Bitcoin was created to allow a peer-to-peer exchange of value. It is similar to cash but in the digital realm. You can trade bitcoin for any currency you like, without intermediaries such as banks or payment apps. You could negotiate with someone to pay a certain amount of bitcoin in exchange for mowing your lawn. It would be no different from paying cash for lawn mowing services.
In exchange for bitcoin, you might offer cash or other goods and services to the seller if you are looking to purchase bitcoin.
However, most people do not use bitcoin in their daily lives as a means of exchanging money. It’s usually more difficult to find peer-to-peer sellers/buyers than to trade in local currency. We now have to introduce the concept of “liquidity.”
What’s the liquidity?
Liquidity is the ease of trading in and out of an asset. It depends on how many buyers and sellers there are for the asset. Because cash is universally accepted, it’s usually considered to be the most liquid asset. It’s also easy to exchange cash for almost anything. Cash is more liquid than a house. It takes some effort and time to find a buyer for a house. A luxury and big house would be even less liquid because the potential buyers pool is much smaller.
Bitcoin is the most liquid cryptocurrency because it has the largest number of market participants and the highest volume of exchange. Bitcoin’s daily trade volume is in the hundreds of billions. It’s still not as liquid as cash, especially when used to purchase goods in the real world. Bitcoin exchanges are needed for this reason.
What is a Bitcoin exchange?
Any service that connects buyers and sellers of bitcoin is called a bitcoin exchange. These exchanges make Bitcoin a liquid asset that traders can use on a large scale.
Most people refer to bitcoin exchanges as centralized custodial platforms such as FTX, Coinbase, and Binance. These platforms allow for the trading of bitcoin and other cryptocurrencies. Cryptocurrency exchanges are similar to trading platforms like Robinhood, Ally invest, or other stock brokers. They match buyers with sellers.
A centralized cryptocurrency exchange is essentially responsible for taking custody of your bitcoin. This has many implications, not only in terms of security but also regarding the freedom to use your bitcoin however you want.
People must verify their identity to use a centralized bitcoin/cryptocurrency exchange
Legal implications can arise from taking custody of customers’ bitcoins and other cryptocurrencies as centralized exchanges are required to do. These exchanges are subject to money transmitter laws in any jurisdiction where they are registered.
Most centralized cryptocurrency exchanges require that you complete a registration process. This will verify your identity and allow you to use the platform. This requirement is imposed by regulators to protect against money laundering, terrorist financing, and tax avoidance. Exchanges are often required to provide customer information, including trading history, upon request by regulators.
You will often be allowed to use the exchange after verifying your email. This ‘lite verification’ usually comes with significant restrictions, including limited purchase amounts and limited withdrawals. In some cases, there may not be any withdrawals at all. You should verify that you are allowed to withdraw before you fund any cryptocurrency exchange using bitcoin or another cryptocurrency.
Uploading a nationally issued identification such as a passport or driver’s license is the next step of verification. You may be asked to upload a picture of yourself holding your ID and next to a piece of paper where you have written, such as the current date or a specific message, depending on the exchange.
Not all exchanges allow certain nationalities to use the exchange.