Exchanges: Where Trading Happens
Understanding centralized exchanges, decentralized exchanges, and traditional financial exchanges
WHAT ARE EXCHANGES?
An exchange is a marketplace where buyers and sellers come together to trade assets. Exchanges facilitate transactions by matching buy and sell orders, providing liquidity, and ensuring fair pricing. Different types of exchanges serve different markets and have different structures.
Note: Companies like Fidelity are actually brokers, not exchanges. They connect you to exchanges (like NYSE, NASDAQ) where trades actually happen. However, they provide exchange-like services through their platforms.
TYPES OF EXCHANGES
Centralized Exchange (CEX)
A cryptocurrency exchange operated by a company that acts as an intermediary, holding users' funds and facilitating trades.
Decentralized Exchange (DEX)
A cryptocurrency exchange that operates without a central authority, using smart contracts and blockchain technology to facilitate peer-to-peer trading.
Traditional Financial Exchanges
Stock exchanges and brokerage platforms that facilitate trading of traditional assets like stocks, bonds, and ETFs.
EXCHANGE COMPARISON
Compare centralized exchanges, decentralized exchanges, and traditional financial exchanges:
HOW EXCHANGES WORK
Centralized Exchange (CEX)
You deposit funds to the exchange. The exchange holds your funds and matches your buy/sell orders with other users' orders. When you trade, the exchange updates your account balance. You can withdraw your funds back to your wallet.
Decentralized Exchange (DEX)
You connect your wallet (you keep your funds). When you want to trade, you approve a transaction that interacts with a smart contract. The smart contract automatically matches your trade or uses an AMM (Automated Market Maker) to provide liquidity. Your funds stay in your wallet.
Traditional Exchange (via Broker)
You open an account with a broker (like Fidelity). You deposit money. When you place an order, the broker routes it to an exchange (NYSE, NASDAQ). The exchange matches orders. Settlement happens T+2 days later. Your broker holds your stocks in a custodial account.
FIDELITY & TRADITIONAL BROKERS
Fidelity is a brokerage firm, not an exchange itself. Here's how it works:
What Fidelity Does
- Acts as an intermediary between you and stock exchanges
- Provides trading platform and tools
- Holds your assets in custody
- Routes your orders to exchanges (NYSE, NASDAQ)
- Provides research, advice, and support
- Handles tax reporting
Key Differences from Crypto Exchanges
- Trading Hours: Market hours only (not 24/7)
- Settlement: T+2 days (not instant)
- Regulation: Heavily regulated by SEC, FINRA
- Insurance: SIPC insurance up to $500k
- Assets: Stocks, bonds, ETFs (not crypto)
- Fees: Often $0 for stock trades, but spreads apply
KEY CONCEPTS
Order Book
A list of buy and sell orders. Centralized exchanges use order books to match buyers and sellers at specific prices.
Liquidity
How easily you can buy or sell without affecting the price. High liquidity means many buyers and sellers, making trades easier.
Market Maker
Entities that provide liquidity by always being willing to buy or sell. They profit from the spread (difference between buy and sell prices).
AMM (Automated Market Maker)
Used by DEXs. Instead of order books, AMMs use liquidity pools and mathematical formulas to determine prices automatically.
Custodial vs Non-Custodial
Custodial: Exchange/broker holds your funds. Non-Custodial: You hold your funds in your own wallet.
KYC/AML
Know Your Customer / Anti-Money Laundering. Regulations requiring exchanges to verify user identity to prevent illegal activities.
WHEN TO USE EACH TYPE
Use Centralized Exchange (CEX) When:
- You're new to crypto trading
- You want to trade with fiat currency (USD, EUR)
- You need customer support
- You want high liquidity and fast trades
- You're comfortable with custodial services
Use Decentralized Exchange (DEX) When:
- You want full control of your funds
- You value privacy (no KYC)
- You want to trade 24/7 without restrictions
- You're comfortable with smart contracts
- You want to avoid account freezes
Use Traditional Broker (Fidelity, etc.) When:
- You want to trade stocks, bonds, ETFs
- You want regulatory protection and insurance
- You need professional advice and support
- You want dividend income
- You prefer established, regulated markets