What is a cryptocurrency exchange?

what is a cryptocurrency exchange

Many of us have heard about cryptocurrencies such as Bitcoin, Dogecoin, and Ether. But, what is a cryptocurrency exchange, and how does it function?

In a nutshell, a cryptocurrency exchange is a platform that enables investors to buy or sell a particular cryptocurrency in exchange for fiat money (dollars, pounds, euros, etc.) or another cryptocurrency.

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What is a cryptocurrency exchange? A detailed answer

Cryptocurrencies grew in popularity over the past decade or so. It all started with the introduction of Bitcoin as the first cryptocurrency to the market. Following Bitcoin’s (BTC) success, many more cryptocurrencies were launched, some with more success than others. Notable successors include Cardano (ADA), Dogecoin (DOGE), Ethereum (ETH), Litecoin (LTC), and Ripple (XRP).

This growing interest in cryptocurrencies created a need for exchanges to help investors trade digital coins. Bitcoin exchanges started to appear in 2010, including the Bitcoin Market and Mt. Gox, both of which are defunct now.

Bitcoin Market and Mt. Gox

The Bitcoin Market was launched in 2010 by a forum member of bitcointalk.org named dwdollar with the following announcement:

Hi everyone.  I’m in the process of building an exchange.  I have big plans for it, but I still have a lot of work to do.  It will be a real market where people will be able to buy and sell Bitcoins with each other. 

https://bitcointalk.org/

The Bitcoin Market enabled investors to buy or sell Bitcoin through PayPal. However, PayPal withdrew its support in 2011 due to fraudulent activities on this exchange.

Another forum member of bitcointalk.org named mtgox whose real name is Jed McCaleb (a well-known programmer who was later involved in projects like Ripple and Stellar) announced the launch of his exchange back in 2010 as follows:

Hi Everyone,

I just put up a new bitcoin exchange.

Please let me know what you think.

https://mtgox.com

https://bitcointalk.org/

Mt. Gox was an acronym for “Magic: The Gathering Online Exchange” as Jed McCaleb’s original intention was to use his domain to trade cards for the Magic: The Gathering game. The exchange experienced a significant level of growth in size and popularity following its launch, and Jed McCaleb sold it the following year.

Unfortunately, the success of Mt. Gox was short-lived. The exchange became a constant target for hackers. In 2014, the exchange stopped its operations and filed for bankruptcy. The value of Bitcoin stolen by hackers was estimated to reach $460 million. Only a portion of the stolen Bitcoin was ever recovered.

Centralized exchanges vs decentralized exchanges

Cryptocurrency exchanges exist in two main forms: centralized and decentralized. In a centralized exchange, the trade between a buyer and seller is secured and verified by a third party (i.e., a middle man). On the other hand, a decentralized exchange (DEx) is characterized by the absence of a third party. As such, the emphasis is on peer-to-peer trading. While centralized exchanges involve escrow services, decentralized exchanges rely on smart contracts.

Traditionally, centralized exchanges have been more popular than decentralized exchanges as they offer better liquidity. However, there are signs that the landscape is changing as DExs continue to gain popularity. This is not least because of the security concerns and hacks that have surrounded centralized exchanges. For example, Coinbase admitted hackers stole cryptocurrency from at least 6,000 accounts during the spring of 2021 due to a security gap in their two-factor authentication system.

Centralized exchanges charge fees for the services they provide, whereas there are minimal fees involved in the case of decentralized exchanges. Furthermore, the buyer and the seller retain more control over the transaction in the latter type of exchange. Centralized exchanges typically come with the “know your customer” or “know your client” (KYC) rule, requiring identification information from their users.

List of popular cryptocurrency exchanges

Here is a noncomprehensive list of some of the most popular cryptocurrency exchanges.

Binance – Started operations as a centralized exchange. Now offers a DEx as well.

Coinbase – Conducted an IPO in 2021 (ticker: COIN) with its shares starting to trade on NASDAQ.

dYdX – A DEx powered by the Ethereum blockchain.

Huobi – Went public in Hong Kong through a reverse takeover in 2018.

Kraken – It is one of the older cryptocurrency exchanges and was launched back in 2013.

Uniswap – One of the most popular decentralized exchanges.


What is next?

This post is part of our free course on Tokenomics. The previous post offers an introductory guide to tokenomics. The next post in the series focuses on non-fungible tokens (NFTs).

Further reading and useful links on cryptocurrency exchanges:

The Inside Story of Mt. Gox, Bitcoin’s $460 Million Disaster

Top Cryptocurrency Spot Exchanges

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What is a cryptocurrency exchange?

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