How to Choose a Crypto Exchange

20 Jul 2021

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NGRAVE The first end-to-end security solution to manage your crypto.

How to Choose a Crypto Exchange

A cryptocurrency exchange is an online marketplace for buying, selling and exchanging cryptocurrency. Unfortunately, there is no one-size-fits-all approach to how a crypto exchange provides those three fundamental functions.

  • Article Quick Links:
  • The five main types of crypto exchange
  • The Simple Conversion Style Crypto Exchange
  • The Trading Style Crypto Exchange
  • The Decentralised Exchange
  • Peer-to-Peer Exchange (P2P)
  • Over The Counter Exchange (OTC)
  • Exchange Specific Criteria
  • Great overview, but how do I explain it to a friend?

There are actually five broad types, which can make choosing the right crypto exchange quite a bewildering experience. So our challenge is to describe the main selling points of each type, based on key criteria. That way you can decide which is the most suitable approach, based on where you are now in your crypto journey, as well as your future ambitions; then choose from brands that offer that style of crypto exchange.

The five main types of crypto exchange

Picking from a list of five types of crypto exchange might bring back bad memories of multiple choice exams; don’t worry, each exchange type is targeted at a specific type of user, which should make it easier for you to decide what makes sense for you.

The table below is intended to give some high level context. Don’t worry, we’ll drill down into the specifics of each type, and what the difference between centralised and decentralised means. Key terms have links to our glossary so you can understand what they mean.

The Simple Conversion Style Crypto Exchange

Taking the plunge and buying crypto is scary to newcomers, so it isn’t surprising that most will take the path of least resistance. This invariably means using an exchange that offers a simple conversion approach.

This approach is as straight-forward as using a foreign exchange service at an airport to exchange. If you want to exchange €100 Euros for an equivalent amount of Dollars you’ll be quoted a EUR/USD exchange rate - normally displayed on a digital board - and a small commission charged by the Forex Service.

If you want to go ahead you choose from the available payment methods to fund the purchase (bank card, Apple Pay etc) in exchange for the quoted amount of dollars, and within minutes you can head off to duty free - dollars in hand.

By taking this conversion style approach, buying, selling or exchanging crypto can be just as simple, minus the cheap vodka. To buy €100 of bitcoin would requires just a few inputs into an online widget, then clicking a button to proceed:

  • What currency you want to spend e.g Euros
  • How much you want to spend e.g €100
  • How are you going to pay e.g your bank card
  • Which cryptocurrency you want to buy e.g Bitcoin
  • You’ll then see a message like this: €100 will buy you 0.005 Bitcoin - Proceed Yes/No

Just like at the airport, the emphasis here is on simplicity and convenience. It is the fastest way to purchase cryptocurrency without any fuss, which is why it is the most popular approach for anyone looking to use a cryptocurrency exchange for the first time.

Coinbase, the world’s most popular exchange, uses this simple conversion approach because it understands that the majority of new users prioritise simplicity and speed, though this comes with some pretty significant trade-offs.

Cost

The convenience of the conversion approach comes at a price. Firstly, you are paying an inflated commission of around 0.5% on the amount of crypto purchased - Coinbase makes this fiendishly difficult to understand.

You also pay a transaction fee, which varies depending on the payment method used. If you are paying by card - which is the fastest option - you pay a whopping 3.9%. You can fund a transaction by bank transfer, which is only 1.49% (depending on your location) but that takes more time and hassle.

So for a €100 bitcoin purchase you might end up paying close to €5 in fees. Most newcomers might accept that simply because they are happy to pay for the convenience, and are eager to make their first crypto investment.

Be aware that if you intend to set recurring purchases - known as Cost Averaging, which effectively automates regular purchases for you - those fees quickly mount up.

Flexibility

The quick conversion exchange gives you little flexibility, as it boils down to a, take or leave it’ approach to buying crypto. In the same way that you can’t haggle at the Forex Kiosk, you cannot control what’s called your entry point - the price you buy at - when buying crypto via a widget. That is why Coinbase users can be described as simply buying crypto.

