A cryptocurrency exchange also called a digital currency exchange (DCE), is a business institution that allows customers to trade their cryptocurrencies for fiat (or ‘real’ cash), or other cryptocurrencies. It can be a business with a physical location, or wholly incorporated online. Most cryptocurrency exchanges operate outside the USA to avoid excessive regulations that are imposed by the US Securities Commission (SEC) and the Commodity Futures Trading Commission (CFTC). Exchanges became mainstream after Bitcoin, and other digital currencies started circulating in international markets.
Types of cryptocurrency exchanges and how they work
Exchanges are a medium between buyers and sellers. There are four different exchange types, as follows:
Broker Platforms determine coin prices, before selling or buying them from cryptocurrency players. Broker platforms have simple interfaces which make buying and selling to be straightforward. The problem with brokerages is that coins are more expensive compared to trading platforms. Coinmama and Coinbase are broker platforms.
These platforms connect users automatically. When sellers come to the platform, they place ‘sell’ orders, while others come to the platform to place ‘buy’ orders. These two groups are then connected automatically, without having them communicate. Examples of trading platforms are Binance and Cex.io.
Peer-to-Peer (P2P) Platforms
P2P platforms act as escrow, connecting sellers and buyers directly. The platforms allow for a wide variety of payment methods, including cash. They also do not have strict know-your-customer (KYC) practices. Although the trading process is simple and intuitive, peer to peer sites also carries the risk of losing coins or money because users are anonymous. Examples of P2P platforms are Localbitcoins.com and Paxful.com.
CFD platforms act as both exchanges and investment instruments. They allow users to bet on the future price of Bitcoins or other cryptocurrencies. They do not allow you to withdraw the digital assets to your wallet and bear a lot of risks.
CFDs also give you the possibility of earning money on the futures by borrowing for leverages. Although these futures give people a chance to make easy money, it also bears the risk of losing all the funds that you have bet.
History of cryptocurrency exchanges
The first businesses to offer exchanges of digital assets (then called e-currencies), operated in Australia as early as 2004. These were Ozzigold.com, Goldex.net, and Sydneygoldsales.com. However, these exchanges were compelled to close down by the Australian Securities and Investment Commission (ASIC) for operating without a financial instruments license.
GoldAge.Inc, based in the US, started operating in 2002 but was shut down by the US Secret Service in 2006, after transmitting more than $30 million to its users by exchanging e-currencies. The proprietors of this exchange were charged with breaking federal banking laws and sentenced to five years’ probation.
After the launch of Bitcoin in 2009, it took a year for the inaugural Bitcoin sale to take place. Due to its anonymous nature, Bitcoin became a popular payment method for darknet markets, helping fuel the Silk Road trade in contraband goods. With the trade, there arose a demand for a method of changing the coins into fiat currencies. On 22nd of May 2010, there was an exchange of 10,000 Bitcoins for two pizzas, which (later) made these to be the most expensive pizzas ever. It was widely heralded as the first real-world interaction of Bitcoin.
Most regulated exchanges came into the market between 2012 and 2017. Fully regulated exchanges came to be in 2017 and 2018. Coinbase, which was founded in 2012 as a Y Combinator startup, is one of the most popular exchanges today.
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