Types of cryptocurrency exchanges
Your first experience buying bitcoin and altcoins will likely involve a cryptocurrency exchange. Exchanges are trading platforms that allow you to buy and sell cryptocurrencies. They are the best way to get bitcoins for most users, because they greatly simplify the buying process. Before you start trading, you need to understand the differences between different kinds of exchanges and decide which type is right for you.
This article looks at the four main types of exchanges that allow you to buy bitcoin and other cryptocurrencies: centralized exchanges (CEX), decentralized exchanges (DEX), money transmitters with accounts, and money transmitters without accounts. The first two allow you to trade against the market. In the latter two, you trade against the exchange itself.
Exchanges Where You Trade against the Market
Cryptocurrency exchanges that allow you to trade against the market act as matchmakers. Let us say you want to buy Bitcoin (BTC) for a specific amount of Ethereum (ETH). After you place your trade order, the exchange will try to match you with someone wanting to sell Bitcoins and buy Ethereum. If a match is found, the trade will happen. If no one on the exchange wants to buy Ethereum at that price, the transaction will not go through.
At no point are the exchange’s own funds traded. This lack of a need for the exchange to keep its own stock of bitcoin, altcoins, and fiat currency is what allows decentralized, peer-to-peer exchanges to exist.
As you are trading against the market, the valuations seen on these exchanges are most representative of the real bitcoin price and the prices of other cryptocurrencies.
Centralized Exchanges (CEX)
Centralized exchanges act as an intermediary throughout the whole trading process. They store your funds, take in and fulfil trade orders, and can buy bitcoin from you at the end of the process. Examples of centralized exchanges include Kraken, Binance, and Bittrex.
There are several advantages to using centralized exchanges. They are easy to use, because they handle almost the entire trading process for you. They tend to have intuitive UI. Many of them offer good customer support. Lastly, many traders choose centralized exchanges because they feel more comfortable buying bitcoin through an actual company, rather than an anonymous, distributed network.
There are three main downsides to centralized exchanges when compared to decentralized exchanges. The first and most important issue is security. As your bitcoin is stored on the exchange, there is a risk of it being stolen in the event of a hack (as has happened many times before). The second downside are the commissions on which centralized exchanges rely to cover their running costs and make a profit. Lastly, as the exchange is run by a legal entity, it may be subject to government interference, oversight, and regulations.
Pros: direct trade against the market, customer support
Cons: security concerns, commissions, government oversight
Best suited for: people wanting to trade against the market
Decentralized Exchanges (DEX)
Also known as peer-to-peer exchanges, decentralized exchanges are an attempt to solve the issue of storing user funds on the exchange. Rather than being run by a company, these exchanges are hosted on a distributed network. After the traders are matched, they exchange funds directly via off-chain order books with on-chain settlements or through smart contracts. Examples of decentralized exchanges include IDEX, Bisq, and LocalBitcoins.
Aside from security, this model has two main advantages. Firstly, as no one is running them, decentralized exchanges cannot be subject to government regulation, oversight, and interference. Secondly, running on a peer-to-peer network, these exchanges have virtually no operating costs. Because of this, they do not need to rely commissions to stay in operation. This makes them one of the only ways of how to buy bitcoins without paying a commission.
The DEX model is far from perfect, however. Maintained by volunteers, many decentralized exchanges struggle with ensuring a good user experience. Navigating them can be difficult due to a clunky, unintuitive UI. The process of making a trade can be more difficult than necessary. There is no customer support to help you if something goes wrong. Lastly, the tech that helps run these exchanges is still in a rather raw state. According to experts, several issues need to be solved before decentralized exchanges can become a viable option for most users.
Pros: low commissions, no government oversight, security
Cons: clunky UI, lack of customer support, undeveloped technology
Best suited for: seasoned crypto traders wanting to avoid commissions
Rather than matching buy and sell orders, money transmitters trade with you directly. This means that your trade is virtually guaranteed to go through and to do so at the advertised price.
The biggest advantage of money transmitters is their simplicity and ease of use. These exchanges can allow you to start trading bitcoin and altcoins in a manner of minutes. They tend to be well-maintained and to offer good customer support.
Much like traditional currency exchanges, money transmitters have to rely on commissions to cover their running costs and make a profit. It is important to note that all money transmitters, without exception, take commissions. The difference is that some money transmitters are transparent about their commissions, while others hide them in their Bitcoin price.
Money Transmitters with Accounts
Most money transmitters belong to this type. As was the case with centralized exchanges, your funds need to be transferred to an account on the exchange before you can start trading. One obvious benefit to storing your funds this way is that trades can happen almost instantly. Popular money transmitters of this type include the world’s most famous exchange, Coinbase, as well as such exchanges as Coinmama and Bitpanda.
The main drawback of this type of money transmitter is security. As your funds are stored on the exchange, they are at risk of being stolen if it is ever hacked.
Pros: ease of use, guaranteed transactions, near-instant transactions
Cons: transaction fees, security concerns
Best suited for: novices unafraid of storing their funds with a third party
Money Transmitters without Accounts
The second type of money transmitter offers the same service without storing your assets. After a trade, the exchange transfers funds directly to your crypto wallet/bank account. Also known as fiat-crypto exchanges, these trade platforms are an easy way for beginners to buy bitcoins with debit card payments or via a credit card.
This type of exchange offers several advantages when compared to traditional money transmitters. Not having your funds stored on the exchange eliminates the concern of having them stolen during a hack. The lack of a need to setup an account to hold your bitcoin makes getting started quicker, simpler, and more straightforward. Lastly, there are no commitments. If you decide to take your business elsewhere, you do not have to worry about being subject to any kind of hidden withdrawal fees.
Here at Wunderbit, we offer precisely this type of service.
Pros: easiest way how to buy bitcoins, fastest setup time, guaranteed transactions, security
Cons: transaction fees
Best suited for: those searching for the fastest and simplest way to buy bitcoins
No one type of exchange is better than any other. Your choice will depend on your unique needs and use case. If you are looking for a simple way of how to buy bitcoin, you might want to look at the services of a money transmitter. If you want to buy and sell bitcoins against the market, a centralized exchange (CEX) may be more up your alley. Advanced users looking for the best bitcoin price by avoiding commissions might find decentralized exchanges (DEX) to be their best match.
It is also important to note that not all exchanges of a given type are created equal. If you are just getting started, you will need to an exchange that allows you to buy bitcoin with debit card payments or through a credit card. While you can buy bitcoin on almost all exchanges, support is much less widespread for other cryptocurrencies. Thus, if you want to invest in a lesser-known altcoin, you will need an exchange that supports it. Lastly, as with anything else in life, remember that you are buying the seller as much as what they sell. You should only buy bitcoin and altcoins from reputable, transparent companies/networks that you trust.