What is a cryptocurrency exchange?
A cryptocurrency exchange (or digital currency exchange) operates on the same principles of a stock market exchange or stock exchange platform, except for instead of exchanging money for stocks, you are exchanging bitcoin for altcoins, or altcoins for other altcoins, or altcoins for tokens — or tokens for other tokens. Unlike stock trading platforms or brokers that only allow you to trade money for stocks or vice-versa, and do not allow you to trade stocks for other stocks, this is not the case with cryptocurrency exchanges. Some coins/tokens can be purchased directly using fiat currency or USDT (USD Tether – an altcoin whose value is pegged to that of the U.S. dollar). Though most cryptocurrency trades involve trading bitcoin for another altcoin, trading pairs not involving bitcoin at all are becoming more and more common, and indeed we will get into that soon. But first, let’s go through the different types of cryptocurrency exchanges available for your use, shall we?
A. Bitcoin Exchanges. A bitcoin exchange is exactly that — an online currency exchange which allows you to buy, sell and trade bitcoin using a number of fiat currencies. By far and away, the most successful – and easiest to use – bitcoin exchange is Coinbase. One of the longest lasting, most trustworthy, and secure exchanges still in existence, Coinbase has been in operation since 2012, and in this 5+ year time period they have yet to suffer any hacks, server crashes or mishaps that resulted in the loss of user funds. They make it super easy to attach a bank account or credit card to their website and explains the process of buying, selling, and transferring your bitcoin (or Ethereum, or litecoin), in a highly detailed, yet easy to understand manner.
For the total bitcoin noob, we definitely recommend Coinbase as a good starting place. They provide you with your own bitcoin wallet, they have a nice mobile app, and for the advanced user, offer a wide variety of trading options through their advanced exchange known as GDAX. If there’s one complaint we have about Coinbase, its that they are not available for service in many parts of the world, including several states within the U.S. This is because they are heavily involved in maintaining compliance with local and federal jurisdictional issues, as they are trying their darndest to be a legitimate company in hopes of eventually being listed on a major U.S.-based stock exchange.
For a step-by-step tutorial on how to set up a Coinbase account, buy and sell bitcoins (and now litecoins and Ethereum) and then move them around, we highly suggest you read our Bitcoin 101 Guide, as the same principles that apply to using Coinbase pretty much apply to the other well-respected bitcoin exchanges as well. Some of these other exchanges, which have also withstood the test of time and thereby earned respect in our book are included below.
B. Altcoin Exchanges: So, what exactly is an altcoin exchange? It’s basically the same idea as a bitcoin exchange, except for instead of trading fiat currency for bitcoin (or another altcoin), you are trading bitcoin for another altcoin, or one altcoin for another altcoin. These exchanges usually require minimal idealtcoinntification or release of personal information because, unlike bitcoin exchanges, they do not involve the transfer of fiat currency and therefore are not subject to the bureaucracy or red tape that usually accompanies fiat-based transactions (such as Know Your Customer [KYC] or Anti-Money Laundering [AML] statutes. These distinctions have their pros and cons as compared to bitcoin exchanges.
The pros being they are largely anonymous and do not require the provision of bank account or other personally-identifying information, since bitcoin itself has not universally been accepted as legal tender in most countries (Japan being a major exception). This speeds up the process of depositing and withdrawing Bitcoin (cryptocurrency) funds tremendously, whereas there is usually a “clearance” period involved when using fiat currency to directly buy bitcoin or other altcoins. This clearance period can sometimes take days, or even weeks at a time, before the bitcoin is finally deposited into your account/wallet.
The cons being this very lack of regulation and customer identification makes it easier for altcoin exchanges to suddenly close up shop, taking all the coins left on them by users in the process, without any prior warning, in an all too common experience known as an “exit scam.” Altcoin exchanges are not as closely monitored by federal government financial regulatory bodies for the same reason that makes them so easy to use: they do no directly involve fiat currencies, and as such, there is not as much legally-driven incentive to provide oversight for these types of exchanges. Altcoin exchanges can freeze user funds, make them disappear, or lose them through a matter of their own incompetence with very little legal recourse for the user. A few notable altcoin “exit scams” include those of Cryptsy, Vircurex and Mintpal. The sudden and unannounced closure of these major altcoin exchanges eventually resulted in legal action being taken against all 3 since millions of dollars of cryptocurrencies were stolen or “lost” in each individual case.
Similar to the case of Coinbase, there remains only one highly trusted altcoin exchange that has also withstood the test of time, and that exchange is Poloniex. Operated in the United States, Poloniex has also had its share of trials and tribulations, but has managed to maintain operations through a number of DDOS attacks, hacks, phishing scams and ever-growing regulatory hurdles. Bureaucratic obstacles, including exclusion of residents of New York and other states impose restrictions on cryptocurrency trading have only slightly changed the way that Poloniex conducts their business practices. They currently carry over 60 BTC trading pairs, as well as a handful of pairs in ETH, XMR and USDT. This means that instead of trading bitcoin for an altcoin, you are trading Ethereum, Monero or Tether for other altcoins.
Another exchange that has been open for nearly as long as Poloniex, and also with limited interruptions is Bittrex. Bittrex boasts nearly 100 different BTC trading pairs, with a nearly equal number of ETH and USDT trading pairs as well. If there’s an altcoin out there you are trying to purchase, this is probably the best place to find it. Bittrex does over 100,000 BTC in transactions a day, and while it may not offer the same advanced functionalities as Poloniex (like margin trading and coin lending), it does feature an API system that supports custom-built programs for high-frequency trading. Bittrex has not been without its share of controversy over the years, frequently being accused of with-holding withdrawals or freezing user accounts without explanation. They are also located in the United States, and as such, frequently have to change their terms and conditions in order to suit the needs of federal cryptocurrency regulations that change on a seemingly monthly basis.
