Online cryptocurrency exchanges provide a service where users can exchange different cryptocurrencies, sometimes referred to as ‘digital assets’. In some of these exchanges users can also directly exchange fiat currency for Bitcoin, Litecoin or Ethereum.
Exchanges are an essential part of the growing cryptocurrency eco-system and user-friendly services like Coinbase are responsible for increasingly large numbers of people purchasing and using cryptocurrencies. As of September 2017 Coinbase has 10.5 million registered users, with about 40% of those users joining in the last six months.
Users of exchanges fall into similar categories to the users of cryptocurrencies. You get speculators and active traders who will use traditional trading techniques to turn a profit, as well as investors who wish to purchase and hold cryptocurrencies. Most exchanges provide trading for cryptocurrency pairs with Bitcoin (BTC) and Ethereum (ETH) as well as pairing the local currency of the exchange such as the US Dollar (USD) or Chinese Yuan (CNY).
Different types of exchange
There are a few main categories of exchanges, each with a different use case. Some exchanges such as localbitcoins.com exist as an online marketplace solely connecting users who want to buy and sell cryptocurrency. The users set their own prices and all transactions take place between the users via PayPal, bank transfer or cash physically changing hands. Users of this kind of service receive feedback and rankings in a similar way to eBay sellers.
The most common type of exchange is the ‘trading platform’ where users are provided with a platform in which to buy or sell digital assets. Popular trading platforms include GDAX, which is part of Coinbase, as well as Bittrex and Poloniex. As with the traditional stock markets there are also exchanges where leveraged cryptocurrency derivatives and futures can be traded.
As well as trading platforms and marketplaces there are also ‘Over-the-counter’ traders who will deal with large investments in cryptocurrency, accumulating six to eight figure sums of cryptocurrencies for their customers by purchasing from regular trading platforms over a period of time.
How to use an Exchange
For most exchanges all you will need to create a basic account is an email address. Once registered you may find that to be able to make larger sales or purchases, some form of enhanced verification is required. This could include providing Passport or Driving Licence verification.
Nearly all exchanges will allow unregistered users to access their website and view the current order books and historical price data. Many exchanges also offer price alerts and API functionality allowing users to build software that can alert them to specific market changes or conditions for their chosen cryptocurrencies.
Once you have registered at an exchange and completed the required ID verification process then you can begin to fund your account and make your first purchases or trades. Some exchanges entirely operate in cryptocurrencies and therefore you will need to send your digital assets from whatever wallet you use to your wallet on the exchange itself. When you start this process it is usually recommended to send a small amount first to check the transaction completes safely without risking too much of your own funds.
After funding your exchange wallet then you can go ahead and find the currency that you wish to purchase and set an order. The use of trading exchanges can be complex and confusing for first time users and it is worth reading up on order books, market orders and limit orders before you go wading in.
As with all online transactions it is important to consider your safety when using cryptocurrency exchanges. Phishing scams are rife in the crypto world and it is very easy to lose large amounts of your funds.
To start with be sure to create a secure password that you haven’t used elsewhere. On top of this look into a two-factor authentication (2FA) protocol to further secure your account. Two-factor authentication provides an extra layer of security to your account so that even if your password is compromised you are protected. Popular authenticators are Google Authenticator and Authy, both of which are available as apps for iOS and Android. Most of the larger exchanges will guide you through the process of setting up 2FA on your account.
When using online exchanges it is also essential that you check that you have the correct URL address and make sure to have this bookmarked. Recent phishing scams have placed visually similar web addresses as a top Google search result. If a user goes to these sites and inputs their login details and a 2FA code then their real account is entirely compromised; this is the online equivalent to posting your bank card and pin code through a criminal’s letter box!
On top of securing your login details it is also worth considering how much cryptocurrency you store on an exchange. By storing your digital assets on an exchange you are trusting that exchange entirely with your funds and if something were to happen there is very little recourse. Infamous amongst cryptocurrency users is the 2014 ‘Mt Gox hack’, where a Japanese exchange lost 650,000 bitcoins belonging to it’s users. This is the highest profile case of a cryptocurrency exchange losing users funds but there have been many others over the years.
The future of exchanges
Developers are working on ways to improve the security of exchanges and it is believed that the next step for cryptocurrency trading platforms is the use of decentralised exchanges. The largest exchanges are centralised meaning that it is based on web servers, and the entirety of users’ funds are stored by the exchange. By ‘decentralising’ an exchange it means that the exchange will run off a network of peers rather than a centralised domain. Decentralised exchanges work with users’ own wallets and all transactions take place on a peer-to-peer basis.
Currently there are a few decentralised exchanges that can be used. Etherdelta is an exchange that runs on the Ethereum blockchain and works by executing ‘smart contracts’ between users. Recommended further reading includes projects like the Waves Asset Exchange, 0x, and Mothership, all of which stand to revolutionise the user experience of decentralised exchanges as well as providing further security from interference of outside agencies.