Keep at least one coin
Learn Crypto Blog
Learn Crypto
1 months
2,699

A beginner's guide to cryptocurrency exchanges

A beginner's guide to cryptocurrency exchanges
  • What is a Cryptocurrency Exchange?
  • On-Ramps & different types of exchange
  • CEX, P2P & DEX

If you want to participate in the brave new world of crypto, your entry point is almost certainly going to be a cryptocurrency exchange, as that is where you buy cryptocurrency. Choosing one can, however, be confusing for the newbie, as there are three main types of exchange - with their own acronyms and terminology. So we’ve laid out the key differences, as well as the pros and cons of each to help you understand which is relevant for you.

What is a Cryptocurrency Exchange?

Let’s start with a really simple explanation of what a cryptocurrency exchange is, and introduce some of the unique language they use to describe what they do. 

The clue to what a cryptocurrency exchange does is in the word exchange, as a cryptocurrency exchange is a service that allows you to perform one of three basic currency exchanges:

  1. Exchange regular money (dollars, euros, yen etc) for cryptocurrency
  2. Exchange cryptocurrency for regular money (dollars, euros, yen etc)
  3. Exchange one cryptocurrency for another

You can compare what a cryptocurrency exchange does to a Foreign Exchange service, like you see at an airport. The Forex Service will have a board of exchange rates for common currency pairs such as Euro-US Dollar (EUR/USD) or British Pound-Canadian Dollar (GBP/CAD), which show the fluctuating value of one currency in relation to another. You can exchange currencies on the spot, paying a commission for the service.

A cryptocurrency exchange offers a very similar service (though entirely online) facilitating the swap of your local currency for a specific cryptocurrency, based on similar sets of Currency Pairs e.g. Euro-Bitcoin (EUR/BTC), which, just like the Foreign Exchange board, shows the current exchange rate for those two currencies. 

Note: Though a EUR/BTC Currency Pair shows the price per one Bitcoin, you can choose to buy a fraction, often down to just €20 worth. Learn more about why newbies assume you have to buy a whole bitcoin.

Cryptocurrency exchanges often describe the available rate for a Currency Pair as a Spot Price, because the exchange is available on the spot, right there and then.

For some newcomers, the use of the word ‘price’ instead of an exchange rate, can seem a bit odd. We tend to think of goods or services as having a price, but not money. 

Though cryptocurrencies do function as new types of money, they are also traded as assets (like shares) which is why their value is described in terms of price, and also why they fluctuate, because perception of the true price is very hard to know.

To make a clear distinction between the two types of money being exchanged, you’ll likely encounter an unfamiliar phrase to describe regular money: fiat money - often just abbreviated to just fiat. It has nothing to do with the Italian car maker, but is a latin term that describes how modern money is created and controlled by governments. 

On/Off Ramps & The Different Types of Exchange

As we now have two distinct financial worlds - fiat and crypto - cryptocurrency exchanges are often described as providing ‘on and off ramps’ between them.

Just as on-ramps take you from regular roads onto motorways/highways, cryptocurrency exchanges use traditional fiat-based payment routes (bank transfers or debit cards) to transfer value to the new payment rails used by crypto - blockchains.

But if we return to the three basic functions exchanges offer, it is only the first two that involve an exchange to or from fiat, which naturally relies on traditional financial services (customers depositing from or withdrawing to banks) to be at one end of that on/off ramp. 

Any business using the banking system in this way has to follow the required rules and regulations, of which there are many. So when you create an account with a cryptocurrency exchange that handles  fiat you will have to provide a lot of personal information (passport or driver’s license) to satisfy those rules, known as KYC - Know Your Customer.

All of that process requires a traditional centralised business structure, which is why the most common type of exchange is known by default as a Centralised Exchange

The Centralised Exchange (CEX)

Once you have created an online account with a Centralised Exchange and passed KYC you can deposit fiat and exchange it for crypto. The actual exchange process is entirely anonymised, in fact you have no sense that there is a seller at the other end of the process as the exchange automatically matches buyers with sellers.

Inexperienced exchange users will almost certainly take the Spot Price with many exchanges targeting that group by boiling down the buying process to a very simple widget - add card details, spend X, receive Y - with the same simplified approach for selling and exchanging crypto.

Of course not all cryptocurrency exchange users want to buy on the spot, traders want the flexibility to buy/sell/exchange based on their own ideas of where price is moving which is why there is a simplified widget style experience for newbies and a very different view for traders with charts, indicators and live trading information. As a beginner don't make the mistake of trying your first cryptocurrency exchange using a trading view as it is a bit like jumping into an F1 cockpit after just receiving your driving license.

  • Learn all about cryptocurrency trading in our knowledge base

The way a Centralised Exchange functions as a business is therefore dictated by the processes/regulations required for handling fiat money, while the service is tailored to the needs of different customer groups. That combination, however, requires a very significant compromise that runs counter to the main value proposition of crypto compared to fiat - being in control.

