How Do Bitcoin Exchanges Work?

Microsoft, PayPal, Starbucks, Twitch, AMC Theaters and Rakuten. What do these companies have in common?

They are all unicorns and globally renowned brands, but what else ties them to the same conversation?

They all accept Bitcoin payments for their products and services.

Speaking of firsts, did you know that El Salvador is the only country where Bitcoin is legal tender.

Despite this, retail traders remain king in crypto, moving billions every split second.

The next obvious question is: How do Bitcoin exchanges work?

There is no need to rack your brains because we got you covered.

What Is a Bitcoin Exchange?

A Bitcoin exchange is a digital marketplace where investors trade cryptocurrencies using different fiat currencies and altcoins.

Bitcoin exchanges have a similar investment concept to stock markets. Let’s see what they have in common:

  • The platform where the buying and selling take place is the same.
  • Both operate on a money order where the business idea is to buy and sell something as soon as possible.
  • Both leverage limit orders that allow traders to set the threshold they are willing to buy and sell to prevent losses and fetch the best blockchain prices.

While there are similarities, there are also some significant differences, as outlined below:

  • Cryptocurrency is volatile, which is both an advantage and a disadvantage. Traders sit on the asset and profit when it appreciates. The investment is equally susceptible to overnight plunges, meaning it can tank in a split second.
  • Trading risk is significantly higher in Bitcoin investment because of decentralization. On the other hand, trading stocks is less risky since it has government backing.
  • While market manipulation is minimal in stock markets, the crypto community struggles with a clique of individuals christened “whales” notorious for making moves to influence the exchange prices of digital assets.
  • Stock market investors incur many costs, such as trading and brokerage fees. Bitcoin investors only pay minimal transaction fees to legitimate cryptocurrency exchanges.
  • A market cap is imposed on Bitcoin and altcoins to ensure demand is always greater than supply. On the opposite side of the spectrum, there is no trading cap in stock markets.
  • One of the pros of exchanging cryptocurrency is that Bitcoin trading hours are not limited. Unlike stock trading, which is generally restricted to set business hours, crypto can change hands 24 hours a day.

Exchange vs Wallet: What’s the Difference?

A Bitcoin exchange is the matching medium that brings together buyers and sellers. Bitcoin exchanges also offer cryptocurrency conversion.

On the other hand, a wallet is a program that allows an investor to store their cryptocurrency.

There are two types of wallets – a hot wallet that stays online and a cold wallet that stays offline and is less prone to hacks and theft.

How do Bitcoin Exchanges Work

There are three types of exchanges that all operate differently. These are:

  • Centralized exchanges
  • Decentralized exchanges
  • Hybrid exchanges

Centralized exchanges

Centralized exchanges are the most common type of crypto trading platforms. They are owned by private companies and act as intermediaries between buyers and sellers.

This type of exchange tends to have higher trade volumes and liquidity. Since market conditions determine prices, traders work with prevailing tickers. They, however, get to decide whether they would like to do a deal or not.

How do centralized cryptocurrency exchanges work?

To get started, a user has to register with a digital currency exchange. They will then undergo different verification steps to authenticate their identity. Only after these steps, will they be free to exchange Bitcoins. Once a buyer initiates an order, the exchange finds a suitable seller disposing at the lowest price possible.

Centralized exchange platforms support a greater number of crypto trading pairs. They also accept various forms of payment and withdrawal, making them a convenient option.

Decentralized exchanges

Decentralized Bitcoin exchanges are peer-to-peer platforms that operate without a central authority.

Many traders prefer them for several reasons. First, a vast majority of the traders feel decentralized exchanges suit cryptocurrencies’ decentralized nature better than their centralized counterparts.

They are also favored because they ask for less personal information than their peers. Decentralized exchanges also allow you to exchange Bitcoin to USD.

Another reason why they are popular is they eliminate the middleman, meaning users can transfer their coins directly to other users. Consequently, they are less prone to hacks, fraudulent activity, and manipulation.

Due to the sheer scale of the risk involved, most decentralized exchanges have been unable to attract enough user interest in terms of volume and liquidity. Traders are wary that traders do not have a central authority to fall back to in case of fraud.

