What Is a Bitcoin Exchange?
A bitcoin exchange is a digital marketplace where traders can buy and sell bitcoins using different fiat currencies or altcoins. A Bitcoin currency exchange is an online platform that acts as an intermediary between buyers and sellers of the cryptocurrency.
The currency ticker used for Bitcoin is either BTC or XBT.
KEY TAKEAWAYS
- A bitcoin exchange acts as the intermediary between a seller and a buyer or, to use cryptocurrency language, between a “maker” and a “taker.”
- A Bitcoin exchange works like a brokerage; you can deposit money via bank transfer, wire, and other common deposit means. However, you will often pay a price for this service.
- A trader who wants to trade between cryptocurrencies will pay a currency conversion fee, similar to institutional banks when you trade money from different countries.
- Purchases and sales are based on the same ordering system as existing brokerages, where a buyer (taker) places a limit order which is then sold when a corresponding cryptocurrency is available from the seller (maker).
Understanding Bitcoin Exchanges
Bitcoin exchange platforms match buyers with sellers. Like a traditional stock exchange, traders can buy and sell bitcoin by inputting either a market or 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. With a limit order set, the trader 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 an 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 transfer funds into this account before they can buy coins.
Different exchanges have different payment methods that can be used for depositing funds, including bank wires, direct bank transfers, credit or debit cards, bank drafts, money orders, and even gift cards. A trader who wants to withdraw money from the account could use their exchange’s options, including a bank transfer, PayPal transfer, check mailing, cash delivery, bank wire, or credit card transfer.
Decentralized Exchanges
Decentralized Bitcoin exchanges are those that are operated without a central authority. These exchanges allow peer-to-peer trading of digital currencies without the need for an exchange authority to facilitate the transactions.
There are several benefits to decentralized exchanges. First, many cryptocurrency users feel that decentralized exchanges better match the decentralized structures of most digital currencies; many decentralized exchanges also require less personal information from their members than other 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. Third, decentralized exchanges may be less susceptible to price manipulation and fraudulent trading activity.
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 exchanges with centralized authorities.
Special Considerations
Fees
Making deposits and withdrawals comes at a price, depending on the payment method to transfer funds. The higher the risk of a chargeback from a payment medium, the higher the fee. Making a bank draft or wiring money to the exchange has a lesser risk of a chargeback than funding your account with PayPal or a credit/debit card, where the funds being transferred can be reversed and returned to the user upon request to the bank.
In addition to transaction and funds transfer fees, traders may be subject to currency conversion fees, depending on the currencies the Bitcoin exchange accepts. 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.
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.
Foreign exchange spreads are important measures when transacting in bitcoin and vary depending on how liquid the exchange is.
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 coins securely. To be more technical, bitcoin wallets store private keys to authorize transactions and access a user’s Bitcoin address. Most bitcoin exchanges provide bitcoin wallets for their users but may charge a fee for this service.
Makers and Takers
Online bitcoin marketplaces usually designate bitcoin participants as either makers or takers. When a buyer or seller places a limit order, the exchange adds it to its order book until another trader on the opposite end of the transaction matches the price. When the price is matched, the buyer or seller who sets the limit price is referred to as a maker. A taker is a trader who places a market order that immediately gets filled.
Example of a Bitcoin Exchange
For example, on a Bitcoin exchange, three coin sellers ask for BTC/USD 2265.75, BTC/USD 2269.55, and BTC/USD 2270.00. A trader who initiates a market order to buy bitcoins will have their order filled at the best ask price of 2265.75. If only five bitcoins are available for the best ask, and 10 coins are available for 2269.55, and the trader wants to buy 10 at market price, the trader’s order will be filled with 5 coins @ 2265.75 and the remaining 5 @ 2269.55.
However, a trader who thinks they can get bitcoins for a better price could set a limit order for 2260.26 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.