As a beginner don't make the mistake of trying your first cryptocurrency exchange using a trading view as it is a bit like jumping into an F1 cockpit after just receiving your driving license.

If you use a CEX and buy crypto, it sits in your online account, in the custody of the exchange, rather than in your custody. Without understanding the concept of custody, this might seem like a sensible arrangement, similar to how a bank operates, but though a CEX will have similar requirements to a bank, it won’t offer the same protections, which are crucial given that the world of crypto has a significant problem with scams, hacks and businesses folding.

So a Centralised Cryptocurrency exchange straddles the worlds of fiat (regular money) and crypto, which dictates its design and function.

Pros

  • Allows you to exchange fiat for crypto
  • Allows you to sell crypto for fiat and withdraw back to your bank
  • User experience is simplified for newcomers & complex for traders

Cons

  • You have to provide personal information (KYC)
  • The exchange controls your crypto funds, not you

The Peer-to-Peer Exchange (P2P)

A Peer-to-Peer Exchange, sometimes abbreviated to P2P,  fulfils the  same basic function of cryptocurrency exchange, but in a much more focused way than a Centralised Exchange, removing the range of trading tools and simply connecting a buyer with a seller for a distinct single transaction. Think of P2P being about person-to-person transactions.

The process is very similar to eBay, as customers deal directly with merchants and the P2P Exchange plays the role of the middleman, holding funds until the trade has been executed satisfactorily and mediating in case of any disputes. P2Ps don't have the automated trading engines of a CEX, instead each merchant offers a Spot Price, range of payment methods and a trading limit at that price. Merchants have ratings, just like eBay, so customers choose them based on that combination of factors:

  • Price offered
  • Range of payment methods
  • How much/little they are willing to trade at that price
  • Their Rating & number of previous transactions

In the early days of crypto P2P exchanges functioned without the KYC requirement and so were popular for users wanting to cash out their Bitcoin, in some cases literally, with physical cash exchanged in person, once the bitcoin transfer had been confirmed.

Given the increasing regulation of crypto, and the potential for money laundering, most P2P exchanges now require some level of KYC, so have a similar degree of centralisation to the CEX approach but there is still a meaningful difference.

The convenience of automation/speed from a CEX is replaced by a slower but more customised approach via P2P where you will have a wider choice of methods for depositing/withdrawing fiat, with price set by the merchants/sellers which will be below the Spot Price at exchanges enabling them to make a profit.

Because P2P platforms are more like a marketplace for buying/selling crypto, they are more popular in the developing world - growing fast across Africa and Asia - where business transactions traditionally rely on personal interaction and reputation, and it is less common to have a bank account. 

Pros

  • One-on-one process with more flexibility on payment methods
  • Offer a more localised service

Cons

  • The exchange process is slower 
  • KYC is still generally required
  • Greater risk of something going wrong

The Decentralised Exchange (DEX)

In any other industry the word ‘Centralised’ is assumed, because that is how our economy/society work. So we don’t talk about Centralised Supermarkets or Centralised Mobile Phone Networks. In the world of crypto, decentralisation is a defining property so the distinction is necessary.

The CEX and P2P models are centralised by necessity as they involve fiat money and therefore require interaction with traditional banking (with its associated regulation) and require staff/process to deal with all the inevitable customer issues that arise. 

Decentralised Exchanges operate solely in the crypto realm, enabling the exchange of one crypto for another, facilitated by decentralised blockchains and applications built on top of them. They are what happens after the on-ramp and before the off-ramp, never touching fiat,

Not only does this remove the regulatory requirement for KYC, but means the full power of decentralised systems - blockchains - can be leveraged. 

Decentralised exchanges are the crypto purist’s preferred form of trading/transfer as users have more control of their funds, and there is no need to create a formal account. You just connect your browser wallet like MetaMask, with a single click, then choose the Currency Pair you want to exchange or leverage in some other way.

Smart Contracts running on platforms like Ethereum or Solana automate the exchange process, which removes the need for Support Teams to mediate disputes about funds not arriving.

There is a much broader range of Currency Pairs as users are incentivised to provide trading liquidity, essentially lending their coins to create trading pools.

Given that the defining feature of decentralised exchanges is that they function autonomously, you must already have crypto to want/need to use one. For this reason alone they really aren’t suited to newbies but just as importantly are the risks involved.  A DEX is run by code, not humans, but someone will have written that original Smart Contract code, and inevitably mistakes are made which hackers will exploit to drain funds potentially stealing your money with no safety net. 

Pros

  • No KYC
  • The exchange doesn’t control your funds
  • Wider choice of Currency Pairs
  • Better incentives for trading

Cons

  • Complicated for a beginner to understand
  • Need crypto to start with
  • Risk that Smart Contracts can be hacked and drained of funds
  • No customer service; you are on your own

Your choice of cryptocurrency exchange will largely be dictated by your level of experience and how you manage your fiat money. Centralised Exchanges are the common and sensible choice for newbies, just don’t think your journey starts and ends there, as it is just the beginning. Learn how and why to move your crypto so you are fully in control.

No results