Hybrid exchanges

Hybrid exchanges were birthed out of a need to counter the limitations of centralized and decentralized exchanges. They combine the positive features of both types — the privacy and security of decentralized platforms and the liquidity and usability of central exchanges.

Users have a total grip on their funds. They can trade digital assets directly from their cryptocurrency wallets and deposit tokens into the robust smart contract without sweating over interference from third parties.

Before hybrid exchanges, investors had to contend with high cryptocurrency fees and a lack of complete autonomy over their funds on centralized exchanges.

Centralized exchanges store investors’ funds in hot wallets, which can be hacked. On the other hand, decentralized exchanges process transactions very slowly, which turns off investors seeking to capitalize on volatile prices.

Amid these limitations, hybrid exchanges stand out as the obvious choice for many investors.

How Is Bitcoin Traded

As outlined below, bitcoin transactions happen differently on various exchanges.

Centralized exchanges

Here, trades are completed via a buy order aggregated into an order book maintained by all Bitcoin trading exchanges.

Most exchanges allow traders to set both ‘market buy’ and ‘limit buy’ orders.

A market buy order allows you to state how much Bitcoin you would like to purchase. The exchange matches a buyer with a seller offering the lowest price and initiates the trade. Once you submit the order, the Bitcoin is sent to your wallet.

A limit buy order allows you to stipulate how much Bitcoin you wish to purchase and the price you are willing to pay for it. If there are willing sellers at that point, your order will be initiated, and the Bitcoin will be sent to your wallet.

Decentralized exchanges

In these peer-to-peer Bitcoin exchanges, no intermediary is involved. Buyers and sellers are linked through self-executing agreements written in code known as smart contracts.

So, how to exchange cryptocurrency on a decentralized exchange?

The first step when trading Bitcoin via a decentralized Bitcoin exchange is deciding which network you prefer to use. The next step is choosing a wallet compatible with the specified network and funding it in its native token.

These tokens are acquired from centralized exchanges and can be easily identified from the ticker symbol they use, such as BTC for Bitcoin. After purchasing the tokens, you will be required to transfer them to a wallet you control.

Recovering funds sent to the wrong network is a tough task in a decentralized cryptocurrency exchange. Therefore, you must ensure that you input the correct address.

You will then be able to connect your funded network through a pop-up prompt or the “Connect Wallet” button customarily situated on the upper corners of a DEX’s website.

Hybrid exchanges

When trading Bitcoin via a hybrid exchange, the first step is to transfer your private keys to the order pool. This is done to decrypt the instructions and send them to the corresponding engine.

The blockchain then monitors all trades, and depending on the executed trades, the cash and crypto balances change.

How Do Bitcoin Exchanges Set Their Prices?

Unlike legal tenders, Bitcoin is not issued by a central bank or backed by a government. Therefore, traditional currency factors like monetary policy and inflation prices do not sway Bitcoin prices.

To that effect, Bitcoin prices are influenced by:

  • Supply and demand
  • The cost of Bitcoin mining
  • Compensation to Bitcoin miners for verifying transactions to the blockchain
  • Market factors surrounding competing blockchain currencies
  • Regulations governing the sale and use of Bitcoin
  • Important news developments

Supply

As mentioned earlier, Bitcoin mining is regulated to ensure market equilibrium.

The number of Bitcoins circulating in the market has reduced since its inception in 2009.  The supply of the most popular digital currency fell from 6.9% in 2016 to 4.4% in 2017 and 4% in 2018.

Bitcoin halving events that happen quadrennially (every four years) coincide with an increase in Bitcoin prices.

Demand

Retail investors unperturbed by the short-term price volatility of Bitcoin are cryptocurrency’s biggest demographic. Various reports have pointed out that this group is happy to ride out short-term turbulence with eyes trained on the long-term goal.

However, it is essential to point out that geo-economic considerations are significant in how Bitcoin moves.

Citizens of countries with high inflation levels like Venezuela increasingly fell back to Bitcoin as their home currency tanked to near-worthless value. The same applies to countries like China, whose citizens used Bitcoin to work around repressive capital control policies before regulators banned cryptocurrency trading.

