How cryptocurrency exchanges work
Key takeaways
04 · ideas- Centralized exchanges hold your crypto on your behalf (custodial)
- Decentralized exchanges run on smart contracts with no company custody
- Maker-taker fee structures are the most common pricing model
- Exchange insolvency has historically meant potential loss of user funds
Basic level
The essentials · 1 min
A cryptocurrency exchange is a platform where buyers and sellers of crypto assets are matched.
Centralized exchanges (CEX): A company operates the platform. Users deposit funds and the exchange holds them. Trades happen in the exchange's internal ledger. The exchange takes custody of user assets.
Decentralized exchanges (DEX): Smart contracts on a blockchain match trades automatically. No company holds your funds. Users retain control of their private keys throughout.
Custody difference: When you hold crypto on a centralized exchange, you hold a claim against the exchange rather than the crypto directly. The phrase common in crypto communities — "not your keys, not your coins" — reflects this distinction.
Intermediate level
How it applies · 2 min
How prices are set
Order book model (most CEX): Buyers submit bids and sellers submit asks. The exchange matches compatible orders. The difference between the best bid and ask is the spread.
Automated market maker (AMM, most DEX): Liquidity providers deposit paired assets into a pool. Prices are set algorithmically by the ratio of assets. Trades execute against the pool.
Maker-taker fees: On order book exchanges, makers (who place limit orders) typically pay lower fees (0-0.1%) than takers (who place market orders, 0.1-0.5%).
Exchange risk
If a centralized exchange becomes insolvent, is hacked, or commits fraud, recovery depends on the exchange's insurance, reserves, and applicable legal frameworks — none of which are standardized. Self-custody in a hardware wallet eliminates exchange counterparty risk but introduces the risk of losing access to the private keys.
Advanced level
The math, step by step · 1 min
Market microstructure
Crypto markets are fragmented across hundreds of exchanges globally. Price discovery happens simultaneously across venues, with arbitrageurs keeping prices aligned.
Slippage occurs when a large order moves the market price during execution. Impact varies by order size relative to available liquidity in the order book.
Wash trading (a trader buying from and selling to themselves) has been documented at various exchanges, creating artificial volume figures. Third-party data providers attempt to identify suspected wash trading, and verified volume is typically lower than total reported volume on some platforms.