A cryptocurrency exchange is a digital marketplace where traders can buy and sell digital currencies using different fiat currencies or other digital currencies. An exchange acts as an intermediary between buyers and sellers of the cryptocurrency.
All currencies are identified on the exchange with their currency ticker. The currency ticker used for bitcoin is either BTC or XBT.
Exchange platforms match buyers with sellers. Like a traditional stock exchange, traders can opt to buy and sell bitcoin by inputting either a market order or a limit order. When a market order is selected, the trader is authorizing the exchange to trade his coins for the best available price in the online marketplace. With a limit order set, the trader directs the exchange to trade coins for a price below the current ask or above the current bid, depending on whether s/he is buying or selling.
For example, on a bitcoin exchange, three coin sellers are asking for BTC/USD 2265.75, BTC/USD 2269.55, and BTC/USD 2270.00. A trader who initiates a market order to buy bitcoins will have his order filled at the best ask price of $2265.75. If only five bitcoins are available for the best ask and 10 coins are available for $2269.55, and the trader wants to buy 10 at market, his order will be filled with 5 coins @ $2265.75 and the remaining 5 @ $2269.55. However, a trader who thinks that he can get bitcoins for a better price could set a limit order for, say, $2260.10. If a seller matches his/her ask price with this order or sets a price below this figure, the buyer will get filled.
Online marketplaces usually designate exchange participants as either makers or takers. When a buyer or seller places a limit order, the exchange adds it to its order book until the price is matched by another trader on the opposite end of the transaction. When the price is matched, the buyer or seller who set the limit price is referred to as a maker. A taker is a trader who places a market order that immediately gets filled.
All exchanges have transaction fees that are applied to each completed buy and sell order carried out within the exchange. The fee rate is dependent on the volume of bitcoin transactions that is conducted. For example, bitcoin exchange Poloniex has its rate ranging from 0 to 0.25%, GDAX fees range from 0 to 0.30%, Kraken’s fees range from 0 to 0.36%, and Paxful charges 1% of the amount of a sale to the seller but buyers don’t get charged.
To transact in an exchange, a user has to register with the exchange and may have to go through a series of verification processes to authenticate his or her identity. Once the authentication is successful, an account is opened for the user who then has to transfer funds into this account before buying coins.
Different exchanges have different payment methods that can be used for depositing funds including bank wires, direct bank transfers, credit or debit cards, etc. Similar options are provided to trader who would like to withdraw money from his or her account. You can also fund your account using cryptocurrencies.
Making deposits and withdrawals come at a price, depending on the payment method chosen to transfer funds. The higher the risk of a chargeback from a payment medium, the higher the fee. Making a bank draft or wiring money to the exchange has a lesser risk of a chargeback compared to funding your account with PayPal or a credit/debit card where the funds being transferred can be reversed and returned to the user upon his/her request to the bank. Cryptocurrency deposits are usually free of charge whereas there is a nominal fee on withdrawals as compared to other methods.
In addition to transaction fees and funds transfer fees, traders may also be subject to currency conversion fees, depending on the currencies that are accepted by the exchange. If a user transfers Canadian dollars to an exchange that only deals in US dollars, the bank or the exchange will convert the CAD to USD for a fee. Transacting with an exchange that accepts your local currency is the best way to avoid the FX fee.
Note that a cryptocurrency exchange is different from a cryptocurrency wallet. While the former offers a platform through which buyers and sellers can transact with each other, the latter is simply a digital storage service for digital coin holders to store their coins securely. Most exchanges provide wallets for their users and may charge a fee for this service.