If you want to exercise more control, such as dictating the price you purchase is triggered at, you trade-off the simplicity of the conversion exchange approach to trade crypto.

For that you need to enter a completely different world - the trading style platform - which is the next type we’ll examine.

Security, Custody & KYC

The most important compromise users opting for a quick conversion approach to buying crypto is leaving their bitcoin in their exchange account.

Cryptocurrency is decentralised money, money with no central authority; you are in control. You can read an entire NGRAVE Academy post on what that means, but the TLDR is that buying crypto with regular money (known as fiat money) requires handling that decentralised money in a centralised way.

That compromise comes from the fact that in order to offer you a way of buying crypto via the existing financial system (e.g debit card) you have to follow the rules of that centralised system.

Those rules mean proving your identity to the exchange before being able to buy (also known as KYC) - by submitting a copy of your passport or driver’s license. The world’s largest exchange by volume - Binance - recently changed its policy, requiring all users to pass KYC, so this is the norm.

But decentralised money like bitcoin is intended to be custodied (looked after) by the user. This means controlling something called a Private Key (think of it like a password) in a digital wallet. When you buy crypto from a centralised exchange you not only have to trust them with your identity, but the keys to the crypto you just purchased.

Many newcomers might shrug at that, and prefer the exchange to hold the keys, treating the exchange like a regular bank. This is personal choice, but the reason crypto exists is because of the dangers of centralised money, in which case a centralised exchange can be regarded as a necessary evil, providing an essential ‘on ramp’ to the new money world of crypto.

The exchange controls your keys, but you still have to secure your account, using features like two factor authentication, biometrics and email passcodes.

Once you’ve made your purchase, you can take full control of your crypto and Private Keys, moving them from the exchange to something called a crypto hardware wallet, which is what we at NGRAVE make.

The Trading Style Crypto Exchange

The conversion approach we’ve just discussed is the ideal way for beginners to buy crypto, because of the convenience, but comes at the expense of control, cost and custody. If you don’t just want to buy in a take-it-or-leave-it way, but trade crypto with control and flexibility, you need to use a trading style crypto exchange, which comes with a lot more whistles and bells.

Complexity

A lot of reviews of crypto exchanges miss the key distinction between the conversion approach and the trading approach. If you have a background in trading stocks/shares, using betting exchanges or prediction markets, then a full blown trading crypto exchange will feel fairly familiar, but as a newbie landing on an exchange designed for trading is like landing on Mars.

Flexibility

The widget style spend X, get Y conversion interface is replaced by an intimidating array of price/technical charts, order books, and a variety of methods for dictating the price you want to buy at. This gives you enormous flexibility over when and how you enter the market, at the expense of simplicity. As a trader this is exactly what you need, but as a newbie, it is like taking a first driving lesson on the fast lane of a highway.

Cost

Conversion style platforms make money by acquiring news users, while trading style platforms profit from volume of trade. This is why Coinbase charges expensive flat fees, while trading platforms use a sliding commission structure, which gets cheaper the more you trade. Volume provides efficient markets - reducing the difference in the best price to sell and best price to buy. This is known as the spread, and contributes to the price of trading.

To stay with Coinbase as an example, they are actually two exchanges in one. Most of their marketing goes into promoting Coinbase.com, capturing crypto newbies who want an easy conversion style experience. What they don’t realise is that there is another trading style exchange sitting behind, called Coinbase Pro. That is where their widget style purchase is actually executed.

When you create an account with Coinbase, you automatically get a Coinbase Pro account too, though most users aren’t aware of it. Trading directly on Coinbase Pro is cheaper, whereas on Coinbase, you pay an inflated spread as you effectively outsource your purchase.

As customers become more sophisticated and confident with buying crypto, as well as aware of how they are paying through the nose to trade, they will go straight to the source, and migrate from buying to trading.

