So you’ve decided to invest in cryptocurrency. Rather than set up an expensive mining rig or join a mining collective to try and guess the correct nonce to win the block reward, you’ve decided instead to purchase it instead. So, how do you actually buy (and sell) cryptocurrency?
Cryptocurrencies and digital assets can be bought in a few different ways, via Centralized Crypto Exchanges, Decentralized Exchanges, and Crypto Brokers.
How you choose to purchase crypto assets depends on your own familiarity with cryptocurrency investing and your comfort level with where your digital keys are kept.
Centralized Crypto Exchanges (CEX)
The most common way to buy cryptocurrencies is through a Centralized Crypto Exchange or CEX. A centralized crypto exchange acts similarly to a stock exchange as an intermediary between buyers and sellers to trade many different types of cryptocurrencies and other digital assets such as NFTs.
Popular crypto exchanges include Coinbase, Crypto.com, Gemini, and Binance. Much like stock trading websites or apps, the exchanges allow cryptocurrency investors to buy and sell digital assets at the prevailing price, called spot, or to leave orders that get executed when the asset gets to the investor’s desired price target, called limit orders.
CEXs operate using an order book system, which means that buy and sell orders are listed and sorted by the intended buy or selling price. The matching engine of the exchange then matches buyers and sellers based on the best executable price given the desired lot size.
Hence, the price for a digital asset will be dependent on the supply and demand of that asset versus another, whether it be fiat currency or cryptocurrency. CEXs decide on which digital asset it will allow trading in, which provides a small measure of comfort that unscrupulous digital assets may be excluded from the CEX.
Centralized crypto exchanges also offer an easy user experience in trading cryptocurrencies and relatively low fees. Almost all exchanges offer their own proprietary trading platforms that provide performance metrics (like stock performance metrics), including charts, graphs, statistics, and news, giving users access to information that can help guide their decision on purchasing cryptocurrency, as well as educational resources which further help guide trading decisions.
Another key role that centralized crypto exchanges play in how individuals purchase digital assets is acting as a fundraiser for Initial Exchange Offerings (IEO). Similar to an Initial Coin Offering (ICO), an IEO helps the thousands of cryptocurrency and blockchain projects attract the investment capital they need to get the project off the ground.
Lastly, one of the other benefits of certain CEXs is the option to leverage your investments using borrowed money from the exchange, called margin trading. It allows investors to reap higher returns, but losses can also be amplified.
While centralized cryptocurrency exchanges have varying degrees of regulatory oversight, most follow compliance rules such as KYC (Know Your Customer), fair pricing, security, and customer protection. In return, the exchange charges fees on transactions, listings, and other trading activities.
When it comes to paying for the cryptocurrency that you’ve successfully purchased, most companies will allow you to fund your account with credit and debit cards, bank transfers, or some other third-party payment channel.
However, some crypto exchanges do not allow users to purchase cryptocurrencies with fiat currency (for example, U.S. dollars) and only allow for the purchase of cryptocurrencies with other cryptocurrencies. Additionally, there are most often costs associated when you want to withdraw your funds from your account with the crypto exchange.
Lastly and most importantly, most CEXs will hold your digital asset as a custodian in their own digital wallet rather than allow you to store your private keys on your own digital wallet. While more convenient when you want to trade, it comes with several drawbacks, such as the risk of the centralized cryptocurrency exchange failing, fraud, and hackers.
Decentralized Exchanges (DEX)
A decentralized exchange is another type of exchange that allows peer-to-peer transactions directly from your digital wallet without going through an intermediary. Examples of DEXs include Uniswap, PancakeSwap, dYdX, and Kyber.
The decentralized exchanges rely on smart contracts or self-executing pieces of code on a blockchain. The smart contracts allow for more privacy and less slippage (another term for transaction costs) than a centralized cryptocurrency exchange. On the other hand, even though smart contracts are rules-based, the lack of an intermediary third party means that the user is left to their own, so DEXs are meant for sophisticated investors.
As decentralized exchanges are non-custodial, meaning that your private keys are held in your own digital wallet, you don’t need to use someone else’s digital wallet; only need to link your digital wallet with the DEX.
DEXs are best for investors looking to switch from one digital asset to another and not well suited for someone looking to buy or sell digital assets with fiat currency, called on and off-ramping. Since DEXs don’t exercise censorship, more cryptocurrencies and digital assets are available than through a CEX. As a matter of fact, many Altcoins are only available on DEXs.
While some decentralized exchanges operate using an order book system, the problem is with the myriad of cryptocurrencies; you might only be able to find liquid prices on some trading pairs. More DEXs are moving to an Automated Market Maker (“AMM”) model to improve liquidity. The model uses a pool of cryptocurrencies that are priced by an algorithm to improve the liquidity in a currency pair.
Another place to buy cryptocurrencies is through a Crypto Broker. Examples of Crypto Brokers are BlockFi, Robinhood, Voyager, and SoFi. Crypto Brokers act similarly to stockbrokers. Crypto Brokers act as intermediaries and allow a buyer to place an order through the broker to buy their desired cryptocurrency. This method allows for a very simple experience in buying cryptocurrency.
However, there may be higher fees associated with using a Crypto Broker than with using a CEX or DEX. Further, it is important to understand how Crypto Brokers earn their fees when you place an order. They can either charge an upfront fee, or they may not charge an upfront fee but sell your trade information to other brokers. The latter can ultimately lead you to paying a higher price for the cryptocurrency, similar to if you were charged a fee upfront; this fee method has been popularized with Robinhood.
It should also be noted that Crypto Brokers may have more restrictions than Crypto Exchanges. For example, some Crypto Brokers may not allow you to take your cryptocurrencies off their platform into a crypto wallet. It may limit the use of the cryptocurrencies you own as it may be difficult to use the cryptocurrencies in decentralized applications if you cannot take them off the Crypto Broker’s platform, for example.
Lastly, much like CEXs, another issue is who is actually holding on to your cryptocurrency and digital assets. Buying through a crypto broker means you trust the broker to be a safe and legitimate custodian for your assets.
Thank you for reading CFI’s guide to How to Buy Cryptocurrency. To keep advancing your career, the additional CFI resources below will be useful: