What investors need to know

Unlike stocks or bonds, most traditional investment brokers do not yet offer exposure to crypto for trading purposes. Therefore, crypto exchanges were developed as an easy way for investors to buy digital assets. Although the majority of these exchanges have similar offerings, such as spot markets for tokens such as bitcoin and ether, there is wide variation based on the amount of tokens offered, other services available, and security. Additionally, while some use traditional centralized corporate structures, others embrace the industry’s decentralized ethos by avoiding the appearance of having any specific people in charge.

Centralized exchanges

Binance, Coinbase and Kraken are good examples of centralized exchanges. Newbie investors tend to flock to these options because they offer 1) customer support, 2) the ability to fix bugs or hacks, and 3) a level of investor protection that decentralized exchanges simply cannot. For example, each of these platforms has a team that checks tokens for listing to ensure they are secure and not fraudulent (although these decisions are not always unanimous). Decentralized exchanges do not display listings. Many of the services offered by these organizations mirror those offered at traditional financial exchanges and brokers.

Exchange fees

Centralized exchanges generate a large portion of their revenue from the fees they charge to carry out transactions such as trading and withdrawals. It is important to note that fees can vary widely between exchanges, and prices go down for large and frequent users. With the cost of trading stocks, especially on traditional exchanges, averaging close to 0%, the fees charged by some crypto exchanges may come as a surprise. For investors placing orders up to $10,000, for example, fees can average 0.5%.

Account financing

To trade, first-time investors must move fiat currency to an exchange. This action is called funding an account and is similar to the approaches of traditional brokerages. Common ways to fund these accounts include 1) credit cards, 2) debit cards, 3) wire transfers, and 4) wire transfers.

Risk and coverage

There have been many cases of hacks and breaches that have occurred on crypto exchanges, including thefts at Binance ($40 million), Crypto.com ($34 million), BitMart ($150 million), AscendEX ($80 million) and IRA Financial Trust ($37) million). This is in addition to the multi-billion dollar flames of exchanges such as FTX and Voyager or lending companies such as CelsiusCEL
and BlockFi which offered some brokerage services.

To make matters worse, the vast majority of crypto investments are not covered by insurance policies that protect traditional financial products such as securities and bank deposits. An additional thing for investors to keep in mind is that crypto exchanges, even those that offer insurance, typically do not refund users whose accounts are hacked due to poor password protection, phishing links, or similar actions that are considered user error.

Decentralized exchanges

Decentralized exchanges (DEX) have grown rapidly in popularity since their launch in 2018. Some of the most prominent names include Uniswap, AAVEAAVE
Curve, PancakeSwapCAKE
dY/dX, SushiSwap and BalancerCAMPFIRE
. These platforms aim to replicate services on the centralized exchanges (CEX) mentioned above, but without the traditional corporate structure. In this way, the founders behind these platforms and their users tend to lean more towards crypto’s decentralized ethos and are more technologically savvy. For example, DEXs cannot be funded with credit/debit cards or traditional bank accounts. Traders will typically need to acquire crypto on their own and then connect to a wallet, such as MetaMask (software) or a hardware wallet from Trezor and Ledger, to participate.

DEXs tend to list many more tokens than CEXs, as there are no gatekeepers to prevent fraud or duplicates. Users often come to these platforms if they do not have access to a traditional exchange in their home market or if they want to trade esoteric cryptocurrencies. Indeed, unlike the traditional order book model of centralized exchanges (adapted from the likes of the New York Stock Exchange, London Stock Exchange and Nasdaq), DEX uses a liquidity supply process known as an automated market maker (AMM). The details here are beyond the scope of this report, but AMMs have proven adept at providing better liquidity by pooling pools of tokens that can be exchanged with traders.

An additional benefit of using DEXs is that users can receive rewards in the form of native governance tokens such as uni (Uniswap), aave (AAVE) and curv (Curve) for their participation. Apart from being able to trade these tokens, holders also have the right to propose new features and vote on key proposals for their associated platforms, such as whether to launch on a new blockchain (most start on EthereumETH
).

However, DEXs also come with many risks. For example, because they are essentially programs, they are susceptible to hacking or manipulation. Victims often have little option beyond negotiating directly with a hacker to return part of the funds. Additionally, while DEXs profess to be truly decentralized, many may be more centrally organized than they first appear. Forbes has reported that the Securities and Exchange Commission (SEC) has looked into the entire decentralized finance (DeFi) ecosystem, which includes DEXs as well as decentralized lending protocols. It is possible that a regulatory breach could disrupt the functioning of or demand for these platforms even if they cannot be shut down completely.