Elsewhere, a spike in Russian interest in Bitcoin was also recorded in early 2022 as the country faced a barrage of sanctions for invading Ukraine.

Criminals are a keen demographic in Bitcoin’s development since it has helped them evade scrutiny and move large sums of dirty money.

Widespread media coverage has also influenced the uptake of Bitcoin, allowing financially underserved groups to join the fold.

Cost of production

Bitcoin mining involves solving complex math problems which require massive amounts of electricity and high-grade equipment.

Mining is also about a battle of wits pitting math geniuses. The first miner to crack the problem is awarded newly minted Bitcoins and accumulated transaction costs since the last block.

Some sites have estimated that the electricity costs for Bitcoin mining trump that of other countries. The difficulty level of the algorithm also drives up the power expenses.

The Bitcoin algorithms’ difficulty level also determines how fast the crypto is produced, affecting the demand and supply curve.

Competition

Bitcoin has been the dominant crypto player since 2009, but the rise of other digital assets has been eating into its market share.

Factor this: In 2017, Bitcoin accounted for 80% of the crypto market share, which shrunk to 50% by 2021.

That said, trends in trading cryptocurrencies keep shifting.

While Bitcoin remains the most popular cryptocurrency, other tokens are also gunning for the top spot, most notably Ethereum. Traders have warmed up to ETH because of a boom in Decentralized Finance (DeFi).

News developments

The Bitcoin price is also affected by news developments.

In May 2021, Bitcoin’s price plunged 30% after Tesla Chief Executive Elon Musk announced that the automaker would no longer accept Bitcoin payments. The billionaire cited environmental concerns for the drastic change in tone.

At the corner office, a group of core developers is responsible for formulating Bitcoin policies that affect the cryptocurrency’s price. Therefore, investors and analysts keep tabs on news of disagreements among the developers and influential figures, sharing their views on Bitcoin’s future.

Regulatory developments

Bitcoin’s lack of regulation has its advantages and disadvantages, as illustrated below.

In September 2021, El Salvador became the first country to make Bitcoin legal tender. The cryptocurrency surged by 6% to $37,000 on this news.

In the same month, China imposed a ban on all Bitcoin trading and mining activities. The coin’s price tumbled almost immediately and affected BTC to USD exchange.

Speculation was rife that Beijing grew wary of Bitcoin’s potential to disrupt social and financial order in the country.

The more governments formulate policies to ease the use of Bitcoin in their economies, the better chances the coin stands of being recognized as a legitimate asset class. The opposite also applies.

What to Look For in an Exchange

With the competition for your dollar hotting up, there are hundreds of Bitcoin selling sites waiting to add you as a subscriber.

They all offer different digital currencies, with some constantly improving their services. In that case, how do you know which exchange to go for? Let’s go through the main consideration points.

1. Fees

The risk element in e-currency exchanging has made it impossible to have standard fees across the board.

Traders using the various platforms are charged a fee and potential commissions.

It would help if you researched the best rates in the market. Be sure to check commission-free platforms in the market and whether they work for you.

For instance, by March 2022, Voyager was the only exchange that offered commission-free trading.

Doing this will help you compare Bitcoin exchanges and pick the digital currency exchange platform with the best cryptocurrency conversion rates.

2. Security

Due to the lack of regulation in crypto trading, investors tend to shy off from transacting due to security fears.

Scout for a platform with bulletproof Bitcoin security protocols to avoid being hacked and your holdings stolen.

There are several security features to look out for when picking an exchange, such as encryption, two-factor authentication (2FA), and cold storage.

3. Crypto selection

The number of cryptocurrencies available for trading varies from platform to platform.

For instance, as of March 2022, Coinmama only listed the most traded cryptocurrencies, namely:  Bitcoin, Ethereum, Dogecoin, Litecoin, Bitcoin Cash, Cardano, Chainlink, Uniswap, Tezos, and Ripple.

This is ideal for novice investors keen on only exchanging the top cryptocurrency coins. On the flip side, this might inconvenience experts who are always on the lookout for new currencies with great potential.

