You can think of a crypto exchange as a place to trade crypto, and a bitcoin wallet as the place to “store” crypto. But how a crypto wallet works is a little more complicated.
How a cryptocurrency wallet works
Crypto is both digital and decentralized. It is stored on a blockchain. This is a distributed network that hosts most cryptocurrency types. Crypto wallets allow you to transact and access your crypto via the blockchain.
The wallet software generates pairs, one public and one privately, that allow you send and receive crypto and to manage it.
You can either set up a hot wallet, which stores your money on a computer or another internet-connected device, or a cold wallet that is stored on a piece of hardware, such as a flash disk.
Although most wallets now support multiple types of crypto, not all wallets have the ability to do so.
How wallets and crypto exchanges work together
It is the most secure way to manage your crypto. However, this can limit your options and make your crypto less secure.
Most exchanges do not have insurance and are therefore not subject to regulation. Your crypto could be lost if the exchange goes under, as they did recently in Australia, in October and December 2021.
Setting up your own cryptocurrency wallet is a better option for those looking for more security. While it can be more complex to set up a wallet, for some investors the additional peace of mind is well worth the effort.
What are the Different Crypto Exchanges
There are three types: decentralized and centralized digital currency exchanges. Here are the details:
These exchanges are managed by a third party, who helps to conduct transactions and ensure they go as planned — much like a brokerage.
This may seem strange since one of the founding principles behind cryptocurrencies is their decentralization. It means that they don’t have to be issued or regulated or controlled by any central authority. A centralized cryptocurrency exchange makes it possible to purchase your intended crypto with regular money.
There is a potential risk in some centralized exchanges. These exchanges are more susceptible to attack because they are owned by one entity.
A decentralized cryptocurrency exchange (or DEX), operates without the use of third-party centralized exchanges. Because they are open source, decentralized exchanges can be considered closer to the spirit cryptocurrency world. They rely on peer-to peer trading.
The theory is that a decentralized cryptocurrency exchange would be safer than a centrally managed one. The lack of a central entity or server that can be hacked might make it more difficult to steal cryptocurrency. In a DEX, your transaction fees might be lower and might take longer to process.
The DEX may have some limitations compared to their central counterparts. Because a DEX is not able to make easy transactions from debit cards or bank accounts, you might need to be more tech-savvy to buy crypto.
Some DEXs don’t allow fiat currency change. Your only options are to trade one cryptocurrency against another. You don’t have any insurance on your funds and no one to contact if you have a problem with customer service.
Hybrid Cryptocurrency and Exchanges
Hybrid cryptocurrency platforms are an attempt at combining the best aspects of both central and decentralized exchanges into one. The goal of hybrid cryptocurrency exchanges is to provide end users with the convenience of a centralized and decentralized exchange but also the security and freedom that comes with a decentralized exchange.
While hybrid exchanges may not have the same level of adoption as centralized ones, they might be helping to create a middle ground for consumers and crypto enthusiasts.