By Joel Agbo
Reviewer DailyForex.com Team
This article discusses the differences and similarities between the various types of cryptocurrency exchanges and crypto wallets. The primary aim is to clarify for investors and traders how exchanges and wallets work, as well as explaining the utilities of each.
What Is a Crypto Exchange?
A cryptocurrency exchange is a type of trading platform. Exchanges create a market for cryptocurrencies and enable investors to buy and sell their chosen digital assets. Exchanges are powered by trading technology that receives and executes users’ orders.
What Is a Crypto Wallet?
A crypto wallet is a software application or device that helps crypto investors keep custody of their assets and manage their activities. Crypto wallets connect investors to the blockchain ledger. It packages complicated blockchain transactions into simplified operations. Wallets feature private key security systems that contribute to the security of users’ assets.
Types of Crypto Exchanges
There are three known types of crypto exchanges. Here is a description of each:
Centralized Exchanges (CEXs)
Centralized exchanges are also known as custodial exchanges. Centralized exchanges hold their users’ assets while they trade various types of cryptocurrencies on the platform. They use the order book technology to create a buy-side and a sell-side. The orderbook handles trade transaction execution. Centralized exchanges also offer secondary services and are usually under the regulation of central governments. Examples include Binance, Coinbase, and Kraken.
Decentralized Exchanges (DEXs)
Decentralized exchanges are built on the blockchain. They allow users to trade crypto from the safety of their wallets (to which they hold the private keys). Decentralized exchanges use liquidity pools and AMM (Automated Market Makers) to execute trade orders. Contemporary decentralized exchanges also use decentralized limit order books.
Hybrid Exchanges
Hybrid exchanges combine the features of a centralized and decentralized exchange. They offer self-custody, allowing users to hold their assets in their wallets while they trade on the platform. However, unlike decentralized exchanges, they use a centralized orderbook. Their aim is to provide tighter security than centralized exchanges while offering faster trading technology. Examples include Nash Exchange and Onomy Protocol.
Types of Crypto Wallets
When choosing a crypto wallet, traders can pick between two main types, each of which has unique advantages and drawbacks.
Hot Wallets (Software Wallets)
Hot wallets are software applications for crypto custody. They can be installed on mobile and desktop devices. Hot wallets are recommended for routine transactions. However, their security system is not ideal for keeping a large amount of crypto assets. Examples include MetaMask, Trust Wallet, and Phantom wallets.
Cold Wallets (Hardware Wallets)
Cold wallets are hardware devices for crypto asset custody. They are regarded as the ideal crypto storage medium due to their security infrastructure. Cold wallets store users’ wallet keys offline and are recommended for storing large amounts of crypto assets. Examples include Ledger, Trezor, and SafePal.
Similarities Between a Crypto Wallet and a Crypto Exchange
Crypto wallets and exchanges are similar in the following ways
- Asset Custody: Both exchanges and wallets keep custody of crypto assets. Users can manage their assets using both tools.
- Blockchain Integration: Wallets and exchanges interact with blockchain networks.
- Simplified User Interfaces: Exchanges and Wallets package complex operations into simple, clickable buttons and a friendly user interface.
- Multi-asset support: Most exchanges and wallets support multiple crypto assets. Allowing users to manage and trade several assets on the same interface.
Differences Between a Crypto Wallet and a Crypto Exchange
The differences between a crypto wallet and an exchange include:
- Wallet Key Management: Wallets allow users to hold and manage their private keys. Centralized exchanges retain control of the private keys to wallets that hold users’ assets.
- Primary function: Exchanges are for trading crypto, while wallets are for holding and managing crypto.
- Security: Wallets tend to be more secure than exchanges.
- Asset custody: Wallets allow users to freely transact their assets, while exchange users are required to seek permission from the trading platform before they can move their assets.
Making the Right Choice for Your Crypto Needs
The uses of wallets and exchanges intersect in certain ways. As a result, some investors may use them differently. For instance, many investors primarily hold their assets on an exchange. For convenience, you can hold your assets on an exchange for the period you are trading. However, it is advisable to move them to a wallet after trading.
Also, consider the reputation and security record of an exchange before using it. This is the same for wallets. Ensure that your wallet device or application is developed by trustworthy firms. Verify cold wallets for originality before using.
Additionally, ensure that the exchange is licensed to operate in your region. Also, evaluate the liquidity on the exchange to avoid losses due to slippage.
Moving Assets from an Exchange to a Wallet
After trading on an exchange, it is recommended that you transfer funds that are not in use to your wallet. Wallets, especially cold wallets, offer a more secure environment for your assets. Assets held in an exchange are under the control of the trading platform, as it holds the private keys to the wallet holding the asset. Due to growing cases of exchange hacks and mismanagement of users’ funds, it is advised that you move your assets to your wallet when you are not using them to trade.
Download a software wallet or purchase a cold wallet that supports your assets and withdraw them from the exchange.
My Take
Exchanges and wallets are two major utilities for crypto investors. While one offers a platform to freely swap assets, the other offers a medium to securely hold the assets. It is important to use each one for its primary purpose. This will enable you to leverage the strength of both tools. Keeping your assets on an exchange may pose a security risk. While using decentralized exchanges, make sure to verify the security of the smart contract you are interacting with before signing a transaction. Also, note that cold wallets are the recommended storage medium for crypto assets.
