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Digital Asset Exchange: What Is It & Why They Operate
The crypto ecosystem is vast. From NFTs to coin offerings, investors can buy, hold, and sell a wide range of digital assets. The platforms that enable these transactions are called digital asset exchanges (DAXes). If you’re new to crypto trading, you may have several questions about DAXes, including what they are and how they work. In this guide, we’ll explain the basics of digital asset exchanges, how they operate, and why they’re popular in the crypto universe.
What Is a Digital Asset Exchange?
A digital asset exchange is an online platform that initiates the buying and selling of crypto products. Digital assets can be anything added to a blockchain network and given value, including (but not limited to) crypto assets, stablecoins, or non-fungible tokens (NFTs). Digital asset exchanges facilitate transactions with these assets and can be bucketed into two main categories: centralized and decentralized exchanges.
Centralized exchanges (CEX)
Centralized exchanges (like Coinbase, Kraken, or Binance) are owned and operated by a single entity. In a CEX, traders store their digital assets in wallets that the exchange controls. Users buy and sell orders, and the exchange’s order-matching engine pairs them. CEXs offer several benefits to investors. First, they support a wide range of cryptocurrencies, allowing any investor to conveniently diversify their portfolio. These exchanges also have high liquidity and user-friendly features for beginner and experienced traders alike.CEXs also provide proof of reserves (PoR), which verifies that the exchange has enough liquidity versus stored assets — giving traders added peace of mind.
Decentralized exchanges (DEX)
As you may have guessed, decentralized exchanges are not owned by any single entity. Rather, they facilitate peer-to-peer asset trading directly between users — there’s no intermediary or central authority. Unlike CEXs, traders keep control of their funds and don’t have to entrust their assets to a single entity.DEXs typically use smart contracts to automate the trading process. Since no single person or organization controls a decentralized digital asset, they offer near-unlimited freedom for crypto investors.Decentralized cryptocurrency exchanges were designed to address many of the challenges associated with CEXs (security vulnerabilities, mandatory KYC verifications, complex account management, and control over private keys), but can be less beginner-friendly. Typically, experienced traders flock to DEXs because of their advanced security and open-source atmosphere.
Benefits of digital asset exchanges
Digital asset exchanges are critical in facilitating the buying and selling of crypto assets. They provide traders with some significant benefits, including:
Convenience
DAXes make it easy to buy, sell, and trade digital assets. Users can typically do this with just a few clicks. In fact, if you’re using a centralized DAX, you can use a beginner-friendly user interface to make convenient trades.Digital asset exchanges also offer a simplistic fiat on/off ramp. This is simply the process of exchanging digital currency for fiat currency. The easier it is to navigate the platform, the easier it is to attract traders.
Liquidity
DAXes provide liquidity for digital assets, which means that users can easily buy and sell them without having to worry about finding a buyer or seller. Liquidity drives the performance of all capital markets, both traditional and crypto. Exchanges with high liquidity make it possible for broker-dealers to trade positions as soon as possible.When starting a DAX, securing liquidity can be a considerable challenge. Fortunately, relying on a white-label DAX partner can help new exchanges gain liquidity pools to set up shop.
Price Discovery
DAXes help to facilitate price discovery for digital assets. This means that the prices of digital assets on DAXes are typically more accurate than those on other platforms.This reduces the chance of price slippage, which is the difference between the expected value of a trade and the price at which it’s executed. The best DAXes use real-time price discovery to give traders accurate information.
How Digital Asset Exchanges Work
Digital asset exchanges work like a typical stock exchange. You can create an account within minutes to buy and sell different digital assets. Knowing how a digital asset works is key to making lucrative trades quickly.
- Choose a digital asset exchange and create an account. Ideally, it should only take a few minutes to create an account and verify your identity.
- Deposit fiat currency or cryptocurrency into your account. DAXes gives users a wide range of options to add money to their accounts.
- Select the digital asset you want to buy or sell. DAXes offers all kinds of digital assets, from cryptocurrencies to NFTs.