C. Token Exchanges: Token exchanges come in three different varieties: they are either entirely contained within the platforms of other coins (the most famous being NXT, NEM, Counterparty [XCP] and WAVES), they are run independent of coin platforms by third parties, or the are known as Decentralized Exchanges (DEXs), which are pretty much run by no one except for by those who create and/or download -he required software to use the exchange. In this case, a DEX is very similar to any decentralized piece of software, such as bitcoin or Ethereum. It cannot be shut down by any single entity, regulatory body, or government, and runs entirely on an independent network of users who have downloaded the software and use it to conduct their own trades.
In general, token exchanges are unique because they theoretically allow for the trading of any coin or token for any other coin or token. The main problem these exchanges currently face is lack of liquidity, meaning that just because you create an order to exchange Xcoin for Ycoin, it does not necessarily mean anybody will be interested in taking you up on your offer, or even knowing that the offer exists.
Some token exchanges allow for the trading of non-cryptocurrency tokens for bitcoin, altcoins, or blockchain-based tokens. Probably the most famous of all of these is VirWox, which specializes in the trading of gaming currencies (mainly Second Life Lindens [SLL], and to a lesser extent, Open Metaverse Currency [OMC]), for bitcoin, dollars, euros, or any number of other money exchange companies like OKPay, PayPal and other money transfer services.
How do I know if an Exchange is Good or Right for Me?
A. Fees: Does this exchange offer competitive trading fees? From crypto-to-crypto exchanges, fees may range from the negative (meaning they pay you to deposit coins) to about $0.30 a trade. Be ware of fees much above this. Also, be wary of exchange that charge excessively large withdrawal fees (most of which they chalk up to covering “transaction costs,” while this is usually in part the truth). Exchanges that require initial coin deposits are a big red flag and we do not recommend putting your bitcoin (or other coins) in such exchanges.
B. Deposit/Withdraw confirmation times: What are the average confirmation times / block lengths necessary in order for your money to show up in your account? Some casinos will let you play with no confirmations necessary, on faith that your transaction will be eventually be included in a block on the blockchain (the first one to do so is the one who successfully “mines” the block with your transaction in it. Needless to say, most exchanges don’t operate like casinos and have much more stringent rules. They frequently include:
-3-6 confirmations on the blockchain network before the coins are spendable/withdraw-able.
– Personal Identification, such as a passport, driver’s license, or state ID.
– Provision of a valid email address, user name and password.
These are usually the necessary ID to open an account at a standard, small-to-mid size exchange. Some of the bigger exchanges, with more liquidity and trade options, also insist on being provided with:
– Full name
– Mailing Address
– Phone Number
– Verification of source of funds
C. Markers of a bad exchange: these are rather self-explanatory but just to spell it out for you, here are some of the warning signs that an exchange might not be forthright or legitimate in their business practices. Remember – altcoin exchanges, as well as bitcoin exchanges – have the ability to remain largely anonymous if they want to, a large amount of exchanges in the past 4 or 5 years have gone down by flight-by-night.
Whether it was through fault of their own or, most assuredly a security breach and/or mis-handling of funds meant a bungled securities operation, sometimes costing exchange users millions of dollars in cash. Such exchanges should not be taken seriously if they were to open under a similar name or development team. Here are some of the markings of a bad exchange:
- Exit scams: as previously mentioned above, keep an eye out if your exchange could potentially be on the verge of pulling an exit swindle. The seedier the exchange is, the more likely this becomes a possibility. You could lose everything, and have very little to no legal recourse in getting in back. That’s why we recommend leaving as little money on an exchange as possible. If it’s an exchange that’s not particularly trustworthy, make your trade and then get out of there.
- Lack of customer service / response to problems: There’s no more frustrating experience than being locked out of a user account, and not having any possible way to report your problems. While most major exchanges do have emails and/or phone numbers written down at the bottom of them, sometimes the best way is to stay cool, file a Customer Ticket with the exchange Support section, and give them like a week. After that, you can either refile your complaint, or complain about them publicly on the internet, which we have found, is a surprisingly effective way to resolve a complaint.
- Deposits not received, coins stuck, withdrawals not going through: These are hallmark problems of an insolvent, incompetent or otherwise exit scam-prone exchange. Sometimes it does require a little patience for a transaction (any type of withdrawal or deposit) to go through, but trade orders should be available and credited to your exchange wallet near immediately – definitely within 5 seconds or so. If your altcoin trade doesn’t go through within 24 hours, be sure to notify Support immediately, write a calm and detailed description of the problem, and most competent exchanges are pros at handling these issues. If you find yourself at an exchange where this is not the case – customer support is uninformative, not responding, or not there at all… Well it’s time to jump ship and look for a healthier exchange.
It doesn’t matter if you have to chalk it up to loss or write-off, the lesson stands that you should always begin trades at new altcoin exchanges with small amounts of dough.
- Liquidity problems (fractional reserve banking): An exchange may look great on the outside, low fees, hundreds of trading pairs to choose from. But how much bitcoin (or any other altcoin/token) is flowing through there on a daily basis? 100? 10? 1 BTC per 24 hrs.? If any of these are the case, you may have trouble finding the demand to meet that trade you want, which is why it is best to investigate altcoin exchange pair volume before just dumping your 100 DASH there. Some of the less reputable exchange sell user funds that are tied up in active trades on their market for the own, off-the-books pocketing. This is also sometimes the reason an exchange can’t process that withdrawal that’s been “PENDING” for weeks. So, in conclusion, go with trusted exchanges, test the smaller altcoin markets out first and never leave more money on any exchange that is going to break you banks.
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