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How does a crypto exchanges work?

Exchange refers to any platform that connects crypto buyers and sellers. Exchanges play an important role in ensuring that cryptocurrencies remain a liquid asset for investors. In general, when people refer to Bitcoin exchanges they would typically refer to centralized, custodial platforms. Read more

If one is to go by the definition, as the name suggests, the custodial cryptocurrency exchange would take custody of your cryptocurrency. While this has many security-related implications, it also concerns the liberty you have to use the tokens as it suits you.

For a user, the flow of exchange, in general, would seem like this:

Register for the exchange and submit the necessary documents for identity verification.
Add funds to your new account which could be done through Bitcoin or any other crypto or if your exchange lets you, then your fiat currency.
Set a buy order to carry out a trade.
Banked exchange

Banked exchanges are cryptocurrency exchanges through which you can transfer local currency. There are a few exchanges that let you use local currency for your purchases, usually in the form of a credit card or a payment app. However, they may not allow you to withdraw local currency to your credit card or the app and these are called partially banked exchanges. They are different from a fully banked exchange that lets you add funds through bank transfer and also allows sending local currency to your bank account.

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How does an exchange make money?

The shortest answer is, by charging fees. These could look as follows:

Withdrawal fees
Generally, exchanges charge fees to withdraw cryptocurrencies such as Bitcoin and also for withdrawing fiat currencies. These are charged on the basis of per withdrawal and it keeps changing without any prior intimation.
Trading fees
Trading fees are often assessed as a percentage of the total trade value. A lot is also riding on whether you are a maker or the taker in a transaction as makers typically have to pay fewer fees. The philosophy behind this difference is that makers provide liquidity which makes them worthy of the relaxation while takers reduce market liquidity.
Interest/Borrowing/Liquidation Fees
Certain exchanges would let you trade on margin. You can use this feature to borrow funds to increase your position size. This is also called leverage. Here’s the catch though, exchanges that allow margin trading also charge a fee and an interest rate that depends on the total supply of funds for all traders. If your position gets liquidated, you might also have to pay another set of additional fees.
Several match-making platforms are out there to help buyers and sellers connect so they can trade their crypto assets without taking custody of their tokens. These are peer-to-peer Bitcoin exchange platforms where you can directly negotiate your trades. However, they may seem rather inconvenient as it can be tricky to get the precise amount of Bitcoin you want to buy at a good price. For sellers, there is a risk of legal implications on the basis of the rules and regulations in the area as well as the Bitcoin volume. When we take all of these into consideration, peer-to-peer exchanges turn out to be less liquid than custodial crypto exchanges.

Published inFinance and Investment

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