Top

A cryptocurrency exchange is a trading venue that allows its clients to buy, sell (and sometimes store) digital currencies. Cryptocurrency exchanges are online platforms (digital marketplaces) where traders can exchange cryptocurrencies for other cryptocurrencies or fiat money (like the USD or Euro). The process of exchange is usually based on the market value of the particular asset. However, exchanges can differ in their pricing process. For example – some may provide a flat rate but charge additional fees depending on the preferred payment method, while others may provide a total sum that has everything included (rate, trading fee, payment fee, and others).

Cryptocurrency exchanges are very similar to traditional stock exchanges. For example, buyers and sellers can place limit orders or market orders, and the brokering process works the same way it would with any other type of asset. When a market order is selected, for example, the trader authorizes the platform to take care of his coins and find the best possible price to execute the trade at. With a limit order, on the other hand, the trader instructs the exchange to jump into a trade only if the price is below the ask or above the bid (depending on whether they are selling or buying), at the particular moment. The cryptocurrency exchange serves as an intermediary that helps with the order matching and fulfillment and collects fees. However, at the same time, cryptocurrency exchanges have some core differences, when compared to traditional exchanges. For example – the majority of cryptocurrency trading venues are unregulated.

There are two main types of cryptocurrency exchanges – centralized (CEX) and decentralized (DEX). The majority of digital asset trading platforms worldwide are centralized. The idea of centralization refers to having a middle man (the exchange operator) who helps conduct transactions. This means there is one central authority that governs the whole process, much like traditional stock exchanges. This type of setup is widespread also within other financial institutions like banks and brokerage companies. In general, the buyers and sellers trust the exchange operator to take care of the trades' execution and fulfillment. Decentralized cryptocurrency exchanges, on the other hand, have no authority to control them. They are an alternative that cuts out the middlemen and creates a “trustless” environment, based on smart contracts. The idea behind decentralized exchanges is to serve as a P2P (peer-to-peer) trading venue. At the time of this writing, though, decentralized cryptocurrency exchanges are significantly behind the centralized ones in terms of trading volume, users’ base, and overall usability. Apart from CEXs and DEXs, however, there are also websites that are not cryptocurrency exchanges, such as https://localbitcoins.com/ which also allow to buy and sell digital assets. However, if you want to take advantage of professional trading tools and high liquidity, it is always better to choose between some of the leading cryptocurrency exchange service providers.

To engage in trading on a centralized exchange, in most cases, a user has to go through a series of verification procedures to authenticate their identity. That is because most of the leading centralized digital asset exchanges adhere to KYC and AML policies. What this means is that the users are required to submit personal details and scanned documents that can verify their identities, such as government-issued ID or Passport, address (and a utility bill that confirms it), telephone number, email, and others. Although this goes against one of the core ideas of cryptocurrencies, in the face of anonymity, it ensures better protection of users’ funds and a higher level of security. Once the authentication is successful (the time needed for identity verification depends according to the policy of each exchange, but most of the time is within 24 and 72 hours), an account is opened, and the user can fund his account and start trading. Regarding account deposits, it is worth noting that different exchanges support different payment methods. Some support direct bank or wired transfers, while others allow for using credit and debit cards. Those types of cryptocurrency trading venues are known as entry-level exchanges. Some exchanges, however, require the account deposits to be in cryptocurrencies.

Although cryptocurrency exchanges had been around since the early 2000s with the birth of the first digital currencies (like E-gold), they became popular with the rise of Bitcoin and the following increased interest in the digital asset class. At the time of this writing, there are more than 160 cryptocurrency exchanges listed on Nomics. In reality, digital asset trading venues pop up almost daily. While some fail along the road, the overall number of cryptocurrency exchanges follows a positive trend.

This is, probably, the most common question when it comes to cryptocurrency trading. The biggest issue with cryptocurrency exchanges is how to find a service provider that is secure, credible, and transparent. In the years since the introduction of Bitcoin, there have been numerous cases of cryptocurrency exchange businesses that have closed shops due to internal or external reasons. Some have suffered from massive hacker attacks, while others ended up being scam schemes. In most cases, those who were affected the most were the traders who ended up losing their funds. Reports point out that more than $1.7 billion were stolen from exchanges in 2018. According to industry experts, the figures for 2019 are projected to exceed $4 billion.

That is why choosing a cryptocurrency exchange to execute your trades on is such an important matter. Although, nowadays, the number of active cryptocurrency exchanges is rising exponentially, the issue with finding a reliable service provider still remains.

To help you find out what is the best cryptocurrency exchange to serve your needs, here are five things to look for:

1. History

The first thing to look for is the exchange’s history. Go as far back as possible to find out whether the platform had been involved in some shady business activities. Try to understand as much as possible about the background of the founders and the operating company. Sometimes, the operating entity is covered in secrecy or hidden behind circles of other companies, just like the cases with C2CX and GDAC.

Bear in mind that obtaining the complete history for an exchange often is a tough task. There are lots of service providers that share very limited information or even try to cover their tracks intentionally. Let’s take BTCsquare or Livecoin, for example – the cryptocurrency exchanges don’t share anything related to their founders, operating company, or official address. This often is a red flag, so make sure to stay away from such service providers.

Another essential thing is to try finding out whether the particular exchange had been subject to hacker attacks or governmental investigations. If it had been investigated or compromised, analyze what the exchange’s response was and how it navigated the situation. This can be either an alarming or a positive sign. For example, although Nova Exchange suffered a hacker attack, it faced the problem publicly and notified all its users immediately, which helped mitigate the consequences. The platform also went on to help other victims of hacker attacks like the token projects from the failed Cryptopia, by listing them for free. Alternatively, let’s look at Zaif, for instance – although the exchange was hacked, it made everything possible to compensate its clients for the suffered losses and worked in close cooperation with local authorities to track the cybercriminals. Some of the leading cryptocurrency exchanges like Binance and Bitstamp have also been hacked. However, this didn’t stop them from becoming leaders in the industry. On the other hand, trading platforms like Coincheck found it hard to recover from the security breaches they suffered. In a nutshell – try to learn as much as possible about the exchange’s history of security issues, and more importantly, how it reacted in crisis situations. This can serve as a good indication for its plans, reliability, and attitude towards its user base.

2. Transparency

Think of this, also like the way the exchange treats you, as a potential client. Does it find it necessary to reveal important details that may help you make an informed decision? Does it face the public openly by stating who runs it, and what are their long-term plans? Does it have a solid media appearance or just paid PR articles? Are there any questions that remain unanswered after going through all the information on the platform’s website?

At Nomics, we say that “Transparency must be trustless.” That is why we have created our Transparency Rating system, which helps users distinguish the exchanges that are open to the public, from those covered in secrecy (examples of exchanges with the highest transparency rating on Nomics are Deribit, Switcheo, Binance and others). However, many cryptocurrency trading platforms fall in the second category. To avoid falling for scam schemes or unethical service providers, make sure to focus on the information coming directly from the exchange. You can start with the “Terms and Conditions”, for example. We have reported about several exchanges (OOOBTC, BTCBox, and others) that copy their terms directly from one another without changing even a slight bit of the information. However, this is not the worst case. Bitbegin, for example, has a clause in its terms page that requires the client to pay them “at least \$1 million in compensation” should they breach the agreement. JEX has a similar clause, but the compensation there is estimated at “at least \$2 million.” Considering the fact that most of the time, these agreements are very general, written in poor English, thus a subject to wide speculation, users can often end up owing the exchange compensations. Do your best to stay away from such platforms.

Another good thing to do is to get familiar with the feedback from the exchanges’ existing clients as this is the most accurate and objective way to tell whether the particular service provider is reliable. A good starting point is the user-generated exchange reviews available on our platform. Take Binance, Kraken, or Bitstamp’s pages, for example. Plenty of users describe their experience with the platforms and openly admit if they have had some issues as well. Also, make sure to check Bitcointalk, Reddit, and Trustpilot to find out whether there are unsatisfied customers and what they are most often frustrated about. If the exchange lists ICO tokens, try to find out what is the feedback from the project owners. In the case of Tradesatoshi, for example, thanks to information from the teams running projects, listed there, the exchange was exposed to doing unethical practices like delisting, without prior notice, and stealing the tokens, left in the platform.