Some exchanges offer hundreds of cryptocurrencies. For example, in March 2022, Binance offered 500 currencies, including Bitcoin Cash and Bitcoin Gold. The platform also allows you to buy Bitcoin Cash with USD.

4. Availability

Another essential factor to consider is whether the platform is eligible in your country or state.

If you fancy a specific exchange not yet available in your jurisdiction, keep checking for updates because companies are constantly expanding.

Similarly, be on the lookout for regulatory changes if you use an international exchange. A Bitcoin exchange platform could be banned or restricted at any moment. Staying in the loop will help you protect your investment.

5. Buy/trade options

There are various ways to fund a crypto account, including bank wires, direct bank transfers, and credit & debit cards. However, some exchanges do not support some of these options.

Some coin market exchanges also support crypto to crypto trades while others won’t.

Research will help you find the most convenient exchange and Bitcoin currency converter.

6. Wallet

Not all digital exchanges come equipped with a wallet to store your crypto holdings.

Identifying an exchange that allows you to manage your wallet and exchange coins simultaneously is a huge plus.

An external cold wallet is better for investors with a broader pool of crypto assets for added security.

7. Makers and Takers

Makers and takers is simply the size of an exchange’s order books. People who place buy and sell Bitcoin orders are also referred to as makers and takers.

The more orders listed on a book, the easier it is for people to acquire and dispose of large amounts of Bitcoin at prices much closer to the global market rate.

In crypto jargon, takers can refer to two types of traders:

  • Those who reduce liquidity by taking orders already on the books
  • Those who place a limit order that matches another person’s order already on the books

Where to Exchange Bitcoin?

Some platforms allow you to buy Bitcoin with low fees, while others offer cryptocurrency conversion. Your choice should be based on your needs and experience level.

That being said, some of the best crypto platforms include:

  • Uphold – Best for cross-asset trading
  • eToro – Best for beginners
  • Kraken – Best for US-based users
  • Coinbase — Best for security
  • Blockfi —  Best for earning interest
  • Crypto.com — Best for active traders
  • Binance — Best for low fees
  • Bisq — Best decentralized Bitcoin money exchange.

Uphold

Plenty of crypto enthusiasts consider Uphold the most versatile tool in the market. The exchange has unique features headlined by an interface allowing users to trade directly between asset classes. It also stands out for its lack of trading commissions and all-inclusive pricing model.

  • No trading, deposit or withdrawal fees
  • Cross-asset trading
  • Wide cryptocurrency selection

Plenty of crypto enthusiasts consider Uphold the most versatile tool in the market. The exchange has unique features headlined by an interface allowing users to trade directly between asset classes. It also stands out for its lack of trading commissions and all-inclusive pricing model.

eToro

eToro is a fully regulated trading platform with over 15+ million users. It comes with a mobile cryptocurrency wallet where you can trade and transfer funds while allowing you to invest long-term in a portfolio of the most popular cryptocurrencies with no fees.

  • Award-Winning Social & Copy Trading (15+M user base)
  • Best For Beginners: Try Virtual $100K
  • 16 Cryptocurrencies & 94 Crypto Crosses Available

eToro is a fully regulated trading platform with over 15+ million users. It comes with a mobile cryptocurrency wallet where you can trade and transfer funds while allowing you to invest long-term in a portfolio of the most popular cryptocurrencies with no fees.

eToro is a multi-asset investment platform with more than 2000 assets, including stocks, ETF’s, indices, commodities and cryptoassets. eToro offers over 14 cryptoassets to invest. By investing in their CryptoPortfolio, investors can benefit from the accumulated growth of Bitcoin, Ethereum, XRP, Litecoin and other leading cryptocurrencies. eToro users can connect with, learn from, copy or get copied by other users. All in all, it is an excellent P2P Bitcoin trading platform.

