BTC): BTC to USD (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 USD to ETH. Altcoins typically have fewer trading pairs than the most popular cryptocurrencies (BTC and ETH), but this level of flexibility is still a nice feature to consider within the future development of cryptocurrency exchanges.
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.
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.
Types of 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. And from there, you’ll probably become so widely spread out across multiple 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.