What Is a Bitcoin Exchange?
A Bitcoin exchange is a digital marketplace or online platform where traders can buy and sell Bitcoins using different fiat currencies or altcoins. These marketplaces and platforms act as intermediaries and facilitators between cryptocurrency buyers and sellers.
Key Takeaways
- A Bitcoin exchange acts as the intermediary between a seller and a buyer or, to use market jargon, between a “maker” and a “taker.”
- A Bitcoin exchange works like a brokerage, and you can deposit money via bank transfer, wire, and other common means of deposit. However, you will often pay a price for this service.
- If a trader wants to trade between cryptocurrencies, they will pay a currency conversion fee, similar to fees at traditional banks when you trade money from different countries.
Understanding Bitcoin Exchanges
Bitcoin exchange platforms match buyers with sellers. Like a traditional stock exchange, traders can opt to buy and sell bitcoin by inputting either a market order or a limit order. When a market order is selected, the trader authorizes the exchange to trade the coins for the best available price in the online marketplace. A limit order directs the exchange to trade coins for a price below the current ask or above the current bid, depending on whether they are buying or selling.
To transact in Bitcoin on a regulated exchange, a user must register with the exchange and undergo a series of verification processes to authenticate their identity. Once the authentication is successful, an account is opened for the user, who must then transfer funds into it before they can buy coins.
Different exchanges have different payment methods that can be used to deposit funds. Funds can include bank wires, direct bank transfers, credit or debit cards, bank drafts, money orders, and even gift cards. A trader who would like to withdraw money from the account could do so using the options provided by their exchange, including a bank transfer, PayPal transfer, check mailing, cash delivery, bank wire, or credit card transfer.
Decentralized Bitcoin Exchanges
Decentralized Bitcoin exchanges operate without a central authority, only providing a place for buyers and sellers to connect. These exchanges allow peer-to-peer trading of digital currencies without the need for someone to facilitate the transactions.
There are a few benefits to decentralized exchanges. First, many cryptocurrency users feel they better match the decentralized structures of most digital currencies themselves; several decentralized exchanges also require less personal information from their members than centralized (registered and regulated) exchanges.
Second, if users transfer assets directly to other users, that eliminates the need to transfer assets to the exchange, thereby reducing the risk of theft from hacks and other fraud.
On the other hand, decentralized exchanges (like all cryptocurrency exchanges) must maintain a fundamental level of user interest in the form of trading volume and liquidity. Not all decentralized exchanges have been able to achieve these important baseline qualities. Further, users of a decentralized exchange may have less recourse if they are the victims of fraud than those who use regulated ones.
Special Considerations
Fees
Making deposits and withdrawals comes at a price, depending on the payment method chosen to transfer funds. Exchanges may charge higher fees based on the risk of chargebacks if they accept credit or debit cards.
In addition to transaction fees and fund transfer fees, traders may have to pay currency conversion fees, depending on the currencies that are accepted by the Bitcoin exchange. If a user transfers Canadian dollars to an exchange that only deals in U.S. dollars, the bank or the exchange will convert the CAD to USD for a fee. Transacting with an exchange that accepts your local currency is the best way to avoid the FX fee.
Nearly all Bitcoin exchanges have transaction fees applied to each completed buy and sell order carried out within the exchange. The fee rate depends on the volume of Bitcoin transactions conducted on the network.
Foreign exchange spreads are important when transacting in Bitcoin and vary depending on the exchange’s liquidity.
Bitcoin Wallets
Note that a Bitcoin exchange is different from a Bitcoin wallet. While the former offers a platform through which bitcoin buyers and sellers can transact with each other, the latter is simply a digital storage service for bitcoin holders to store their private crypto keys securely. Most Bitcoin exchanges provide wallets for their users but may charge a fee for this service.
Makers and Takers
Similar to stock and commodity exchanges, online Bitcoin marketplaces usually designate Bitcoin participants as market makers or takers. A market maker is a trader who always tries to buy and sell at the best ask and bid, and a market taker tries to execute their trades immediately. Takers are more concerned with liquidity and quick trades.
Example of a Bitcoin Exchange
Imagine a Bitcoin exchange where three coin sellers are asking the following:
- BTC/USD $2,265.75
- BTC/USD $2,269.55
- BTC/USD $2,270.00
A trader initiates a market order to buy 10 bitcoins and fill their order at the best ask price of $2,265.75. However, only five bitcoins are available at the best ask, and 10 coins are available for $2,269.55. The trader’s order will be filled with five coins at $2,265.75 and the remaining five at $2,269.55.
However, a trader who thinks they can get Bitcoin for a better price could set a limit order for $2,260.10. If a seller matches their ask price with this order or sets a price below this figure, the order will get filled. All of this is done by the exchange, which takes a percentage of each transaction for their business.
How Does a Bitcoin Exchange Work?
Bitcoin exchanges provide a platform for traders and investors to place market or limit orders or purchase and sell Bitcoin to others.
What Is the Safest Bitcoin Exchange?
There are many Bitcoin exchanges, but the safest ones are those that are registered in the countries they operate in and regulated by the appropriate agencies. However, even this isn’t a guarantee of 100% safety—it only ensures that you have a better chance of being protected if something were to happen.
Can You Exchange Bitcoin for Cash?
Yes. There are several ways to do this. You can use an online exchange account linked to your bank account or find a cryptocurrency ATM near you that will cash your Bitcoin. However, cryptocurrency ATMs have exorbitant fees in addition to the transaction fees owed to the cryptocurrency network.
The Bottom Line
Bitcoin exchanges are online platforms that connect cryptocurrency buyers and sellers. They also provide other services, but what they offer depends on customer demand, local regulations, and if the service can be provided.
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