In a similar way, many Apps that offer this widget style way of buying crypto - think Paypal, Venmo, Revolut etc - are simply sending the trades to a full-blown exchange to be executed, and adding fees on top. Users are still happy to pay because they want the convenience, can’t be bothered to directly place the trade themselves, and probably don’t realise how the fee structure works.

Security, Custody & KYC

Though using a cryptocurrency exchange with full trading functionality gives you more flexibility and can be more cost-effective with fees, in order to on-ramp customers from the fiat world, this type of exchange is still centralised, and still has custody of your coins.

This also means that KYC is still required and traditional account security remains important and your responsibility.

Though the example of Coinbase has two experiences across two distinct websites, some exchanges offer them under one roof, but labelled as separate views. Binance is a good example of this, calling them Convert and Classic.

There are pros and cons to those approaches. Offering them under one website there is a danger that a newbie struggles to find the simple Convert view among all the other confusing options. Conversely, having the two options within one navigation makes it easier to move to trading, as and when you feel ready.

The Decentralised Exchange

So far we’ve introduced two types of crypto exchange, one focused on providing a simple and convenient way to buy crypto, the other focused on trading crypto through a greater deal of control. Both share the drawback of being centralised, because the user journey starts in the regulated world of fiat money, with the exchange providing an on-ramp to the new decentralised world of crypto. But what if you already have crypto and simply want to exchange it?

At this point we can introduce you to the Decentralised Exchange (DEX). Given the name, it should be pretty obvious that there is no connection to the regulated and centralised banking system. If you bought crypto via either of the options already described you are free to move it to a wallet you control - such as a non-custodial hardware wallet like the NGRAVE XERO - and then connect that to a DEX.

A DEX will offer the option to swap currencies (similar to conversion), familiar trading features, but with the addition of a wider array of services that are focused on generating YIELD rather than just a profit from buying/selling. All of these functions happen via Smart Contracts, rather than systems managed by people. This is the full fat world of decentralisation, as Smart Contracts are agreements written in code and executed on blockchains - such as Ethereum or Solana.

Flexibility

Given that blockchains are distributed across a network, there is nowhere that a DEX can be considered to reside from a regulatory perspective. There is no KYC, no need to establish trust, everything runs on code and transactions are executed on a blockchain. There is also a much greater choice of tradable pairs because the liquidity that fuels two sides of any given market is provided by DEX users and what are known as AMM - Automated Market Makers.

If this all sounds like a nirvana for crypto trading, there are a few DEX drawbacks that might bring you back down to earth.

Cost

Firstly, to execute a Smart Contract you have to pay fees, which essentially covers the execution bandwidth on the underlying blockchain. Those fees on Ethereum - the most popular blockchain with Smart Contract capability - are eye-watering, and despite a recent system update to address the problem, can mean you might pay €100 in GAS fees to execute a similar sized trade.

Clearly, this won’t make economic sense for small fish. There are competing blockchains bringing down costs, but much of the existing DEX development has happened on Ethereum.

Custody, Security & KYC

Though with a DEX you have custody of your coins, and don’t have to provide KYC, the second black mark (after fees) is security. Though Smart Contracts run autonomously, they are written by humans, who are fallible. Unfortunately, a few lines of loose code can lead to massive losses, at which point the decentralised nature of their operation leaves few options for clawing that money back.

DEX are popping up everywhere, especially as more layer 1 chains with Smart Contract capability gain traction. Smaller operations will often repurpose code from elsewhere, which can simply inherit underlying issues. The more credible DEX’s will pay for external Smart Contract audits, which may provide some reassurance, but doesn’t guarantee safety.

Peer-to-Peer Exchange (P2P)

The idea of a marketplace for crypto might bring to mind people physically coming together to agree a price at which to exchange. This is what is happening in all examples so far, but technology anonymises the process through a website interface for speed and convenience.

There are good reasons, however, for the digital exchange to be explicitly one-to-one, which is what happens at a Peer-to-Peer Exchange, where speed, convenience, range of cryptos and cost-effectiveness are sacrificed for greater flexibility over the payment method and trade size.