Bear in mind that the reliable cryptocurrency exchange won’t hesitate to provide information about its official address, working hours and the team behind the platform. That is its way to say that it is open to communication and is willing to assist you in case you need so. Unfortunately, the majority of the platforms avoid providing such information. On the other hand, they often request from you to adhere to their KYC procedures and provide sensitive personal information such as a copy of ID or a Passport, official address, telephone number, etc. Make sure to avoid registering for platforms which don’t find it necessary to be fully transparent with their clients, while at the same time request the same from you.

3. Security

Security is the biggest pain point when it comes to cryptocurrency exchange businesses. While no platform is completely immune to hacks or security breaches, some are safer than others or at least try their best to protect their clients.

When searching for the best cryptocurrency exchange to trade on, try to find out as much as possible about the employed security measures. Bear in mind that the most widely adopted protection is two-factor authentication, so it is safe to say that it is the industry minimum. However, a big number of the platforms don’t go past that, which is the reason why, in recent years, many clients have lost their funds.

Don’t forget that even the most secure platforms can’t ensure 100% protection of your funds if you don’t help them. The easiest way to do that is to ensure the safe storage of your coins by keeping them in an offline (cold) wallet. Many investors underestimate the importance of this and keep their coins in hot wallets, integrated into the exchanges’ websites. Although most of the platforms migrate the majority of the funds from users’ accounts to offline wallets, they usually keep 5% to 10% online, as capital buffers for immediate transactions. However, don’t forget that it is always better to rely on yourself, rather than the service provider.

4. Liquidity

One of the key selling points of cryptocurrency exchanges is the trading volume they generate. Generally speaking, the higher the levels of trading volume, the lower the volatility and the risk for market manipulation that is likely to take place on the exchange. That is the main reason why shady cryptocurrency exchanges often provide false information regarding their trading volume. We have already discussed the problem with fake liquidity present within the majority of trading platforms and how it affects their clients. In fact, that is the main reason why we created the Transparency Rating system. That way, our audience can easily find out which exchanges provide real data and which remain in the shadows.

So, what risks does an investor face when using a low-liquidity exchange? First of all, there is the risk of price instabilities. Next, the investor risks missing a key trading opportunity due to the lack of buyers or sellers. You can find out more about this on forums like Reddit and Bitcointalk, where clients of shady exchange service providers report about placing orders that are left pending for days.

Here we should also mention volatility as another crucial consideration. Because of the time it takes for transactions to be completed, the price of a given coin can change between the time the transaction is initiated and the time it is finalized. The higher the trading volume and the faster the transaction can be processed, the less likely it is for such a fluctuation to occur.

5. Trading features & fees

Of course, traders should also base their choice on the features that the exchange provides. For example – traded markets, supported payment methods, charting tools, identity verification requirements, platform usability and accessibility, geographical restrictions, etc.

Let’s start with traded markets. Some cryptocurrency exchanges (Coinbase included) are focused on offering only leading coins like BTC, ETH, LTC, XRP, and so on. Others, on the other hand, operate in the niche of more exotic altcoins, listing upcoming tokens. However, most of the biggest exchanges, like Binance, and Gemini, offer a variety of digital assets, which grants flexibility.

When it comes to the supported trading methods, it is worth noting that some cryptocurrency exchanges (known as “entry-level”) support fiat deposits, while others offer only cryptocurrency deposits. Entry-level platforms usually support various methods such as bank transfers, credit and debit cards, gift cards, PayPal, and so on. If you choose to fund your account via a wire transfer, you should know that the procedure is quite slow and will take several days to complete. Credit and debit card account funding, on the other hand, happens instantly. However, it is usually associated with higher fees (up to 5%) and requires identity verification.

If you are an advanced trader who aims at using professional trading tools, then you should get familiar with the trading features, offered by the exchange. Many platforms provide simple functionalities like buying and selling, without even supporting basic charting tools. However, if your trading strategy employs multiple indicators and hand-picked trading mechanics, then you should choose one of the more advanced exchange service providers (or use third-party software for charting).

It is also a good idea to analyze the exchange’s usability. The good user interface and smooth user experience usually are signs of a well-developed platform. If you plan to trade on the go, then make sure to find a platform that has a fully-functional mobile app.

Some exchanges also impose restrictions depending on the users’ location. Most of the platforms have a list of high-risk countries that they don’t operate on. However, although the majority of the platforms try to expand their operations worldwide, at the time of this writing, most of them serve local markets (US, EU, Asia, etc.). Often is the case when some European or Asian cryptocurrency exchanges don’t serve US clients due to the strict regulatory landscape in the country. Yet, when it comes to geographical restrictions, the biggest service providers are usually the best choices, as they are usually open to clients from all around the world (aside from the high-risk markets).

Here we should also mention the platforms’ fee policy. Most cryptocurrency exchanges should have fee-related information on their websites. Before setting up an account, make sure to get familiar with the deposit, withdrawal, and transaction fee structure. For example, when it comes to account funding, most individuals prefer wire transfers as they are cheaper, although a bit slower. For those who want to start trading instantaneously, most exchanges offer support for credit/debit cards. However, in this case, the general principle is that you will be charged a higher fee (up to 5%). When it comes to trading fees, it is worth noting that most exchanges employ a maker-taker model. A maker fee is paid when the user generates liquidity (places a limit order), while a taker fee is paid when the trader removes liquidity (places a market order). Fees are usually a proportion of the transaction and can range from 0.1% up to 0.5%. However, in some instances, the transaction fees can be lowered. Clients who generate higher trading volumes enjoy lower fees, while some exchanges, like Binance, for example, offer fee reduction for the holders of their token.

So last, but not least – don’t forget about customer support. This is one of the things that many service providers struggle with, and users often report about. Make sure to use a platform that supports several communication channels such as email, live chat, telephone, social media, and so on. Bear in mind that unresponsive customer support is a common thing and in cases where a user can’t see his funds in the account, it can be very stressing.

The good thing today is that the cryptocurrency exchange niche isn’t the Wild West that it used to be, a few years back. Today, there is plenty of information to help you find the perfect service provider, according to your needs – just follow the steps mentioned above, and you will be in safe hands.

Cryptocurrency exchanges usually restrict investors who want to trade larger amounts of cryptocurrency via the conventional way. They do so because, currently, although on the rise, the trading volume on most cryptocurrency trading platforms still remains relatively low, when compared to traditional FX and stock markets. Due to the low trading volume, investors who want to place large orders (also known as “whales”) can significantly affect the price of a particular digital asset. This is harmful to the market and the trader, himself, as the price of the instrument can be moved even before the trade is completed (this is also known as “slippage”). Aside from that, exchanges might need to divide the big order into a few smaller ones, which can end up executed at different prices and at different times. So, in situations, where the value of the order placed is relatively significant to the amount of the daily trading volume, generated on the particular exchange, the investor is required to find another way of executing his trades.

So, when is an order considered a “big” one? Hedge funds, high-net-worth individuals, and wealth management companies, for example, often trade millions worth of cryptocurrencies at once. However, traditional cryptocurrency exchanges offer OTC trading services to investors who want to trade over $100,000 worth of cryptocurrencies, in the case of Poloniex (Circle), $250,000 in the case of Bittrex, and 20 BTC for Binance’s users.

The most preferred way to exchange larger amounts of cryptocurrency is through an OTC desk (over-the-counter). The OTC trading process mechanics is based on big chunks of buy and sell orders known as block trades. What OTC desks do is find buyers and sellers with significant portfolios and pair them together to conduct a trade. That way, the parties can fulfill their trades at once and at a fixed price, without affecting the trading process for smaller investors on the exchange. Another benefit that OTC trading provides is shorter withdrawal times. Instead of having to wait for a few days, traders can withdraw at once and, in most cases, within 24 hours.

