What is a crypto exchange?

A crypto exchange is a marketplace where people buy, sell and swap cryptocurrencies. Some exchanges are companies that hold customers' money and coins. Others are software running on a blockchain that lets users trade directly from their own wallets.

How does a centralized exchange work?

A centralized exchange is run by a company. Coinbase, Kraken and Binance are well-known examples. Customers open an account, pass an identity check called KYC and deposit money or coins.

Trading runs through an order book, a live list of the prices at which people are offering to buy (bids) and to sell (asks). The exchange's software matches a buyer with a seller when their prices meet. The gap between the highest bid and the lowest ask is called the spread.

Trades are recorded in the company's own database, not on a blockchain. Only deposits and withdrawals touch the blockchain itself. The exchange makes money mainly from fees on each trade.

What is a decentralized exchange?

A decentralized exchange, or DEX, has no company in the middle. It is a set of smart contracts, programs that run on a blockchain. Users connect a wallet and swap tokens against a shared pool of funds, with no account and usually no ID check.

Users keep control of their coins until the moment of the swap. The trade-offs are different ones: bugs in the code, fake tokens that anyone can list, and no customer service desk when something goes wrong.

Who holds your coins?

On a centralized exchange, the company holds the private keys that control the coins. The balance on screen is a claim on the company, much like a balance at a broker. This is called a custodial arrangement. It is convenient, but the customer depends on the company's honesty, security and solvency. The guide to exchanges and wallets sets out the difference.

What happens if an exchange fails?

When an exchange is hacked or runs out of money, it typically freezes withdrawals. If it enters bankruptcy, customers can become creditors who wait in line with everyone else the company owes. Mt. Gox, once the largest bitcoin exchange, filed for bankruptcy in February 2014 after losing customers' coins. FTX collapsed in November 2022 after misusing customer funds. In both cases customers waited years for repayment.

The safety nets of banking do not apply. The Federal Deposit Insurance Corporation has said US deposit insurance does not cover crypto assets or the failure of a crypto company. The Securities and Exchange Commission's investor education office has warned that the protections attached to brokerage accounts do not extend to accounts at crypto firms.

Some exchanges publish "proof of reserves" reports to show they hold the coins they owe. Critics note that such reports often show assets without a full picture of the company's debts.