How cryptocurrency exchanges work: orders and custody
A crypto exchange is a marketplace that matches buyers and sellers and records each trade. US exchanges verify identity under the Bank Secrecy Act.
Vahe HakobyanEditor-in-chief
Updated Oct 5, 20263 min readFact-checked
On this page
- A custodial exchange holds your crypto until you withdraw it.
- US exchanges verify identity under the Bank Secrecy Act.
- US exchanges send tax forms and report some activity to the IRS.
- Use a unique password and multifactor authentication.
You open an account at a cryptocurrency exchange, verify your identity, fund the account, and place an order. The exchange then matches your order and records the trade, while a decentralized exchange does not store users' funds and instead facilitates peer to peer trading.
What you need before you start
US exchanges verify your identity before you trade, under the Bank Secrecy Act. You also need an email address, a unique password, and a funding method.
How a crypto exchange works step by step
A cryptocurrency exchange is a marketplace that matches buyers and sellers of digital assets. Some act as market makers and take the spread between the bid and the ask; others only match customers and charge fees.
- 1Pick a marketChoose the pair you want, such as bitcoin for US dollars, and check the fee.
- 2Enter the orderType the amount, and for a limit order add the price you will accept.
- 3Review the orderCheck the pair, the amount, the price, and the fee before you submit.
- 4Submit and matchThe exchange matches your order against its order book or fills it as a market maker, then records the trade.
Where your crypto is held
At a custodial exchange, your crypto stays in the exchange's custody until you withdraw it to your own wallet. The exchange holds the private keys, so your balance is an entry in its records.
After the trade: records and safety
Protect your account with a unique password and multifactor authentication. US exchanges send tax forms and report certain customer activity to the IRS.
- Download monthly statements and trade confirmations.
- Track the cost basis for each trade.
- Note the fee on every trade.
Frequently asked questions
A centralized exchange holds customer funds and matches orders on its own order book. A decentralized exchange does not store users' funds and instead facilitates peer to peer trading, but you still face smart contract and wallet risks.
Yes. A freeze can leave your balance stuck, and a failed exchange may leave you as an unsecured creditor.
Open your wallet's receive page and copy the address. In the exchange withdrawal page, choose the matching network and check the address before you confirm.
Usually yes. The IRS treats crypto as property, so a swap can create a taxable gain or loss.