There are several ways for one to get involved in OTC trading, such as via an electronic chat, telephone, and cryptocurrency ATMs. Traders prefer these ways due to anonymity, as the trades aren’t audited or reported to external agencies. However, a big part of the OTC trading activity takes place on cryptocurrency exchanges, as well. Some platforms like Binance, Coinbase, and Kraken, for example, provide such a service. To benefit from it, the investor should set up an account and pass an identity verification, in accordance with the KYC and AML policies, adopted by the particular exchange. Once the account is successfully established, the trader can proceed with requesting a quote. The OTC desk will then try to find a match for the quote. If it can’t find a match, it gets back to the trader with other terms, similar to his. Once both parties agree on a price, the trade is executed.

As you may, or may not know, depending on your country of residence, you may be required to pay taxes on your cryptocurrency investments. Although some countries like Germany, Switzerland, Malaysia, Malta, and Portugal may not consider cryptocurrency investments as taxable, under most jurisdictions, you are required to pay taxes on your returns from investing in digital assets. In the US, for example, no matter whether you collect mined or forked coins, or exchange crypto-for-crypto or crypto-for-fiat (except buying crypto with fiat), your transactions should be reported to the IRS. IRS Notice 2014-21 defines cryptocurrencies as property, which means that everything you buy with digital coins will be taxed as a short- or long-term capital gain, depending on the holding period. So, yes, even the coffee you bought this morning with Bitcoins qualifies here.

To comply with the law, you should keep records of your transactions, including all buy and sell orders and overall portfolio performance. As a rule of thumb – the more data you store, the better prepared you are. However, for residents of the US, the most important thing here is always to be prepared with information about the base price of the cryptocurrency you are selling, especially when you are cashing out crypto for fiat money. For example, if you bought BTC at $3,000 and decided to cash out five months later after it hit $8,000, you will have to pay a short-term capital gains tax. The basis for taxation is the \$5, 000 that you have earned. Consider this tax as the equivalent to one’s income tax. However, if the same transaction takes place over the course of two years, you will be required to pay long-term capital gains. The general rule of thumb in many countries, the US included, is that long-term investors usually have lower capital gains taxes.

If you are selling cryptocurrencies that you have mined yourself, then the situation is quite different, as the profit made is taxed as business income. Now about the case with the cup of coffee you bought with BTC. It is essential to keep records of the price of the coin at the time of purchase as, later on, when the time for dealing with the taxes comes, the transaction will be denominated according to the current price of the digital asset. The case is quite the same with crypto-to-crypto transactions. If you are buying Ripple with Bitcoin, you have to report the difference in the price of the asset you are selling (Bitcoin) at the time when you have bought it and when you have spent it on Ripple. Once you buy the new coin, you should record its price and keep it for the time you sell it when you will have to go through the same situation.

The concept of cryptocurrency investment accounting may appear somewhat too complicated for non-accountants, which is understandable. One of the main reasons for that is the continuing lack of a focused effort from national tax authorities around the globe to issue detailed guidance on the treatment of digital currencies. In a chaotic situation like this, the most important thing to do, to keep yourself away from trouble with authorities, is to keep records of all cryptocurrency transactions that you are involved in. Most cryptocurrency exchanges help organize this by offering convenient trading data exports for free. Once you download all your transaction information, you can reach out to a professional accountant or seek assistance from traders that are more experienced in dealing with taxes to help you determine what you owe. It is advisable to do so, at least the first time you are filing your tax form, to avoid risks of missing crucial information or misrepresenting your taxable trading activity.

Nomics currently lists 99 active cryptocurrency trading platforms that support USD trading pairs. You can buy cryptocurrencies with USD from: Binance, Bybit, Huobi Global, OKEx, FTX, Bitforex, Bitmex, HitBTC, Coinbase Pro, Phemex, Kraken, Bitfinex, DeversiFi, Bitstamp, bitFlyer, Liquid, Gemini, Delta Exchange, CoinField, Uniswap, and more.

In recent years, we’ve witnessed a significant increase in the number of active cryptocurrency exchanges. There are two main reasons for this – 1) the market is growing, and there is massive potential, and 2) it is easy to launch a cryptocurrency exchange. Let’s focus on the latter and analyze the process behind starting a cryptocurrency trading platform.

In terms of technology, there are three main options that you may choose from when launching a cryptocurrency exchange:

Build the platform from scratch

Like any other software, this option guarantees a 100% propriety platform and grants you full control over its development and maintenance. However, it also comes at higher costs as you will have to hire an entire team of developers, designers, and consultants to take care of the security features, KYC procedures, payment processing services, etc. Bear in mind that currently, there is a shortage of blockchain developers, and you should have to set aside a higher budget to attract skilled professionals.

The most important thing here is to perform an excellent initial analysis and try to estimate the total cost and length of the project. Building a platform from scratch is associated with constant development, maintenance, and upgrades, which will require an additional budget. Depending on your budget and the expertise of the team, the project may take 1-2 years or more to be concluded. Try to picture what the situation in the niche will be after that period and whether it will still offer the same profit opportunities.

Open-source technology

There are plenty of resources online in places like GitHub and other forums that provide open-source cryptocurrency exchange scripts. They grant a significant advantage as you get a solid technological base to get things going at a zero initial investment. Because the source code is free, however, it is essential to get your programming team to inspect it and improve it. They will also be able to add customizations and build new features. Overall, this way of working saves time and resources.

However, it is worth noting that, due to their nature, open-source scripts can end up being less secure, with plenty of bugs, and even malicious code to serve as a backdoor. That is why it is imperative to ensure that there are security experts and experienced developers to inspect it.

The most popular open-source protocol used for the design of cryptocurrency exchanges is 0x. Built on the Ethereum blockchain, the 0x protocol ensures the swift P2P exchange of ethereum-based tokens.

White label software solutions

There are also several options for white label solutions that you can use to kickstart your cryptocurrency exchange. The good thing about them is that they are proven to work and provide you with the flexibility to add modules, customize existing features, develop new functionalities, implement new languages and supported currencies, etc. White label solutions provide a solid foundation, consisting of a tested trade engine, wallet, admin panel, UI, charting features, third-party integrations, etc. The rest is up to you to tailor it according to the individual characteristics of your brand.

White label solutions save you the trouble of having to deal with technical execution and ongoing maintenance. You also don’t have to pay for a new license as the system already has one. Bear in mind that a proper working exchange software usually is a combination of several modules and elements (trade engine, wallet, payment processing, etc.) that should work in perfect harmony. That is why using a time-tested solution often is the preferred choice.

However, starting a cryptocurrency exchange is not only about figuring out the right technology. Another essential thing that you should also consider is where to do business. The truth is that the regulatory world doesn’t have a middle ground. While many countries ban cryptocurrency-related companies from operating on their territories, several much more liberal jurisdictions have made attracting cryptocurrency exchange projects the core of their strategic development. Malta, for example, is one of the countries with the best environment for launching a cryptocurrency exchange business. It has a dedicated portal that makes it easy to get familiar with the business climate there and helps navigate the whole process. The welcoming environment in Malta has led to a highly positive impact as the country became the home of several cryptocurrency exchanges, such as Binance, OKEx, ZB.com, etc.

When choosing where to do business, make sure to figure out whether you are planning to operate locally or globally. Also, get familiar with the country-specific policies (KYC, AML). Before setting up your plan and to avoid missing crucial information, make sure to seek legal counsel that will help you get familiar with the regulatory environment within the country where you plan to set up the exchange. Bear in mind that you should get licensed not only by local authorities but also by the jurisdictions where you plan to conduct business.

Of course, starting a cryptocurrency exchange requires additional considerations such as finding funding, organizing the operational structure, maintaining adequate customer support, dealing with third-party service providers, building liquidity, and so on. Yet, if you figure out the technology to power your exchange, as well as where to start your business, the rest will come naturally.