- Place an order to buy or sell the digital asset. This step works just like buying a traditional stock. You can customize your order based on the volume, percentage, and price.
- Your order will be matched with another user's order, and the trade will be executed. Your order will be completed across a blockchain network, and it only takes a few seconds.
- The digital asset will be transferred to your account.
The Technical Anatomy of a Digital Asset Exchange
Digital asset exchanges work like traditional web properties. Here are the main components of any digital asset exchange:
Frontend
The frontend is the user interface that users interact with to buy, sell, and trade digital assets. It is typically a website or mobile app. The frontend of your DAX will directly impact user experience (UX).That’s because it will dictate how simple it is for traders to buy and sell, as well as fund their accounts. The best DAXes have a user-friendly frontend that makes it easy to facilitate trades.
Backend
The backend is the software that powers the exchange. It is responsible for matching buy and sell orders, executing trades, and processing deposits and withdrawals. You can think of the backend as the brain of the DAX. The backend includes vital components that make an exchange work, such as the wallet, APIs, matching engine, and security features. It also includes the order book. The order book is a data structure that stores all of the open orders on the exchange. The matching engine uses it to match buy and sell orders. Typically, you’ll need to hire professional computer scientists to build the backend of a DAX.Now, white-label partners like AlphaPoint make it easy to purchase an out-of-box solution and customize it for your brand.
Matching Engine
The matching engine is the core component of the exchange. It is responsible for matching buy and sell orders and executing trades.You can think of the matching engine as the nucleus of a digital asset exchange. Without it, exchanges would never gain momentum. The matching engine is located inside the backend and is created by software developers.
Wallet
The wallet stores users' digital asset classes. It can be a hot wallet or a cold wallet. Hot wallets are secured via the internet and exit online. Cold wallets are offline devices that can come in the form of a USB stick. Since wallets hold precious financial assets, they must be secured with state-of-the-art encryption.
Security
The exchange must have robust security measures in place to protect users' digital assets from theft and unauthorized access. Centralized digital asset providers need to be especially careful since they hold private user data on their servers. Some common security measures include Know Your Customer (KYC) and two-factor authentication (2FA).
Other Critical Components of a Digital Asset Exchange
Digital asset exchanges also involve a wide range of other components, such as:
Margin Trading
Margin trading allows users to borrow money from the exchange to trade digital assets. Margin trading is a risky proposition that allows people to borrow money they don’t have in order to bet on crypto positions. Digital asset exchanges offer this option to investors, but it does come at a higher risk for both parties involved. Offering margin trading can be a great way to invite a broad audience of traders who may not have the capital to trade outright.
Lending
Lending allows users to lend their digital assets to other users at interest. This peer-to-peer transaction typically requires borrower collateral and comes at high interest rates (usually at 20% or above). This option can help DAXes build a vibrant community and encourage increased trading activity.
Staking
Staking allows users to earn rewards by participating in the PoS consensus mechanism. Staking is how payments across blockchain technology are processed, verified, and completed. It’s a necessary process in any digital asset exchange. DAXes need to deploy an efficient staking process to process payments appropriately and keep the platform running smoothly.
Derivatives
Derivatives are financial contracts that derive their value from another asset, such as a cryptocurrency. Digital asset exchanges offer derivatives to give traders a wide range of options to diversify their portfolios. As a result, DAXes should offer derivatives on their platforms to boost signups from experienced investors.
Try AlphaPoint Today
Digital asset exchanges hold a special place in the crypto ecosystem because they enable traders to buy and sell various digital assets. If you want to develop your own digital asset exchange to capitalize on this trend, you don’t have to build an entire platform on your own. Using a digital asset partner like AlphaPoints makes it easy to piece together your own digital asset exchange under your own brand. Our team of fintech innovators have years of experience empowering businesses to seamlessly expand into lucrative crypto offerings. We even provide turnkey exchange software that you can fully customize yourself — no advanced coding required. Request a demo today to learn how AlphaPoint can transform your crypto initiatives with powerful, battle-tested white-label services.
