An exchange is a real or virtual marketplace where financial instruments like commodities, securities, and cryptocurrencies are bought and sold.
Marketplaces have been around for as long as people have. A marketplace is also known as an exchange because traders exchange goods there. These days though, an exchange is as likely to have a digital-only presence as a real-world one, because the electronic trading of financial instruments does not necessarily require a physical location.
One of the primary things an exchange does is provide liquidity within a securely organized trading environment. It performs the function of a trusted intermediary, or go-between, providing a forum where traders can buy and sell their assets with confidence.
Exchanges can be grouped under different categories. Classical exchanges are the place for spot trades where settlement is immediate. But other exchanges focus on derivatives trading, dealing in options and futures, and settlement in these scenarios is naturally delayed.
Exchanges can also be grouped in terms of what’s being traded, so think cryptocurrency exchange, stock or securities exchange, commodities exchange, and Forex. Of course, some feature combinations of the above and different trading options too, so it isn’t always easy to draw distinct lines between one exchange and another.
There is a primary stock exchange for each country, and you may have heard of the New York Stock Exchange, the Tokyo Stock Exchange, and the London Stock Exchange. For a company to be eligible for listing on any of these usually requires adherence to strict listing criteria, which may vary between them.
A cryptocurrency exchange fulfills the same sort of function as traditional trading platforms, the only difference being that traders will be exchanging different cryptocurrencies and perhaps fiat currencies too. At the moment, the majority of cryptocurrency exchanges are run by private companies. Some of these are centralized, and they have the advantage of offering traders access to liquidity and ease of use. The downside to a centralized exchange is that it may be more prone to downtime and more vulnerable to cyber-attacks. For this reason, it is advisable to undertake research before committing to a particular exchange.
The alternative is to go with a decentralized exchange or DEX. These platforms cut out the middleman and allow traders to interact directly with each other using a trustless automated environment that runs on smart contracts. The disadvantage with a decentralized exchange is that although its infrastructure is more robust and less susceptible to cyber-attacks and downtime, it won’t provide fiat currency services. This might help to explain why trading volume in a decentralized exchange tends to be a lot lower, another factor that you need to consider before committing to one.