One of the things that interest cryptocurrency beginners the most is how can they exchange their digital coins for fiat (USD, EUR, GBP, etc.). Answering this question, however, depends on the type of cryptocurrency that you would like to exchange for fiat. If you have a portfolio of altcoins, then the best way to proceed is to sell them for a more popular cryptocurrency like BTC, ETH, XRP, and others. After you have sold your exotic coins for one of the leading cryptocurrencies, you will have more options. Here are the five most popular ways to turn your cryptocurrency in fiat:

1. Exchange cryptocurrency for fiat via an exchange

This is the most popular way as most of the leading centralized cryptocurrency exchanges allow you to exchange crypto for fiat in a simple and straightforward procedure. Exchanges that allow for purchasing crypto with fiat are referred to as On-Ramps. Coinbase, Gemini, Bitstamp, Kraken, and many others support fiat transactions. All you have to do is link a preferred payment method, such as a bank account, a PayPal or else, that you can use for fiat funding and withdrawals. Bear in mind that if you want to cash out, most crypto exchanges require you to be compliant with their KYC and AML policies. Aside from that, some exchanges have withdrawal limits or withdrawal fees that you should take into account.

Keep in mind that transfers to bank accounts take several days, but usually no more than a week. That is why, if you need to have your cash quickly, it is a better idea to consider one of the next options.

2. Exchange cryptocurrency for fiat via P2P websites

The next option is P2P platforms like www.localbitcoins.com. What they do is to match buyers and sellers and let them post their own bid and ask prices.

You wonder how does the exchange happen and whether there is any risk of selling your coins without receiving the payment? Don’t worry – the website adopts an escrow service that eradicates the risk of getting scammed. Aside from that, before getting into a trade, you will be able to get familiar with its terms and conditions (when and how will you receive your fiat payment).

Once both parties agree on the transaction terms, the cryptocurrency you are selling will be transferred to the platform’s escrow account. The buyer will release the agreed amount of fiat in the same way. Once you receive the payment, you confirm to LocalBitcoins.com that it is all good, and the crypto is then released to the buyer.

Some use the mentioned P2P platforms to arrange meetings with buyers/sellers in person, where they can fulfill the exchange face-to-face. Although this helps you avoid paying the platform’s fees, it increases the risk of getting robbed or scammed, so be careful with such an option.

3. Exchange cryptocurrency for fiat via an ATM

If you happen to live in a city that has a crypto ATM, then you have another easy option to take advantage of. Bitcoin ATMs are convenient ways to convert crypto to fiat. The major downside is that they charge relatively higher fees when compared to exchanges or P2P marketplaces.

Cryptocurrency ATMs usually work the same way as traditional ATMs. The difference here is that once you enter the amount you want to exchange for cash, you will be provided with a wallet address to transfer the cryptocurrency to. After you finish the transaction, the ATM will release the cash. If the transaction takes too long to be completed, you will be provided with a redemption code that you can use and get your cash from the ATM later.

It is worth noting that the exchange of bigger sums at some ATMs may require ID verification.

The good thing with cryptocurrency ATMs is that their popularity is increasing continuously, and they are becoming widely accessible (check the graph about the growth in the number of ATMs worldwide). New Bitcoin ATMs are launched literally every day. If you want to find out where is the closest crypto ATM to you, check here. The website provides information about the ATM’s operator, the fees that it charges as well as the supported cryptocurrencies and withdrawal limits.

4. Exchange cryptocurrency for fiat via a cryptocurrency debit card

Cryptocurrency debit cards are similar to traditional debit cards. All you have to do is to top up your account with a cryptocurrency of your choice, and you will then be able to convert it into USD or another currency easily. Crypto debit cards offer numerous advantages - instant conversion from crypto to fiat, lower commission fees, accessibility that allows you to use them at ATMs or PoS systems at retailers to purchase goods and services, etc.

Bear in mind that cryptocurrency debit cards are not yet supported in all countries. If you are using a debit card in a country that is not supported, you will have to pay an additional fee for FX conversion.

Aside from that, getting a debit card requires identity verification that includes submission of government-issued ID, proof of address, and other personal details that are usually collected from KYC-compliant service providers.

It is worth mentioning also that getting a cryptocurrency debit card initially usually takes a bit longer when compared to the time it takes to exchange crypto for fiat via an exchange or a P2P marketplace. Crypto debit cards also have limits on how much you can withdraw. The good thing here, though, is that you can increase the limits by passing through a stricter verification procedure.

5. Take out a loan instead of selling your coins

Another option worth considering is loaning out your cryptocurrencies. This works the same way as a mortgage scheme. You put your crypto as collateral and get fiat for it. Then you proceed to pay back the way you do with traditional loans. Your coins are kept under the rules of a smart contract that guarantees their safe storage.

Cryptocurrency loans are becoming increasingly popular due to the flexibility they provide. They are also preferred as they allow you to avoid a taxable event (a sell of crypto) but still take advantage of fiat money whenever you need it. Aside from that, you won’t have to go through all the buying and selling once you decide to get back in cryptocurrency investments, as the coins will remain your property. That way you will save time and avoid paying fees should you decide to buy crypto in the future.

One of the most popular cryptocurrency loan services is Nexo.io. It allows clients to set up an insured account and borrow more than 45+ fiat currencies instantly. The client isn’t required to go through credit checks, and there are no minimum repayments. Those who decide to lend their cryptocurrencies, on the other hand, can earn daily interest.

The main goal of new token projects is to get listed on a major cryptocurrency exchange, as this increases their market potential significantly. But not every exchange can shoot token projects in the stars. Getting listed on a leading platform with high liquidity and fiat on/off ramps support compared to a not-so-popular crypto-to-crypto exchange can result in a difference of millions of clients. The truth is that even projects with the highest potential may fail to live up to it if they can’t reach a wider audience. That is why the competition among token projects to get listed on one of the top crypto exchanges worldwide is so fierce.

So, what should you do to get a new cryptocurrency listed on an exchange? The straightforward answer to this question is that it varies depending on where you want to get your project listed. Different exchanges have different terms for including new tokens. That is why the best thing to do is to get familiar with the requirements of each of your preferred exchanges and to approach the platforms one-by-one.

Although the requirement of the separate trading venues may vary, the procedure that you must follow is pretty much the same for all of the leading exchanges. It can be summarized in the following key steps:

1. Choose an exchange and apply

The first obvious step is to choose the exchange you want to get featured on. Most project owners usually aim at the top-level platforms, which is understandable, considering the skyrocket effect they can have on a particular cryptocurrency if it gets listed. However, there are a few things to consider here, such as the competition, listing policy, and fees (more on this in a moment).

Let’s assume that you’ve already chosen the exchanges you want to get listed on. The next step is to apply to their programs. Most of the time, you will have to fill out an online form where you will describe the name and the description of the token, how can investors earn it, whether there are any trading specifications, what are the token holders’ rights, if any, etc. You will also have to provide them with the whitepaper to help the exchanges’ representatives get familiar with the project’s roadmap, the team behind it, and your goals. Try to provide as much details as possible. In a world where leading cryptocurrency platforms try to build credibility and distinguish themselves from the world of scammers, and pump-and-dump schemes, they make everything possible to stay away from listing shady or suspicious projects.

When you apply, the exchange team will usually perform a preliminary analysis of your project. Some platforms will let you know whether you qualify right away. However, others may require to go through a more in-depth review. During the detailed analysis, the listing team may require you to provide additional documents to confirm the authenticity of the information. You will, most probably, be requested to sign a non-disclosure agreement.

Coinbase’s listing policy is a good starting point and an example to help you find out what information you may be required to provide. You can also check the online form of Poloniex and Switcheo for further reference. If you want to get familiar with the requirements of decentralized exchanges, you can take a look at the IDEX exchange’s guide.

2. Deal with the corporate stuff

Exchanges list projects that are run by active companies, registered under an official jurisdiction. Bear in mind that conceptual ideas run by a group of enthusiasts that aren’t linked together under the rules of corporate law, won’t make the list.

Aside from that, most platforms require account verification for the leading members of the team. Some may require information only for the CEO of the company, while others will insist on having all shareholders or team members having a certain degree of control over the company (above 10%, for example) to get verified.

3. Get a legal opinion letter

Although this isn’t a mandatory requirement for all platforms, the leading exchanges in the US won’t get you listed without it. The idea of a legal opinion letter is to have a lawyer who makes an official confirmation that the project isn’t a security. In most cases, the legal opinion should be issued from law firms that operate in the same jurisdiction as the company that runs the project.