Payment Methods

Credit Card, Debit Card, Wire Transfer, PayPal, Skrill, Neteller, Yandex, WebMoney, MoneyGram

Top Coins

ADA BTC XLM XRP LTC

Kraken

Kraken is a US-based exchange that offers trading in US dollars, Canadian dollars, Euros, British pounds, and Japanese yen. They pay special attention to their security with a track record of 0 breaches. Kraken also has an extensive list of crypto assets and covers over 70 of them.

  • Low fees
  • 6 different fiat currencies
  • 100+ cryptocurrencies

Kraken is a US-based exchange that offers trading in US dollars, Canadian dollars, Euros, British pounds, and Japanese yen. They pay special attention to their security with a track record of 0 breaches. Kraken also has an extensive list of crypto assets and covers over 70 of them.

Crypto.com

Offering both centralized and decentralized services through its exchange and DeFi wallet, Crypto.com is one of the best platforms in the market. Liquidity? Check — Global Reach? — Check, Wide Crypto Selection? — Check. NFTs? — Check.

  • Low Fees
  • FDIC insured fiat balances
  • 150+ cryptocurrencies &10M+ registered users

Offering both centralized and decentralized services through its exchange and DeFi wallet, Crypto.com is one of the best platforms in the market. Liquidity? Check — Global Reach? — Check, Wide Crypto Selection? — Check. NFTs? — Check.

Final Thoughts

Let’s take a moment to look at something critically.

A Venezuelan works hard their whole life and amasses enough savings to set them for retirement only to end up in a situation where the currency is worthless.

Another Venezuelan with a similar range of savings has enough Bitcoin stored in their wallet to ride out the storm.

Same country, same timeline, both ruined by the mistakes of others. But one is insulated by a futuristic investment decision.

How much value do you place on the right information? Our research gives you the right insights to enable you to make the best investment decisions to avoid catch 22 situations.

Food for thought.

FAQ

How do Bitcoin exchanges make money?

Bitcoin exchanges have various revenue streams: Deposit Fees, Withdrawal Fees, Trading Commissions, Listing Fees, and Market Making.

What is the biggest Bitcoin exchange?

Binance is the world’s largest BTC currency exchange as measured by Bitcoin exchange volumes. On March 1, 2022, the platform moved $18.5 billion worth of cryptocurrency.

Can you lose money trading Bitcoin?

Yes, you can.
There are four ways you could lose your money:

  1. Cryptocurrency is volatile, meaning value can drop instantly.
  2. You could also lose money by investing through illegitimate exchanges.
  3. Centralized exchanges store data in one pool, meaning your account could be hacked and your money stolen.
  4. Making transfers to the wrong address. Bitcoin chargebacks are not possible.
Where can I buy cryptocurrency with USD?

Bitcoin prices vary on different exchanges.
Although this list is not exhaustive, some of the best USD to Bitcoin exchanges include Coinbase, Binance, Kraken, Luno, and Coinmama. They also allow you to convert USD to Bitcoin.

How do cryptocurrency exchanges work?

There are three types of cryptocurrency exchanges that operate differently.

Centralized exchanges

Users register and are matched to buyers and sellers. The exchange is the middleman that exists to establish trust.

Decentralized exchanges

No intermediary is involved. Buyers are linked to sellers through self-executing agreements written in code known as smart contracts.

Hybrid Exchanges

They combine the positive features of centralized and decentralized exchanges — the privacy and security of decentralized Bitcoin exchange markets and the liquidity and usability of central exchanges.

Why do Bitcoin exchanges have different prices?

The price variations exist because the markets are not truly efficient.

There are four main reasons for the Bitcoin price difference between exchanges.

  • Liquidity variations
  • Lack of an industry pricing standard
  • An industry infrastructure problem
  • Inefficiency in moving money across exchanges

To be on the safe side, read our ‘How do Bitcoin exchanges work’ explanation and make sure you understand it. Also, make a Bitcoin exchange fee comparison before you embark on trades.

When can I trade bitcoin?

Cryptocurrency trading hours are not limited. You can trade crypto 24 hours a day.

ABOUT AUTHOR

I’m a Kenyan journalist and professional writer. I move words around creatively enough to make you reread a piece. In my home office, you will find a quill and a bottle of ink. That’s how seriously I take this craft. Indulge me.

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