Flexibility

That flexibility can be exerted on the basis of the following:

  • The rate at which a specific Trader will buy from you or sell to you
  • The maximum/minimum amount the Trader will buy/sell at that rate
  • The payment methods the Trader is willing to accept
  • The Trader’s Trust rating based on previous completed trades

The buying process becomes more like a marketplace negotiation - within the advertised parameters - as you directly message the Trader to confirm the process. The role of the exchange is to act as the mediator and hold the payments (known as escrow) until the buyer is satisfied.

Cost

The Trader makes money by offering a rate - fixed for a specific period of time - which is generally below that available the Spot Price via the conversion approach or a trading exchange. You may also pay fees to deposit or withdraw. The Trader will get charged a commission on the exchange.

Security, Custody & KYC

Users are willing to compromise on price at a P2P exchange in return for the flexibility of payment method. P2P exchanges are growing fastest in the developing world where having a bank account is the exception, not the rule, and peer-to-peer trading is culturally the norm.

P2P are also popular where Conversion/Trading style exchanges are illegal or heavily regulated but the majority still require KYC, custody your coins and require you to secure your account.

Over The Counter Exchange (OTC)

As the name suggests, an Over The Counter Exchange is a much more analogue experience; you can think of it as more of a concierge service for trading crypto. The speed and convenience of the online options for buying/selling/exchanging crypto discussed so far, are replaced by direct discussion with a broker. Apart from the personal touch, what is the benefit?

Flexibility

OTC only makes sense when trading significant amounts where you want the guarantee of executing a purchase, sale or exchange at a specific price. The way the exchanges already introduced work is via order books, where users define how much and at what price they are willing to buy or sell a given cryptocurrency, with the platform automatically matching the demand of buying with selling.

If someone wants to execute a large trade at a specific price, the order book might not be able to support it, so the average price may deviate from what was optimal.

Were a large holder to try and execute a trade on an exchange it would also signal their intention and influence other traders - like showing their hand - and drive the price of purchase up, or sale down to their disadvantage. OTC enables the trade to happen away from the prying eyes of the market, but to enjoy that benefit you naturally have to pay.

Cost

As OTC trading is more of a personalised service the cost of transacting may come down to negotiation, but only becomes cost effective for trades of significant size as there will be both a commission and fee for the service.

Security, Custody & KYC

KYC is a critical part of OTC given the risk of money laundering. Security and custody may come down to your preference as a customer, but given the scale of investment, you should do considerable due diligence on the OTC security before transacting.

Exchange Specific Criteria

Everything introduced so far is aimed at helping you differentiate exchange types. When it comes to picking a specific brand there are range of additional criteria you should use, which might include:

  • Reviews - How do existing users rate their experience?
  • Support - One of the biggest areas of frustration is poor support & delays in response. What do users on Reddit or forums say about support?
  • Localisation - To what degree are you looking for a localised experience in terms of language & payment methods; is your country even supported?
  • Security - How seriously did they treat security? Do they enforce 2FA? Do they have a history of security breaches

It is also important to realise that you don’t have to restrict yourself to using one exchange. Just as you might use several streaming services to get access to the broadest range of content, you can hold accounts with several exchanges to mix and match based on specific criteria, such as the cryptocurrencies they offer.

As you’ll now know, there is a lot to learn about buying, selling and exchanging cryptocurrency, so treat it as a journey. Start slowly, build your knowledge and confidence, and as you become more comfortable, move on to the more sophisticated ways to build your crypto portfolio.

Great overview, but how do I explain it to a friend?

Buying crypto can be scary for beginners, so most prioritise ease of experience. That's understandable, but convenience comes with some pretty significant trade-offs.

If you want to know what they are, and what other users prioritise for buying, selling and exchanging crypto, this article is worth 10 minutes if your time.

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The first end-to-end security solution to manage your crypto.
NGRAVE

NGRAVE is a digital asset security company and the creator of the world’s most secure cryptocurrency wallet, NGRAVE ZERO. NGRAVE ZERO was developed in collaboration with a world-renowned team of cryptography and security experts.