Digital Currency Exchange
A digital currency exchange is an online service which allows users to trade digital currency assets. Users can open an account and deposit a supported fiat currency or cryptocurrency into their account balance. With this balance, users can trade with other users using buy and sell orders supported by the exchange software, which will match buyers and sellers when their preferred conditions and prices are met.
It simulates a stock exchange, with buyers and sellers in a constant price tug-of-war, but most trades executed on an exchange aren't actually transactions between cryptocurrency holders: exchanges track such trades off the underlying blockchains. They periodically bundle these off-chain transactions and settle up their accounts with on-chain transactions.
Some exchanges don’t act as an intermediary between traders and instead only allow users to buy and sell Bitcoin and other digital assets at a fixed price from the exchange itself. Users can later withdraw their account balance in digital currency or fiat supported by the exchange.
To store Bitcoins and other digital assets, exchanges use a combination of hot and cold storage systems. A hot wallet is a storage system connected directly to the internet, which includes all the keys required to sign transactions. Hot wallets are convenient and necessary for real-time withdrawals and transactions, but are as inherently vulnerable as the server upon which they reside, and therefore at risk to hackers.
To mitigate the risks of storing digital assets online, many companies make use of cold storage systems. Cold storage systems preserve digital asset keys offline. Many exchanges hold millions of Bitcoins in reserve, so as insurance against hackers and other risks they keep large amounts of digital assets and their corresponding keys in cold storage.
The first major digital currency exchange sporting digital asset trading was Mt. Gox. The exchange was launched in 2010 by programmer Jed McCaleb supporting the exchange of Bitcoin and fiat, using an exchange framework and domain name he had created earlier for trading cards online like stocks. He recognized that users of digital currencies would need both a central place to find buyers and sellers and an escrow provider who could ensure trades took place reliably.
In March 2011, Jed Mcaleb sold Mt. Gox to Tibanne Co. in Japan, and by 2013 it was handling 70% of all Bitcoin transactions. In February 2014, Mt. Gox filed for bankruptcy, after losing up to $480 million dollars in Bitcoin. Reasons of the loss were initially unclear, though new evidence presented by WizSec in April 2015 shows that Mt. Gox had been insolvent for years, as “Most or all of the missing bitcoins were stolen straight out of the MtGox hot wallet over time, beginning in late 2011.”
Though many individuals lost money in the Mt. Gox debacle, many other exchanges had been launched in the years after the creation of Mt. Gox and have quickly risen to fill the gap it left behind. A feature Mt. Gox had also been lacking but has been covered by most exchanges is support for the rapidly developing altcoin market, as many exchanges today support Ripple, Darkcoin, Litecoin, and many others.
Besides just Mt. Gox, other exchanges have had issues over the years as well. In 2014, $1,480,000 worth of Bitcoins were stolen by Moopay CEO Alex Green, who was arrested later in 2015. Also in 2014, Canadian Bitcoin bank Flexcoin lost $600,000 worth of Bitcoin to hackers, and in January 2015, the Luxembourg exchange Bitstamp lost $5,000,000 worth of Bitcoins to hackers.
As cryptocurrencies have become increasingly popular, exchanges have been subjected to a plethora of different legislations worldwide. For instance, a bill seeking to ban the exchange of Bitcoin in Russia would effectively make Bitcoin exchanges obsolete. Other countries are more lenient, and allow Bitcoin exchanges to operate, so long as they follow state licensure. For most countries, digital currency exchanges fall under the same regulations as online payment services, which requires the use of AML (anti-money laundering) and KYC (know your customer) systems. Some laws seen as overbearing have caused some exchanges to decide to resign their services from certain areas altogether.
Top Five Exchanges
At time of writing, the five exchanges trading the most significant volume are as follows, but this can vary significantly.
- OKCoin – Bitcoin and Litecoin - Founded in 2013 and headquartered in Beijing, China, OKCoin features trading fees beginning at 0.20% and as low as 0.10% for trades of more than 5000 BTC. OKCoin supports futures contracts, leverage trading and lending with interest, as well as more features in its corporate account, and a client app.
- Bitfinex – BTC, LTC, ETH - Founded in 2013 and headquartered in Hong Kong, supports different fees based on value of USD traded. Features include margin trading and funding, a plethora of order types, segregated wallets and a vast API platform.
- BTC China – BTC, LTC – Founded in June 2011 and based in Shanghai, BTC China features different fees depending on feature used, with as low as no fees for spot exchange trading. BTC China features a spot and pro exchange, a mining pool, Forever Engraving, BTCC Mint, JustPay wallet and a vast API platform.
- Kraken – BTC, LTC - Founded in 2012 by Payward Inc, and headquartered in San Francisco, Kraken applies fees based upon the digital currency and fiat exchange. Kraken features Bitcoin margin trading, advanced order types, proof of reserves audit, an extensive trading guide and a vast API platform.
- CoinBase – BTC - Founded in 2012 and Headquartered in San Francisco, CoinBase has no fees and lets users interchange fiat currency for digital currency through their CoinBase wallet. CoinBase provides instant exchange, insurance protection and multi-signature wallet control. The CoinBase trading exchange now operates under another brand, Gdax.
 For more extensive list of significant hacks and losses, see bitcointalk timeline: https://bitcointalk.org/index.php?topic=576337#post_toc_16
 Excellent summary by Jesse Powell, CEO of popular Bitcoin exchange Kraken: https://m.reddit.com/r/Bitcoin/comments/2uty32/ama_request_usbased_bitcoin_company_kycaml/