Today there are different types of exchanges. Basically exchanges are online marketplaces where users can buy and sell cryptocurrencies. Depending on the exchange this can be achieved with fiat (USD, EUR,…) or cryptocurrencies and sometimes only with cryptocurrencies.
Which types of exchanges are available?
The “Traditional” Exchange
Basically these work like a stock exchange. Potential buyers and sellers are matched via different order types. The exchange earns money by claiming a certain percentage of each trade done via their platform. This is usually somewhere around 0.25% for buying and a little less for selling. Typical representatives of this category include Bitstamp, Kraken, Binance or GDAX. This type of exchange can easily be identified by having their fees for buying and selling somewhere on their website.
This category includes all websites that allow direct peer-to-peer trading between two users. The platforms allows you to find someone willing to sell you cryptocurrencies directly at a certain price. Sellers can set their own prices, so there is no fixed market price. Typically the prices are higher than what you would find on a traditional exchange. Two examples of such platforms are LocalBitcoin and Bitcoin.de. To protect the buyer, the amount of purchased Bitcoin or other cryptocurrencies is held in escrow (does not apply for local trades with cash and meeting in person). The platforms earn money by taking a certain percentage of sellers earnings. This markeplace fee is usually around 1%.
So both Traditional Exchanges and Direct Trading platforms match buyers and sellers. However the fundamental difference is that with the traditional exchange the matching is done automatically, whereas with direct trading the buyer has to manually decide from which seller to buy. Other differences include fee structure, services provided to facilitate trading or the level of anonymity. Furthermore fiat currency never has to be sent to a direct trading platform since the interaction happens directly with the seller.
Decentralized Exchanges (DEX)
As opposed to the vast majority of centralized exchanges that require you to verify your ID or add other details which will identify you (KYC), decentralized exchanges would ideally be “completely anonymous” and protected from attacks by hackers. The idea of decentralized exchanges is to be in line with the original idea of Bitcoin, to create a decentralized financial system which is not in the hands of a few decision-makers, but belongs to everyone. As an example there is Bisq, a decentralized exchange that uses a peer-to-peer network over Tor. It is an open source project organized as a Decentralized Autonomous Organization. The issue with decentralized exchanges is that trades take as long as the blockchain confirmation times of your selected currency. In the case of Bitcoin this will be 10 min for 1 confirmation. Also Bisq has a rather low trading volume and their fee structure is complicated. Other exchanges include Altcoin.io which will launch early 2018 and be powered by AtomicSwaps. Personally I have used IDEX, which is a DEX for ERC20 tokens only, once.
Brokers will sell and buy cryptocurrencies at a fixed price. These prices will usually be 5-10% higher than the prices on an exchange. Coinbase is the most well-known broker for cryptocurrencies. Another example for European customers is BitPanda. So instead of matching buyers and sellers directly, the broker acts as the other party for the transaction.
Other Ways of Investing in Cryptocurrency
So far we have seen 4 different types of exchanges that allow you to buy and sell cryptocurrencies. Today there are actually two more ways of investing in cryptocurrencies that I am aware of.
With the money came Wall Street. With the rise in popularity of cryptocurrencies traditional investment options such as ETFs or index funds made their way into cryptocurrency. The idea – from what I understand – is that these funds can be traded via traditional stock exchanges. Many of these funds are currently not yet approved or active. Some examples include GBTC from the Bitcoin Investment Trust which is already trading and COIN, a Bitcoin ETF by the Winklevoss Trust which is not yet trading. A fund that holds several cryptocurrencies is Bitwise HOLD 10 Private Index Fund, however currently only accredited US investors can invest. If you consider investing in this category I strongly would advise you to actually check the value of the underlying assets. There have been times where GBTC traded at double the value of the underlying assets, so you would have been way better of just buying the Bitcoins yourself.
Tokenized Cryptocurrency Index Funds
I would also like to mention this type of fund, although clearly not a cryptocurrency exchange, since you actually have to buy this fund via an exchange.
This is one of the newest ways of easily holding a portfolio of different cryptocurrencies. You can buy one cryptocurrency that represents several cryptocurrencies. One such example ist Crypto20, the first tokenized crypto index fund as they call themselves. You can buy the C20 cryptocurrency and will automatically be invested in the top 20 cryptocurrencies. The fund automatically rebalances every week and you can avoid the hassle of buying and selling on several exchanges (currently I’m using at least 4 exchanges to buy and sell my coins). This fund has a management fee of 0.5%. Another such fund is The Token Fund. It invests in various cryptocurrencies that are selected by the fund managers. The fee structure is a little bit different here in that you pay an entry and an exit fee of 5%, however if you buy via the exchanges you won’t pay this.
There are many types of exchanges that you can use to buy or sell cryptocurrencies. I myself have only used traditional exchanges as well as one DEX. This is mostly due to the higher prices of brokers and direct trading plus already being fully verified with some traditional exchanges. I also own some coins of a tokenized cryptocurrency fund.
Your primary concern when selecting one exchange over another should be your perceived trustworthiness of the exchange. More on this topic in another post.