Regarding the requirement for tokens to not be classified as securities, many platforms explicitly instruct teams to adhere to the Howey Test (a precedent from a 1946 Supreme Court case that helped SEC establish a clear framework for securities classification). In fact, the DAO tokens, one of the biggest crowdfunded cryptocurrency projects in history, failed the test and were declared securities by the SEC.

4. Smart contract security audit

Some exchanges also require for the project to pass a smart contract security audit. The procedure is pretty straightforward, and you can easily find companies that offer such a service. However, it may take up to a month to finish the whole procedure.

Also, here, we should mention the technical side of things. Most platforms require you to upload the source code of the project on GitHub. Their technical team will then perform due diligence and will come out with a statement on whether they see any potential issues. The idea is to make sure your project is well-delivered in terms of a technical standpoint and that there are no risks for fraudulent activities (malicious lines of code, security concerns, and potential backdoors or loopholes).

5. Get and remain listed

Once you are compliant with all the requirements of the particular exchange and if your project is selected, it will get listed. However, bear in mind that there are also platforms that don’t have an established procedure for token project listing. Some of them analyze on a case-by-case basis. Others, like Poloniex, for example, state that they “listen to the community” and select unique and innovative projects that may be of interest to their clients.

In a bid to increase their market potential, token project owners usually try to list their assets on as many exchanges as possible from the start. However, this is not an easy task as it requires having a massive budget to cover the listing fees of each platform. Cryptocurrency exchanges currently try to exploit that niche by setting very high listing fees. According to a Business Insider research, cryptocurrency exchange listing fees range from a few thousand dollars up to a million. It is worth noting that most platforms don’t explicitly state their listing fees on their websites. What they do, most of the time is to mask the full cost of the listing process under several minor fees charged for procedures, such as market entry or “due diligence” to confirm that your project is good-to-go. Coinbase, for example, points out that they don’t charge an application fee initially. However, they state that they reserve the right _“depending on the volume of submissions, to impose an application fee in the future to defray the legal and operational costs associated with evaluating and listing new assets.” _This may often confuse token project owners as they can’t be sure what fees (if any) to expect in the future.

What this means is that cryptocurrency exchange listing fees are way higher than those of traditional stock exchanges like NYSE or NASDAQ. The NYSE, for example, has set a limit of $250,000 as the maximum fee that an issuer of an ETF product can be charged per year. For stocks, NASDAQ rarely charges over $80,000. As can be seen, stock market fees are clearly defined and way lower than those of crypto exchanges.

This often is a stumbling block in front of projects with lower budgets, which is why many consider the market unfair. Projects that can’t afford the hefty listing fees of leading exchanges can opt for decentralized exchanges like EtherDelta, for example. The platform lists the majority of the Ethereum-based tokens at no cost. However, the problem with decentralized exchanges, at the time of writing, is that they still struggle to generate high trading volume.

It is worth noting that there are some centralized trading platforms like Bittrex, that list projects for free. Even market leaders like Binance have made a step in the right direction by providing token issuers with the flexibility to choose the amount of the listing fee that they want to pay. There is no minimum set by the exchange, and all collected listing fees are donated.

Those who can’t afford the high listing fees but still want to try to get featured on a top tier exchange can take the alternative path, offered by platforms like Binance. What they do is to organize a monthly coin vote among the holders of their BNB tokens. Clients can choose one project from a list of preselected tokens and vote. Each vote costs 0.1 BNB.

It is essential to bear in mind that, although leading platforms receive thousands of applications, they list just a few projects every week. This only comes to show how strong the competition in the field is. So, if you get rejected, try to find out what were the reasons for that and come back with an improved application.

Another thing to keep in mind is that once listed, there is no guarantee that your token will remain trading on the exchange forever. Just the opposite – some platforms may proceed to delist your token if it doesn’t generate enough trading volume. This may happen as soon as 3 or 6 months after you have been listed. So, make sure to find the perfect timing for your launch.

Aside from that, don’t get your expectations too high or get too encouraged if you experience a skyrocket boom once you get listed. The potential of your idea aside, this may be due to pure market mechanics. Traders usually have a thing for newly-listed and unexplored assets as they often pose a greater risk, thus a higher profit potential. The case is the same even when a new stock is listed, as its first market direction usually is upwards (although the risk there is way lower as the whole process is strictly regulated). What this comes to show is that you must proceed with marketing your project even after it is listed. Don’t rely on past glory as a sudden drop in the investors’ interest may result in lower liquidity in the long term, which may get you delisted. Bear in mind that the place of your project on the exchange is precious, and there are hundredths of other projects that are in the queue to take it. In an effort to further monetize the cryptocurrency project listing process, some exchanges offer services like “spotlighting” or “suggesting” projects. This basically means that you can pay the platform to promote your project among its clients, thus attract more investments. If you think it is worth it, then go ahead and try it.

If you find the whole token listing procedure too complicated or time-consuming, you can always hire a company to handle it for you. There are token listing and promotion services that guarantee that you will get listed on a particular platform and will take care of the marketing part for a certain fee.

To understand how do cryptocurrency exchanges work, we will explore the mechanics behind the two common types of digital asset trading platforms – centralized (CEX) and decentralized (DEX). Centralized and decentralized exchanges differ from each other in their operational model and governance. Here is how each of them works:

Centralized cryptocurrency exchanges (CEX)

Centralized crypto exchanges serve as intermediaries that are run by a third-party operator. Similar to traditional stock exchanges, centralized cryptocurrency exchanges connect buyers and sellers and allow them to trade coins for fiat money or other cryptocurrencies. In order to make that happen, exchanges serve as an intermediary, ensuring the stability of the trading environment, constant monitoring of trades, order book management, and compliance with regulation (in some cases). However, unlike typical stock exchanges which have fixed trading hours, most centralized crypto trading platforms are open 24/7.

It is worth noting that different cryptocurrency exchanges offer different prices for the assets they list for trading. That is all because of the pricing mechanics. The rate at which a particular asset is traded is driven by the supply and demand on each platform. Each exchange has its own order book that contains all buy and sell orders for all trading pairs. Usually, the highest buy price becomes the official market price (bid) for the particular asset. The case is the same when it comes to sell orders – the lower price at which someone wants to sell a specific cryptocurrency becomes the official market price (ask). However, it is worth noting that the order book doesn’t exactly reveal what trading activity takes place in reality. In fact, it shows traders’ intentions, most of which may never materialize. If you want to find out what other investors are actually paying to buy cryptocurrencies, you should check the trade history. The basic rule of thumb, when it comes to crypto exchanges, is that the bigger the platform is, the fairer pricing policy it offers. Or in other words – more liquidity means more stable and fair prices.

If you want to find out the average price of Bitcoin, at the moment, you can do a Google search. What news aggregators do is to calculate an average price based on the rates for the particular asset on the most popular exchanges. The fact that the price of a specific asset can vary from one exchange to another creates arbitrage opportunities that are exploited by more advanced traders. What they do is to buy the asset from an exchange where it is trading cheaper and to sell it on another where it is traded at a higher price. Usually, the pricing from one platform to another varies in the range of 1-2% but can go as high as 5%.

But how does the trading process on exchanges really work on practice? Once you make an account on your preferred exchange, you will have to go through an initial verification procedure and adhere to the employed KYC/AML policies (if there are such). Upon successful verification, you will be able to fund your account and make your first trade. Let’s say that you are interested in trading BTC. If you are buying, you offer a maximum price-per-BTC. On the other hand - if you are selling, you offer a minimum price-per-BTC. For example – let’s assume that you want to buy BTC for \$1,000. All you have to do is to place your bid order. Then the exchange’s matching engine automatically finds a reverse order suitable for your request, or in this case – someone who is willing to sell BTC. If the bid exceeds the ask price, the exchange matches them, and your transaction is executed.

