The penultimate transaction for the crypto investor is fiat-to-crypto or vice versa. The portals where these transactions take place are exchanges. Cryptocurrency exchanges are where users buy and sell cryptocurrencies in exchange for either fiat or other cryptocurrencies. With the pace of innovation in the industry, it is sometimes difficult to classify these exchanges as capabilities often overlap. In this briefing, you will learn to distinguish between common types of exchanges and their respective capabilities.
Centralized Exchanges
Centralized exchanges are the most popular type of cryptocurrency exchanges. They provide a seamless trading experience and offer both crypto-to-crypto trading and fiat-to-crypto trading pairs. One example is Netcoins (Full Disclosure: Netcoins and BIG are both wholly owned subsidiaries of BIGG Digital Assets). As the name suggests, centralized exchanges maintain a centralized order book and use a trade matching engine to automatically match buy and sell orders. They also have custody of their users’ private keys, making them more efficient and user-friendly, but also riskier since users can lose their funds if the exchange is fraudulent or if it experiences a security breach.
Since many centralized exchanges allow fiat-to-crypto trading, they come under greater scrutiny by regulatory authorities and are expected to have a user verification process in place to meet their AML and KYC obligations.
Visualization of a centralized exchange on QLUE™
Decentralized Exchanges (DEX)
Order Book DEX
These exchanges only offer crypto-to-crypto trading and aim to overcome the shortcomings of their centralized counterparts by focusing on privacy and security. Users trade directly by connecting their crypto wallets and do not have to register for an account nor give up their personal information. The exchange algorithmically matches buy and sell orders through smart contracts and never takes custody of its users’ funds. Illiquidity was the biggest issue that such exchanges faced. Since these exchanges are privacy focused, they usually don’t have a user verification process in place. DDEX and Binance DEX are examples of such exchanges.
Automated Market Makers (AMMs)
AMMs were born to tackle the problem of illiquidity that plagued DEX order books. Instead of using an order book, AMMs rely on liquidity pools, which are essentially pools of different cryptocurrency tokens. Users that deposit these tokens into the pool earn a cut from the trading fees. These exchanges function through smart contracts and only offer crypto-to-crypto trading. AMMs also do not follow KYC procedures. Uniswap and Curve finance are two of the most popular AMMs.
Instant Exchanges
Instant exchanges like Changelly and ChangeNOW use trading algorithms that are integrated with large crypto exchanges. When a user places a buy or sell order, the algorithm places a bid or ask order in one of the integrated exchanges in a matter of seconds. The algorithm then chooses the best price to fulfill the order. Like DEXes, these exchanges are also non-custodial and do not require user verification. Unlike DEXes, however, they can support fiat-to-crypto trading.
P2P Exchanges
P2P exchanges allow their users to list how much cryptocurrency they want to buy or sell in exchange for fiat or another cryptocurrency. Other users can then negotiate with them. If the settlement is in fiat, it can be made via wire transfer, bank transfer or even in cash. These exchanges use escrow services to hold the seller’s cryptocurrency until the counterparty pays for it. Once the payment is confirmed, the cryptocurrency is released from the escrow. Localbitcoins is one of the most popular P2P exchanges. Such exchanges do not usually conduct user verification and are seen as high risk for money laundering as they allow bad actors to sell their crypto for cash while maintaining their anonymity.
It is also important to note that all platforms dealing with crypto trading are at risk of being exploited by fraudulent actors. Exchanges can protect their businesses with a robust compliance solution in place, as well as keeping up with the latest security and compliance measures to mitigate such risks and maintain the trust of their users. BitRank Verified® offers enterprise-grade transaction tracking for exchanges looking to heighten their security, risk mitigation, and compliance. For more information click here.
