What Is a Bitcoin Exchange?

A bitcoin exchange is a digital marketplace where traders can buy and sell bitcoins using different fiat currencies or altcoins. A bitcoin currency exchange is an online platform that acts as an intermediary between buyers and sellers of the cryptocurrency.

The currency ticker used for bitcoin is either BTC or XBT.

Understanding Bitcoin Exchange

Bitcoin 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 they are buying or selling.

To transact in bitcoin on an exchange, a user has to register with the exchange and go through a series of verification processes to authenticate their identity. Once the authentication is successful, an account is opened for the user who then has to transfer funds into this account before they can buy coins.

Key Takeaways

  • A bitcoin exchange acts as the intermediary between a buyer and seller or, to use cryptocurrency language, between a "maker" and a "taker."
  • A bitcoin exchange works like a brokerage, and you can deposit money via bank transfer, wire, and other common means of deposit. However, you will often pay a price for this service.
  • If a trader wants to trade between cryptocurrencies, they will pay a currency conversion fee, similar to institutional banks when you trade money from different countries.
  • Purchases and sales are based on the same ordering system as existing brokerages, where a buyer (taker) places a limit order which is then sold when a corresponding cryptocurrency is available from the seller (maker).

Different exchanges have different payment methods that can be used for depositing funds including bank wires, direct bank transfers, credit or debit cards, bank drafts, money orders, and even gift cards. A trader who would like to withdraw money from his or her account could do so using the options provided by his exchange which could include a bank transfer, PayPal transfer, check mailing, cash delivery, bank wire, or credit card transfer.

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.

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 bitcoin 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.

Foreign exchange spreads are important measures when transacting in bitcoin and vary depending on how liquid the bitcoin exchange is.

Note that a bitcoin exchange is different from a bitcoin wallet. While the former offers a platform through which bitcoin buyers and sellers can transact with each other, the latter is simply a digital storage service for bitcoin holders to store their coins securely. To be more technical, bitcoin wallets store private keys which are used to authorize transactions and access the bitcoin address of a user. Most bitcoin exchanges provide bitcoin wallets for their users, but may charge a fee for this service.

Online bitcoin marketplaces usually designate bitcoin participants as either makers or takers. When a buyer or seller places a limit order, the exchange places 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 bitcoin 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.

Example of a Bitcoin Exchange

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 their 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, the trader's order will be filled with 5 coins @ $2265.75 and the remaining 5 @ $2269.55.

However, a trader who thinks that they can get bitcoins for a better price could set a limit order for, say, $2260.10. If a seller matches their ask price with this order or sets a price below this figure, the buyer will get filled. All of this is done by the exchange, which takes a percentage of each transaction for their business.