Centralized crypto exchanges employ the maker-taker model that allows them to charge commissions from both trade parties – the one making liquidity and the one taking liquidity. They may also charge additional fees for account deposits, withdrawals, or else. Before choosing a crypto exchange, make sure to get familiar with its fee policy.

Centralized exchanges are usually more user-friendly and the better choice for beginner traders as they provide everything needed in one place. They have an integrated wallet (although it isn’t advisable to use it), a variety of payment methods, higher liquidity, an intuitive user interface that doesn’t require prior technical knowledge, and other advantages. However, over time, some people started running away from centralized crypto exchanges in a bid to get more autonomy and handle their crypto trades independently.

Decentralized cryptocurrency exchanges (DEX)

Some cryptocurrency proponents often argue that centralized exchanges don’t represent the core idea of cryptocurrencies, which is decentralization and the elimination of middlemen. That is why decentralized exchanges were born.

Decentralized crypto exchanges don’t have any governing body. They are run by the whole community and on the principle of consensus. They are transparent as each decision is taken by voting, which helps bring the trust back into the system.

Decentralized exchanges work on the principle of putting all the processes in the hands of traders. They are the ones responsible for their trades, storage of funds, transactions, etc. They even vote collectively on issues that are crucial for the development of the platform.

Decentralized crypto exchanges, most of the time, are built via an open protocol, called 0x. Most DEXs operate on the principle of smart contracts. Smart contracts are the digital form of legal agreements. They include a set of rules and requirements which usually work on the if/then principle. This ensures that the organization remains independent, incorruptible, stable, and transparent.

Decentralized exchanges work on a P2P basis as they allow traders to interact and trade with each other, without any interference from a middleman. This means the exchange isn’t responsible for any data collection or asset storage. All it does is to provide the infrastructure where traders can execute their trades.

This brings asset pricing mechanics in the hands of users. There are no additional fees to ensure the profit of the platform, which guarantees a fairer pricing model.

The major downside of decentralized crypto exchanges is their lower liquidity. This means some users may end up waiting for extended periods of time until their orders are executed, which may lead to the loss of potential profit opportunities. Aside from that, DEXs don’t offer fiat trading. They are also not so user-friendly and often have trade limitations.

However, they have several positives, as well. For example, their nodes are distributed, which means there is no central governing body to be the sole target of a hacker attack. It also means there is literally no risk of platform downtime as the distributed nodes keep the infrastructure going permanently. DEXs also guarantee complete privacy as 100% of the trades,

APIs (application programming interfaces) are a mainstay in today’s financial world. An API is a software that ensures the smooth interaction between two sides (applications or an application and a user). In the cryptocurrency world, APIs are used to build the link between two parties, such as a user and a product company, a service provider, an exchange, a market data company, a trading app, etc. In a nutshell, what APIs do is to transfer information - get your request, pass it to the system, and then inform you about the system’s response.

In the cryptocurrency world, one of the main problems that APIs solve is related to trading information. For the broad public to have access to clean, normalized, and gapless trading data, the developers of the particular service/app, have to handle lots of work processes (deriving, cleaning, and maintaining datasets, to name a few).

At Nomics, we have developed a crypto market data platform, enabling market participants such as investors, analysts, and market makers to computationally access clean and normalized primary source trade and order book data. Our API provides direct, streamlined access to price and exchange rate data from all major exchanges, including Binance, Coinbase Pro, Gemini, Poloniex, and others. Instead of integrating each platform’s API, you can process everything via the Nomics API. The API is widely used by hedge funds, quant trading companies, fintech developers, and other market participants.

How to use a crypto exchange API depends on what you want to build with it. For example, our API provides unlimited options as you can develop and integrate mobile apps, charting tools, algorithmic trading solutions, backtesting and portfolio valuation tools, pricing portals, and informational websites.

The most important skill when it comes to interacting with a crypto exchange API is the proper understanding of financial data, including market mechanics, price formats, order book management, and so on. However, there are several technical skills that we should also mention here. To work with a crypto exchange API successfully, it is necessary for the user to be familiar with databases and HTTP requests, as well as to be experienced in working with JSON and CSV data. If we assume that you want to build an entry-level financial portal that reports cryptocurrency pricing information, all that is needed is an HTTP GET request and a basic JSON analysis.

In the case of API integration for the goals of crypto exchange businesses, all you need to start running the Nomics API is to expose three private endpoints, which takes no more than 4 to 8 hours of development time. That way, we would then be able to provide dozens of additional API endpoints, allowing users to retrieve and format market data in various supported formats.

All in all, our API allows for convenient interaction as all features are navigated through requests (we support Shell, NodeJS, Ruby, Python, and JavaScript). A complete tutorial and samples of requests that you may need are available in our Cryptocurrency API documentation.

You can find more technical information about how to use our crypto exchange API in its doc section and our forum.

A decentralized exchange (DEX) is a marketplace for trading cryptoassets that uses smart contracts to facilitate transactions. Smart contracts are computer programs that automatically execute on certain conditions. They can match traders, swap cryptocurrencies, and write transactions to a blockchain. These programs enable DEX users to interact straight from their crypto wallets without the help of middlemen.

Centralized exchanges are intermediaries that manage everything from storing login credentials to updating user balances. To enable trades, these platforms take custody of users' private keys, the series of characters that correspond to blockchain addresses and represent crypto ownership. This obliges centralized exchanges to perform Know Your Customer (KYC) compliance, personal questions meant to establish identity.

Centralized vs. Decentralized

There are pros and cons to both models. Centralized exchanges custody user keys, which means that traders can't sign their own transactions. The exchange signs for them then updates a ledger, which is stored on company servers along with any information obtained through KYC. When a user wishes to withdraw funds, the exchange checks the ledger and pays out accordingly.

In the crypto community, there is a vocal faction that emphasizes financial self-sovereignty and privacy. These individuals would never trust their keys to a third-party. But most consumers are comfortable trading keys – and sensitive personal data – for a familiar user experience that is fast and inexpensive.

Though the DEX experience is improving, decentralized has typically been less intuitive than centralized. And because smart contracts write transactions to a blockchain – instead of a local ledger – settlement can be slow and costly. It depends on the underlying chain. For example, Ethereum (ETH) only processes 15 transactions per second. If the network is congested, fees can soar.

What Is Uniswap?

When people think of decentralized exchanges, they tend to think of Uniswap. Founded in 2018, the Ethereum-based platform boasts more trading pairs than any other DEX and handles over $1 billion in daily trading volume. Like any DEX, Uniswap lets traders interact pseudonymously from their wallets. It also ditches order books for smart contracts that price assets using a mathematical formula.

Order books are the prices at which buyers and sellers are willing to trade. On exchanges that use order books, thin or illiquid markets can result in slippage, a discrepancy between the expected price of a trade and the price at which it is executed.

Uniswap uses a formula, x * y = k, where x and y are the tokens in a trading pair and k is constant. When swapping x for y, the amount of y received depends on k. Anyone can contribute liquidity and earn passive income. Meanwhile, the x:y ratio is stabilized by arbitrage traders.

The design makes it possible to trade small-cap coins without slippage. It's the reason that Uniswap hosts so many markets.

State of DEXes in 2021

When it comes to trading volume, DEXes are dwarfed by centralized exchanges. That said, DEXes have advantages that will always draw users. Namely, they offer non-custodial, pseudonymous trading, access to smaller markets that aren't available on centralized exchanges, and an opportunity to earn passive income by providing liquidity.

In September 2020, following a busy summer in decentralized finance, Uniswap was briefly a top-5 exchange by volume – ahead of established giants like Coinbase and Kraken. Though Uniswap fell back to Earth, DEX volumes are rising as the space innovates to compete with faster, cheaper centralized options.

Judging by metrics like user count and total volume traded, centralized exchanges are light years ahead of DEXes. But it wasn't always that way.

A Brief History of Crypto Trading

In the beginning, Bitcoin (BTC) was traded peer-to-peer (P2P) and even face-to-face. People would meet in online forums and iron out transaction details among themselves. There were centralized exchanges, but they were not a dominant force. Most flamed out.

