How do Cryptocurrency Exchanges Work?

If you want to invest in cryptocurrencies, then one of the easiest ways to do so is through an exchange. A crypto exchange is an online market where people can buy and sell digital currencies with ease. To help you better understand exchanges, we at TruDex™ have compiled for you a list of the pros and cons of cryptocurrency exchanges, as well as the things to look out for when shopping for the right one for you.

Let’s start with the advantages of exchanges for someone looking to transact in cryptocurrencies.

Advantages of Cryptocurrency Exchanges

1. Variety of Cryptocurrencies
One of the great aspects of a cryptocurrency exchange is variety. Most exchanges out there trade in multiple digital coins, meaning you can take advantage of price variations in different currencies and make money. There are hundreds of cryptocurrencies out there and exchanges offer you an opportunity to either buy or sell multiple cryptocurrencies for profit. Without exchanges, this would be impossible.

2. Security in the Crypto Purchase Process
This is one of the best things about crypto exchanges. Most of them have an escrow system where the sellers’ coins are held until the buyer sends the payment. This guarantees the seller’s and the buyer’s security throughout the purchase process. Without this system that exchanges provide, it would be impossible for cryptocurrency trade to take place. That’s because there would be no way for buyers and sellers to guarantee each other’s transaction security.

For instance, imagine having some bitcoins that you want to liquidate for cash. Without an exchange, you would have to advertise those coins on the internet with no guarantees that the buyers will send money once you give them your bitcoins. This is one of the fundamental cryptocurrency problems that exchanges have solved.

3. They Provide the Liquidity Needed to Make Crypto Trading Possible
While all exchanges don’t share the same level of liquidity, most of them have a decent level of it, making it easy for people to trade their Crypto’s. Without an exchange, you would most likely be stuck with your digital coins with no one to sell to. Thankfully, this is something that you will never have to deal with when trading on an exchange. You are always assured that there is someone on the other side waiting to buy your coins, provided you are selling them at the prevailing market rates.

4. Opportunities to Trade in New Altcoins
One of the best ways to make money through cryptocurrencies is to buy into new ones during an ICO, and then sell them once they appreciate. You can only do this through exchanges, where such coins are launched. Without the benefit of an exchange, you would never be in a position to profit from new alt-coins. In fact, there is a good chance that you would never get to know of new coin launches until it is too late.

Disadvantages of exchanges

While exchanges give you all the advantages discussed above, they have some drawdowns too, and here are some of them.

1. They are susceptible to hackers
It’s no secret that anything that makes good money attracts fraudsters and all sorts of criminals. In the last one year, cryptocurrencies have raked in billions of dollars as more people look to them as an alternative investment vehicle. As a result, many exchanges out there have become susceptible to hackers. For example, Bitfinex, one of the largest exchanges in the world was hacked, and people lost millions worth of Crypto. Though many exchanges have invested heavily in security, there is always that risk of losing all your coins in case of a successful hacking attempt.

2. They are conduits for pump and dump schemes
Earlier in this discussion, we touched on how crypto exchanges give you a chance to invest in new coins, and profit as people get to learn of them. But before you invest in every new coin listed in an exchange, you need to understand that some of them are pump and dump schemes. A pump and dump scheme simply means that a group of fraudsters come up with a new coin that has little inherent value, then push it through exchanges. As people take interest in such a coin, they sell their stakes and leave investors holding worthless coins as is illustrated below:

This is a major weakness of many cryptocurrency exchanges because, they list new altcoins without doing any background checks on the viability of such coins, only for them to deregister them later.

What to look out for before putting money in an exchange

While exchanges have their fair share of challenges as discussed above, they are necessary for anyone looking to trade in Crypto’s. To make the best out of an exchange, look out for the following:

1. Compare exchange fees
To make the most out of an exchange, go for one with low fees. Fees are especially critical if you are looking to trade large volumes of cryptocurrencies at any one given time. Before you commit money in any exchange, compare fees on two or three exchanges then make a decision.

2. Deposit and withdrawal limits
Some exchanges have a limit as to how much money you can move at any one time. If you are a large volume trader who wants to move Crypto’s between different exchanges and wallets as the opportunity arises, then you may choose to go for one with no deposit and withdrawal limits. However, if volumes are not your greatest concern, then you may consider other factors like fees and the security capacity of an exchange.

3. Check out online reviews
Most times reviews don’t lie. To safeguard your money, it would be best to go for an exchange that has a good online reputation. Anything with mixed or negative reviews could be a recipe for disaster. You might end up losing your money to hackers if the said exchange has poor security, or you might have your coins frozen on flimsy grounds.

Written by Nicholas Kithinji