Cryptocurrency exchanges are platforms for buying and selling cryptocurrency. A cryptocurrency “exchange” is similar to a stock “exchange.” An exchange is simply a place to buy and sell an asset. You can think of it as a marketplace.

There are two types of cryptocurrency exchanges: centralized exchanges and decentralized exchanges.

A centralized exchange is a business through which individuals or institutions can buy cryptocurrency using traditional currencies. Coinbase is one of the most popular cryptocurrency exchanges that focuses on U.S. residents. It is a centralized exchange. Coinbase is also now a publicly traded company. The defining feature of a centralized exchange is that the exchange has custody over the cryptocurrency that is held on the exchange. Custody means that the exchange owns the cryptocurrency on the user’s behalf. The exchange is the custodian of the cryptocurrency until the cryptocurrency is transferred to a digital wallet outside of the exchange. A centralized exchange stores your cryptocurrency on your behalf. Coinbase refers to this as their Hosted Cryptocurrency Wallet Service, which they offer free of charge.

Centralized exchanges allow you to buy cryptocurrency with fiat currency (like the U.S. dollar). Centralized exchanges available to U.S. residents include Coinbase, Kraken, and Gemini. You will need to create an exchange account and then connect it to a payment option. Kraken and Coinbase were founded in 2011 and 2012, respectively. Kraken is based in San Francisco and Coinbase now considers itself a remote-first company that reflects the decentralized vision of cryptocurrency. Kraken is owned by Payward, Inc. Kraken has the largest EUR market share.

Centralized exchanges are a good place to start for buying cryptocurrency with traditional currencies.

There are transaction costs associated with exchanges. Coinbase charges a spread and a fee for transactions. The spread is about 0.50% for cryptocurrency purchases and sales and the fee for large transactions is 1.49%. This equals a transaction cost of about 2% for purchases from a U.S. bank account. The transaction cost is about 4% when using a debit card.

A decentralized exchange (DEX) is a peer-to-peer exchange that connects buyers and sellers directly. It is an open marketplace for buying and selling cryptocurrency. Uniswap is an example of a decentralized exchange. The defining feature of a decentralized exchange is that it does not function as a custodian of the cryptocurrency. The users of the decentralized exchange trade the cryptocurrency directly with one another (peer-to-peer), thereby maintaining custody of their own cryptocurrency. This allows the user of the decentralized exchange to maintain control of the cryptocurrency rather than delegating that control to a centralized company. Decentralized exchanges are an extension of the vision behind cryptocurrency because they do not rely on trusted third parties. Just as cryptocurrency does not rely on banks, decentralized exchanges do not rely on a market maker. A decentralized exchange is simply code that matches buyers and sellers. It is a trading protocol with a clear and well-defined set of rules for executing transactions. This code is an example of a smart contract.

Local financial regulations apply to centralized exchanges. For instance, U.S. financial regulations require users of Coinbase to verify their identity. This helps prevent the creation of a Coinbase account using a fake identity. Any money transfers in the U.S. are subject to Know Your Customer (KYC) compliance regulations.

If you have heard about Bitcoin being “hacked,” it is likely stories about centralized exchanges that were subject to a cyber attack. Mt. Gox in Japan is a historical example of this. However, it is important to understand this Bitcoin was hackable because Mt. Gox was the custodian storing the private keys on behalf of the owners. Once the private keys are known, all the Bitcoin can be removed from the wallets. To prevent this form of hacking, many are now recommending decentralized exchanges. On a decentralized exchange, the traders retain their private keys and simply transact on the exchange.

Decentralized exchanges are mostly used for trading one cryptocurrency for another. Transactions that are crypto-to-crypto (e.g., buying ETH with BTC) do not involve a traditional currency and are therefore less geographically constrained. This is a swap of one crypto for another crypto.

A digital wallet is required for using a decentralized exchange.

Every exchange charges a transaction fee. For instance, Coinbase adds a spread (i.e., margin) to the market exchange rate on Coinbase’s trading platform, Coinbase Pro. The Coinbase spread is about one-half of one percent (0.50%) for cryptocurrency purchases and cryptocurrency sales.