Bitomat lost access to their wallet.dat file and 17,000 BTC. Bitcoinica was hacked for 43,000 BTC. In February 2014, it emerged that Mt. Gox, then the world's top crypto exchange, had been taken for 850,000 BTC! For more on the Mt. Gox story, check out Flippening episode #82, Boosting Bitcoin by Improving Exchanges, with Jesse Powell, CEO of Kraken, one of the few centralized exchanges to successfully navigate crypto's early days.

Behind the efforts of current market leaders like Kraken, Coinbase, and a handful of others, the centralized exchange space matured and eclipsed peer-to-peer trading. Yet P2P endures because it meets needs that centralized exchanges cannot.

Where DEXes Win

Before trading on a centralized exchange, users must undergo Know Your Customer (KYC) compliance, a series of questions to establish identity. This is required by law to combat money laundering, sanction-breaking, and other criminal activities. Legacy banks and brokers put customers through the same process.

Banks, brokers, and centralized crypto exchanges are obliged to perform KYC because they act as middlemen. Centralized exchanges do not facilitate peer-to-peer trading. Instead, they manage trades by taking custody of user keys, the strings of characters representing crypto ownership. Customers can't sign transactions without keys, so the exchanges sign for them and update a ledger. Not too different from banks that accept customer deposits, update a ledger, then lend out to borrowers.

While most consumers are fine sharing keys and personal details with a reputable third party, there are plenty of folks who view self-custody and pseudonymity as inalienable rights.

Enter decentralized exchanges. Rather than custody user keys, DEXes leverage smart contracts to permit peer-to-peer trading. There is no middleman and no central authority to perform KYC. As a result, users control their own funds and remain pseudonymous.

Smart contracts enable another feature that few centralized exchanges can match – access to altcoins. On centralized exchanges – and DEXes that use order books – trading illiquid markets can result in slippage, a difference between a trade's expected and execution prices. DEXes like Uniswap eschew order books for smart contracts that keep token prices in equilibrium. For more on that, skip to Automated Market Makers in the answer to Question 3.

Why Aren't DEXes More Popular?

Thanks to smart contracts, decentralized exchanges can offer peer-to-peer trading without the intervention of middlemen. But with self-custody comes responsibility.

Lose Your Keys, Lose Your Coins

HODLers who keep keys on everyday devices must watch for malware, man-in-the-middle attacks, even over-the-shoulder spies. It's safer to store keys on a hardware wallet like Ledger or Trezor, but whether keys are offline or exposed to the web, there's still a need to manage a seed or recovery phrase. This 12 to 24-word phrase represents a user's private key and is the only way to recover a lost wallet. It has to be memorized, written down, or otherwise stored offline.

Because centralized exchanges custody user keys, there's no need to worry about seed phrases. If a user forgets their password, there will be an email or authenticator-based method to reset it. For the average consumer, this is by far the more attractive option. After all, few people bury their fiat in a mattress. Most are comfortable working with banks.

How Decentralized?

It's also debatable whether all DEXes are decentralized. In July 2018, decentralized exchange Bancor was hacked, resulting in a loss of 3.2 million of the platform's proprietary BNT tokens and 25,000 ETH. Bancor responded by firing a "kill switch" in its code that allowed it to freeze the stolen BNT. Litecoin (LTC) founder Charlie Lee tweeted, "An exchange is not decentralized if it can lose customer funds OR if it can freeze customer funds. Bancor can do BOTH." Two days later, Bancor clarified that no customer funds were stolen – the tokens were taken from a reserve – but Lee's point is legit and may apply to other self-described decentralized exchanges.

Decentralized finance (DeFi) is a movement that aims to free consumers from banks, brokers, and insurance companies. Among DeFi projects, which number in the hundreds, decentralized exchanges have been particularly innovative.

DEX Basics

Unlike centralized exchanges, which custody private keys and put users through Know Your Customer checks, DEXes leverage computer programs called smart contracts to enable peer-to-peer trading without the intervention of third-parties. This allows users to retain control of their cryptoassets and engage pseudonymously from their DeFi wallets.

While self-custody and pseudonymity come standard with decentralized exchanges, some DEXes, like automated market makers and aggregators, offer additional benefits.

Automated Market Makers

Decentralized exchanges like dYdX, Binance DEX, and ViteX set prices with order books. For every buyer, there is a seller and vice-versa. The trader on the other side of the deal is referred to as the counterparty.

Next-generation DEXes known as automated market makers (AMMs) work differently. AMMs are less peer-to-peer than peer-to-contract. There is no counterparty. Rather, coins are swapped between wallets and smart contracts.

Liquidity is created by liquidity providers or LPs, parties who deposit cryptocurrency in exchange for a slice of the transaction fees. Historically, the process of contributing liquidity has been handled by major financial firms. AMMs democratize this function, allowing anyone to contribute liquidity and earn passive income.

The Slippage Issue

There's another important difference between AMMs and traditional DEXes. AMMs replace order books with formulae like x * y = k, where x and y are the tokens and k is a constant representing liquidity. The equation is maintained by the contract or liquidity pool with which traders interact.

In thinly-traded markets – say for low-cap altcoins – this constant product model minimizes slippage. The same cannot be said of order books. When there aren't enough counterparties, an order will "slip" through the book to a less desirable price.

Unfortunately, AMMs only minimize slippage for small orders. When a pool's x:y ratio is skewed, arbitrage traders swoop in, profit off the imbalance, and thereby restore prices to market rates. Large orders start at going rates, but as Alice buys x, the percentage of y in her pool increases. Before arbitrageurs can correct the imbalance, the price of x goes up, sticking her with a higher-than-expected bill for her tokens.

As AMMs attract users, this issue will shrink in importance. The deeper the liquidity pool, the less likely an order will dramatically alter its x:y ratio.

Aggregators

In resolving order book slippage, AMMs saddle users with slippage of a different sort. On AMMs that rely on constant product formulae like x * y = k, large orders can warp the x:y ratio and result in prices that differ from those that traders expected. Consequently, institutions and high-net-worth individuals had avoided AMMs.

That began to change in 2019 after a new exchange called 1inch was developed at the ETHNewYork hackathon. Dubbed a DEX aggregator, 1inch sources liquidity from across the decentralized exchange spectrum, providing traders with the best possible prices. 1inch has improved the DEX experience – not solely by securing better prices, but by offering a unified dashboard for placing orders.

Traders can get started on 1inch by connecting a compatible wallet loaded with enough ETH or Binance Coin (BNB) to fuel transactions. Behind the scenes, 1inch's "Pathfinder" selects the best routes for swaps, splitting orders across multiple DEXes or even different market depths within DEXes.

Impermanent Loss

DEX aggregators like 1inch make it easier for buyers and sellers to send large orders through AMMs, but the specter of impermanent loss caps the liquidity that folks will contribute.

Impermanent loss is when a liquidity provider would have earned more from HODLing than from providing liquidity. Suppose Bob deposits 1 ETH – worth $100 – and an equivalent amount of DAI. After his contribution, there is a total of 10 ETH and 1,000 DAI in the liquidity pool. Bob's share is 10%.

If ETH's market value increases, arbitrage traders will flip DAI for ETH until the x:y ratio is balanced, at which point there will be less ETH and more DAI than when Bob began. If he decides to withdraw, he'll still get his 10%, but he won't get a full ETH back. He'd have done better on the sidelines.

Dealing With Impermanent Loss

Impermanent loss is offset by trading fees, which liquidity providers earn in exchange for their contributions. The busier the pool, the more LPs earn. LPs can also receive reward tokens. AMMs like Uniswap, Balancer, and Curve distribute UNI, BAL, and CRV, which can be used throughout the DeFi space or traded for other coins.

Recent innovations by Bancor and Uniswap go further. In October 2020, Bancor released an upgrade that blunts the impact of impermanent loss by allocating a portion of trading fees to "Impermanent Loss Insurance" that scales with a liquidity provider's time commitment. Each day, a provider gets an additional 1% coverage until day 100 when they are 100% insured against impermanent loss.

