How do we actually buy and sell, and trade crypto?

We do it on an exchange.

How are the prices of cryptocurrencies determined?

Markets are price discovery mechanisms. Exchanges access markets where buys, sells and trades are made to determine an asset’s price.

Crypto exchanges trade 24/7 every day, unlike stock exchanges which run during working hours Monday-Friday and are closed on weekends and holidays. There are two main kinds of exchanges for crypto: centralized and decentralized.

Order matching, the ability to match buyers with sellers, is a crucial difference between CEX and DEX.

Centralized exchanges (CEXs) are easy to use and come with an attached wallet to store your assets. A CEX is operated by a company that owns it in a centralized way. CEXs offer enhanced liquidity, the ability to exchange one currency for another in a speedy and low-cost manner through deploying their capital and assets, and market makers that have order books and actively trade.

Decentralized exchanges (DEXs) work with no human intermediaries. Some DEXs are governed by a decentralized autonomous organization (DAO) where the holders of the DAO coin vote on decisions relative to the running of the DEX. DEXs trade with a programmed protocol based on functionality programmed on the blockchain in smart contracts.

Order matching liquidity in a DEX is achieved through a liquidity pool that balances out buy and sell orders. A liquidity pool is a bundle of cryptocurrency assets that are held in a smart contract and can be used for exchanges. Investors lend their crypto to the pool in exchange for a portion of the transaction fees generated by the trading. The underlying smart contract will deliver a “liquidity pool token” representing the liquidity provider’s stake when they add their tokens to the pool. They also get a cut of the fees paid by traders who utilize the pool, which is proportional to the value of the liquidity they have risked.

DeFi and Regulation

Without identification checks, converting traditional money into tokens is often challenging. Most firms that trade dollars for ether or bitcoin do “know your customer” checks. (KYC) checks intended to deter money laundering (AML) anti-money laundering. Yet the fact that anyone can quickly move tokens around once in the on-chain world has raised legitimate fears about how criminals will use DeFi to launder and move dirty money.

Regulatory Uncertainty and Risk

Financial intermediaries are expected to be on the alert for questionable transactions by regulators, but DeFi rejects this responsibility. In America, for example, the attempt to add a seemingly minor provision to regulate the business in an infrastructure bill was ill-received by the DeFi movement. Fierce opposition to regulation adds to the sense that it is working against the public interest. It may enhance regulators’ determination to stifle flows into the on-chain world.

CEX

Centralized exchanges are the easiest to use because their user interfaces are familiar and easy to use.

Popular Centralized Exchanges

Binance: Binance was founded by Changpeng Zhao, known as CZ, a developer who had previously created high-frequency trading software for stock traders.

Coinbase: Brian Armstrong is the founder and CEO. Bilaji Srinivasan is the former CTO and one of the smartest people you will ever meet (check out his two podcast episodes with Tim Ferris for a mind-expanding experience). Coinbase is a Public company.

FTX: Sam Baack Fried is the founder and CEO. FTX specializes in derivatives and leveraged products.

Gemini: Cameron and Tyler, the Winklevoss twins, own Gemini. The company’s name is the Zodiac sign of the twins. They are world-class athletes and best known for accepting a $65 million settlement of a lawsuit against Mark Zuckerberg over Facebook.

The founders and CEOs of these four CEXs are all billionaire personalities in the crypto world.

DEX

Decentralized exchanges, or DEXs, operate decentralized or without any interference from third-party control. This form of exchange allows users to conduct peer-to-peer transactions or trade cryptocurrencies with others without entrusting their cash to a third-party custodian or intermediary.

DEXs use AMMs automated market makers to remove some frictions from trading. An automated market maker (AMM) is a process that enables automated trading to offer liquidity to the exchange in which it operates.

What Is an AMM?

AMM systems took off after Shearson Lehman Brothers and ATD first implemented them in the early 1990s. Before their invention, order books were managed by humans who manually initiated trades meant to enhance the market’s liquidity.

This strategy contributed to some market slippage and slowness in price discovery. Market makers have also been accused of market manipulation. When they were first launched, AMMs remedied all of the problems that human market makers had produced. These systems are now being used in blockchain-based decentralized exchanges.

The traditional order book is replaced on AMM-based decentralized exchanges by liquidity pools that are funded on-chain for both assets of the trading pair. Investors contribute liquidity by staking their coins, and they receive passive income on their deposits via trading fees based on the percentage of the liquidity pool they offer.

One decentralized exchange that has implemented an AMM is Uniswap. Uniswap is an Ethereum-based decentralized exchange that allows users to supply liquidity to earn passive income or exchange between various assets.

A big difference from CEX and important to sophisticated users, DEXs allow users to retain control of their wallet’s private keys. Here are some of the biggest decentralized exchange cryptocurrencies.

SushiSwap (SUSHI)

Sushiswap seeks to broaden the AMM and introduce unique features not previously seen on Uniswap. It launched in September 2020. Its native coin is used to compensate users for their share of the network’s fees for transactions that take place in its liquidity pool.

Curve DAO Token (CRV)

Launched in January 2020, Curve is a decentralized exchange for stablecoins that use the AMM to manage liquidity. In addition, it launched a DAO (decentralized autonomous organization) that has CRV as its in-house token.

Loopring (LRC)

It is an open protocol for developing decentralized crypto exchanges that was launched in August 2017. Loopring’s stated purpose is to bring the finest of both centralized and decentralized exchanges together.

PancakeSwap (CAKE)

It is a DEX for swapping BEP20 tokens on Binance Smart Chain that was launched in September 2020. Users of PancakeSwap trade against a liquidity pool using an AMM model. Users that put money into the pool receive LP (liquidity provider) tokens in exchange.

Stellar (XLM)

Stellar allows money to be transported and stored, and it was launched in 2014. Its original purpose was to increase financial inclusion, but today its top priority is to help financial firms communicate with one another via blockchain technology. In addition, its native token helps to make the trading of assets less expensive.

Uniswap (UNI)

Uniswap, launched in November 2018, allows for automatic DeFi token trading. Uniswap’s goal is to make token trading automated and completely open to all token holders. Uniswap’s governance token was intended to cement Uniswap as a publicly-owned and self-sustaining infrastructure while carefully protecting its autonomous properties, according to the company.

Summary

Exchanges are the on-ramp to crypto investing and trading. Check out their websites and explore their features and functionality. Don’t forget your water wings if you decide to dive into a liquidity pool!

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