The role of crypto exchanges

Learn how they act as on-ramps to the Open Money system, their advantages, risks, and their evolving role in the digital economy.

Another important piece of infrastructure in the emerging internet-native digital economy are cryptocurrency exchanges. One way to think about it is that exchanges act as on-ramps and off-ramps for digital asset or Open Money systems.

From the very early days, crypto exchanges have acted as an important hub in the crypto space. At one point, crypto exchanges and crypto wallets were really the only infrastructure available for people looking to buy or trade digital assets. Today, crypto exchanges feel more like utility service providers (like a phone company or something) and less like the only crypto business in town.

Nevertheless, the fundamental reason that crypto exchanges exist is to make it possible to convert fiat (or government-issued) currency into cryptocurrencies. Exchanges also make it possible to convert cryptocurrencies into other assets or switch networks.

Not that long ago, operating a crypto exchange was a pretty straightforward business model. Until recently, the dominant use case for cryptocurrencies was to buy and hold them. But now, as the use cases for crypto and Open Money start to mature, there is a need for people to also bridge currencies (or convert one crypto into another), hold collectibles, have easier and more intuitive transaction capabilities, and use the cryptography aspects of cryptocurrency to authenticate identity across web3 applications.

Over time, the need to serve multiple objectives has made it so that crypto wallets are more of the dominant user interface or main surface that people now interact with Open Money systems. If the trend continues, it’s likely that wallets and the services they provide will become even more intuitive and more a part of everyday transactions on the internet. Eventually, chat-like AI agents might even become the default interactive surface, making Open Money feel even more intuitive and fluid.

But for now, there are two main kinds of exchanges: centralized exchanges and decentralized exchanges.

Centralized exchanges are platforms operated by companies that facilitate cryptocurrency transactions in a manner similar to traditional stock exchanges.

They offer high liquidity, user-friendly interfaces, and customer support, making them accessible to beginners and large investors alike. They also require users to trust a third party to safeguard their assets, which introduces counterparty risk and is counter to the ethos of Open Money in the first place.

These exchanges are also subject to government regulations, such as Know Your Customer (KYC) or anti-money laundering laws, which can impose operational restrictions or lead to account freezes in certain jurisdictions. While centralized exchanges provide convenience and security, their custodial nature means users do not have direct control over their assets, making them vulnerable to hacking incidents or insolvency issues.

Meanwhile, decentralized exchanges (DEXs) operate without a central authority, using smart contracts to facilitate peer-to-peer transactions directly on the blockchain.

This removes intermediaries, allowing users to retain full custody of their assets and trade with greater privacy. DEXs align with the ethos of decentralization and financial sovereignty, offering greater resilience against regulatory crackdowns.

However, they come with their own set of challenges: lower liquidity compared to centralized exchanges, often higher transaction costs due to network fees, and a steeper learning curve for users unfamiliar with blockchain mechanics.

For some time, decentralized exchanges were considered less secure than centralized exchanges. They were hacked more often, and it wasn’t uncommon that the hacks would drain the exchange of funds. But more recently, centralized exchanges are also getting hacked and raided. Not to mention, there have been several high-profile cases of massive centralized exchanges going insolvent—the FTX debacle is a case in point.

The key takeaway here is that exchanges are a key part of the Open Money system, mainly because they act like a critical connector between traditional money systems and more internet-based digital money systems. And while they remain a key part of the entire Open Money flow, they are also really vulnerable to attacks, scams, or other security issues.

This post is part of the Open Money project, an ongoing series that forms the basis of a longer work. Subscribe to get a weekly update as it unfolds.

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