In May 2021, Uniswap transitioned to v3, an upgrade that lets LPs concentrate liquidity in custom price ranges. The closer the range to going rates, the greater the risk of impermanent loss, but better prices attract traders, whose activity generates fees. As Uniswap founder Hayden Adams explained, concentrated liquidity addresses impermanent loss "the only way direct tradeoffs can be solved: exposing the tradeoff spectrum to users."

There's no right or wrong way to trade cryptoassets. In the beginning, crypto enthusiasts swapped Bitcoin in-person and through online forums. Today, high-net-worth individuals and institutions trade over-the-counter (OTC) while retail traders use centralized exchanges like Binance, OKEx, and Coinbase.

Decentralized exchanges don't have the volumes of crypto OTC desks or centralized exchanges, but their numbers are growing thanks to a compelling value proposition that includes self-custody, pseudonymity, access to small-cap coins, and a chance to earn passive income.

Self-Custody

To facilitate trades, centralized exchanges take custody of user keys, the series of characters that point to blockchain addresses and represent crypto ownership. Since users can't sign transactions without their keys, the exchanges sign for them then update a ledger.

But third-party key management can end in disaster. Consider QuadrigaCX, a centralized exchange that collapsed when its founder, Gerald Cotten, unexpectedly died. The exchange fell apart because Cotten was the only person with access to its customers' private keys. At his death, the assets with which those keys were associated effectively disappeared.

Top centralized exchanges are audited for security, and Nomics' transparency ratings order exchanges by their willingness to share data. That said, there are those who will never trust keys to a third-party – no matter how secure or transparent. To swap cryptoassets, these folks might trade face-to-face or through forums, but increasingly, they opt for decentralized exchanges, which do not custody keys but lean on smart contracts to facilitate peer-to-peer trading. Users retain control of their funds and interact from their wallets.

Pseudonymity

Know Your Customer (KYC) checks establish user identity to prevent crimes like money laundering, sanction-dodging, and the financing of terrorism. While KYC is designed to be as painless as possible, providing personal details can have consequences. A data breach could result in the public release of sensitive information. In many countries, citizens have reason to fear their governments. And there's no telling what form a "good" government will take in the future.

All centralized exchanges perform KYC. So do regulated OTC desks and any desk operated by a major exchange. But decentralized exchanges are non-custodial – there's no authority to run KYC. This enables DEX users to transact pseudonymously.

Access to Altcoins

Automated market makers (AMMs) are a special type of decentralized exchange that use smart contracts to ensure steady prices and liquidity for each trading pair or liquidity pool.

If there is demand for an asset, a liquidity pool can be spun up and sustained – even for low-cap altcoins. And users can trade those markets without the slippage they'd experience on order book exchanges.

Passive Income

AMMs also democratize market making. The process of creating liquidity has been the purview of big financial institutions, but AMMs let anyone get involved. For their trouble, liquidity providers or LPs receive a portion of the transaction fees paid by traders.

AMMs like SushiSwap and PancakeSwap – both Uniswap clones – let LPs earn additional passive income. When an LP adds liquidity to these platforms, they receive liquidity tokens. On withdrawal, those tokens are redeemable for the LP's contribution plus any trading fees, but in the meantime, the tokens can be staked to earn extra rewards. For example, the liquidity tokens distributed by PancakeSwap can be locked in exchange for CAKE, PancakeSwap's governance token, which can be staked in Syrup Pools for more CAKE or other coins. This practice is known as yield farming.

Decentralized exchanges have much to offer. Users retain control of their keys. They can skip Know Your Customer checks and trade pseudonymously. Automated market makers enable the buying and selling of small-cap altcoins without slippage. And liquidity providers can earn passive income in the form of transaction fees and staking rewards.

Yet in terms of trading volume and user count, DEXes trail their centralized competitors. There are several reasons for this, but the main culprit is user experience. Centralized is faster and cheaper, third-party key management is convenient, and the volumes flowing through centralized exchanges minimize slippage for commonly-traded assets.

In addition, there have been issues with the smart contracts that run DEXes. While centralized services suffer their share of breaches and software failures, the easy composability of decentralized finance (DeFi) may encourage founders to "move fast and break things." And while a centralized team can respond to vulnerabilities immediately, a decentralized protocol might require community buy-in before its devs can act.

The UX Isn't There Yet

User experience is a broad category covering everything from ease of use to cost of use. Centralized exchanges outperform DEXes in both areas. Accordingly, on any given day, each of the top five to ten centralized exchanges will handle more volume than the entire decentralized space.

Speed & Cost

Consumers gravitate to the fastest, least expensive option. Centralized exchanges do not write transactions to blockchains but to an in-house ledger, which saves time and cost.

When the price of Ethereum rallies, new users join, and the network becomes congested. This can result in transaction fees that equal or even exceed the value being transferred. To get trades processed, users have to entice miners by upping their fees.

Until Ethereum solves its scaling problems, spiralling fees will drive users to centralized exchanges or platforms like PancakeSwap, which runs on Binance Smart Chain, a more economical, less decentralized version of Ethereum.

Account Recovery

Bitcoin's market cap has crossed $1 trillion, there are thousands of dApps on Ethereum, and institutions are piling in. But there are those who question crypto's utility for non-technical users. When naming obstacles to adoption, these critics nearly always cite the account recovery process.

To trade on a decentralized exchange, all one needs is a wallet to store the keys that correspond to blockchain addresses and represent crypto ownership. With that wallet, a user can trade without surrendering their keys to a third-party. This is one of the benefits of DEXes, but it's a double-edged sword.

In the First World, few consumers are used to self-custody. Most deposit their money in a bank. If they forget their PIN or password, it can be reset by customer service. A crypto wallet is a different story. If it is lost, the only way to retrieve it is by entering a 12 to 24-word recovery phrase. Forget or misplace the phrase, and the crypto is gone forever.

Because centralized exchanges take custody of user keys, they can offer a familiar login experience based around usernames, passwords, and two-factor authentication. These platforms' dominance of cryptoasset trading indicates that most folks will happily sacrifice control for convenience.

Slippage

Every day, hundreds of billions of dollars' worth of crypto flows through centralized exchanges. This volume ensures liquid markets and predictable prices for major coins as well as plenty of alts.

However, when it comes to obscure altcoins, specialized DEXes known as automated market makers or AMMs may outperform centralized exchanges, which value assets using order books, lists of prices at which buyers and sellers are willing to transact. If there aren't enough counterparties, trades "slip" through the order book to unfavorable prices. AMMs do not use order books. Rather, they price assets with formulae that keep pairs in equilibrium.

But in doing so, AMMs introduce a different type of slippage. Large orders stress the balance between tokens, resulting in less desirable prices.

Aggregators like 1inch source liquidity across DEXes, minimizing the extent to which slippage hurts high rollers. And market depth will increase as users try AMMs. Yet it's fair to say that while decentralized exchanges reduce slippage for altcoins, a risk remains for big trades.

Security Concerns

Bitcoin has captured the world's imagination because it pushes power to the edges. It also makes headlines for its energy consumption and volatility. Similarly, decentralized finance has broken through as a threat to the legacy system and as a bit of a punchline. From the beginning, the space has had to navigate controversy caused by thoughtlessly deployed code and bad governance.

This can be partly attributed to DeFi's composability. It's easy to start a DeFi protocol using imported infrastructure. But great speed to market does not correlate to consumer confidence – especially when there's value on the line. Before entrusting cash or crypto to a collection of smart contracts, users want assurances that those contracts work as intended.

In March 2021, decentralized exchange DODO was hacked for nearly $4 million in cryptoassets. The hackers exploited a bug in the code running the exchange's Crowdpools, the mechanism by which users distribute tokens. Another example is Bancor, the first AMM on Ethereum. Back in 2018, hackers took the exchange for 3 million of its proprietary BNT tokens. Bancor responded by freezing the stolen tokens, a move that called into question whether it was truly decentralized. For more on the Bancor story, see question 2, Are DEXes Better Than Centralized Exchanges?

DeFi is borderless, permissionless, and non-custodial. It has a bright future. Today, however, security concerns slow its adoption by retail and institutional users. This affects decentralized lending platforms, derivatives, and DEXes.