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How to start your own cryptocurrency exchange

It is undeniable that the cryptocurrency market is currently undergoing a strong slowdown. Just a quick look at Google Trends shows that the level of interest is noticeably lower compared to years of 2017 and 2018 when driven by people’s’ enthusiasm, the crypto industry was constantly growing week by week. This doesn’t encourage investing money into a cryptocurrency exchange. However, considering that establishing such a business requires time, it might turn out this is exactly the time to start if we want to have a functioning exchange at the time when the next crypto rush appears. And the question is rather a when than if.  

Another reason is that some of the exchanges that started operating in the time of crypto glory are just crumbling from the market allowing others to share their piece of cake. But this time crypto entrepreneurs can learn from their mistakes and prepare for the possibility of market collapsing again.  Besides, the cost of setting up a crypto exchange is much lower when the market is in a phase of a slowdown. On the other hand, according to Coinmarketcap, small exchanges located at the bottom of TOP100 crypto exchanges reach an average daily volume of $1 million. Giving that the fees for one side of the transaction vary from 0.10% to 0.40 %, this gives the amounts that allow growing your business even when the market is stalling. 

So where to start the adventure of trading virtual currencies?

Most people begin with software deployment. No doubts, the reliability of the technology and the usability of the exchange are very important to succeed in the long run. But what will guarantee our crypto exchange will stand a chance to compete on the market attracting lots of users? 

Setting up a white label solution will be a lot faster than building an exchange yourself.

Modern technology the old-fashioned way

Ironically, the most important thing in crypto business is not having a cryptocurrency wallet, but a traditional bank account. Every major exchange offers the possibility to deposit FIAT currencies. Times when it was enough to offer the crypto-to-crypto exchange to attract users went away with the bubble burst on altcoins in 2017.

The finance industry has very strict regulations to prevent frauds. And since the whole idea of cryptocurrencies was created to break the monopoly of the banking system and bypass the official money circulation – they’ve become very popular among cybercriminals. Hence, banks are very distrustful of clients from the cryptocurrency industry. So what to do to please the banks and show them that you and your clients are trustworthy?

The answer, at least in theory, is simple – get a licence! Having AML (Anti-Money Laundering) procedures and licence will make more institutions willing to cooperate with us and will also get us better conditions. First of all, you need to keep in mind that not all countries regulate the use of cryptocurrencies in any way, and even if they do, they often do not fully understand their specifics. And the price to pay for such regulation is not only the privacy of our users but also increased bureaucracy and limits imposed by the legislator. For example, the license of the Small Payment Institution, created under the European second Payment Services Directive (PSD II) is relatively simple to obtain, however, it limits the size of the FIAT currency deposit to the equivalent of €2000. 

Which countries offer the best conditions to register a cryptocurrency exchange?

The most important thing in the crypto business is having a traditional bank account.

The situation is changing quite dynamically. Estonia used to be that country where the majority of crypto companies was seeking registration. Currently, due to the fact that the Estonian licence is not widely recognized, companies are looking for other solutions. Lately, Gibraltar has become a popular destination, and not so long ago it even granted a licence to trade futures. It is also worth checking the regulations in Malta or Australia as they are becoming more and more open on the crypto industry. If you decide to get a license for your crypto business you will probably be able to talk to banks without intermediaries. 

To make your exchange more convenient for the customers you should consider providing card payments. If you don’t get a licence you can always look for a suitable Payment Processor who will provide you with bank accounts for your customer service. However, every middleman will charge his commission and there’s always a risk that the bank will drop the Payment Processor as a client because of handling deposits in cryptocurrencies.

The architecture of the cryptocurrency exchange system

Going to the technical side of the crypto exchange – apart from the wallet, it is not that closely related to blockchain, which is a plus when you decide on independent in-house development, because you do not need to hire blockchain technology specialists who are by the way very expensive. If you want to create an exchange from scratch, you have to understand that it will take at least a few months, and the cost is pretty much dependant on the salary of your developers and ongoing business expenses.  On the other hand, a startup business can choose a white label solution. Setup of a fully functioning exchange will be a lot faster than building it on your own. But certainly, the customization will be limited. Regardless of the chosen method of building your exchange platform, several elements need to be polished to for it to function efficiently.

User Interface. Think about what clients are the target of your exchange and customize the look of your platform to match their needs. Clients who are more familiar with cryptocurrencies will require chart analysis and a preview of recent and current orders, while novices users prefer a simple and intuitive interface. Also, do not forget about the mobile version, as studies show that the majority of users will place orders this way.

Matching engine. The core of every exchange, responsible for calculating balances, settling purchase and sale transactions and creating an order book. As the matching engine is closely related to the carried transactions, any error can potentially have a great impact on the correctness of the operation on the entire exchange, so make sure to find a reliable and proven technology. 

Admin panel. A place where the exchange operator will find all the tools needed to manage the exchange. Among others, such as booking payments and withdrawals, setting fees and verifying KYC (Know Your Customer). The administrator panel should be divided into sections to make sure that departments like support or accounting only have access to a specified section. 

Wallet. It supports deposits and withdrawals in cryptocurrencies. These are HD wallets, which means they have many addresses served by one private key. Thanks to this, every customer own an address and payments can be automatically booked. In terms of security, it should be able to confirm larger withdrawals from another panel preferably through multisignature, i.e. requiring confirmation from two or three users at the same time. A wallet connected to the exchange is a hot wallet, so it is more likely to be hacked. To minimize the risk it’s better to only keep 20% of funds on a hot wallet and the rest 80% on a cold wallet.

Create an environment for trading

To make your exchange more convenient for the customers you should consider providing card payments.

First of all, every customer who will visit your exchange would like to be able to trade on it right away. That is why this point is so important and can not be overlooked. You won’t attract any traders with an empty order book, and retail clients are rarely able to create a liquid market because their transaction volumes are simply too small.

There are several solutions to this problem, depending on how technically advanced we are and what risks we want to take as an exchange. Of course, the easiest way is to copy orders from other exchanges.

If we do not secure our transactions, it is theoretically the cheapest solution because we do not even have to make a deposit on another exchange. Theoretically because in such a situation we take on ourselves a huge risk of price changes, and when the customer wants to withdraw the purchased cryptocurrency we will have to buy it elsewhere.

We secure the transaction on the exchange from which we copy orders. It is a capital-intensive but also a safe solution. The problem, however, is that for each transaction we also have to pay the second exchange which decreases our profits.  

Another solution is to find a liquidity provider that will create the market directly on your exchange. This concept works well especially when you offer local FIAT currencies that will be hard to find on other exchanges. Also, you do not take any additional risks. However, it must be assumed that at least in the initial phase market makers may charge fees for maker orders. With time, however, while the exchange will be developing, other market makers will appear on better terms. To use this solution, the exchange must have an API that allows you to place orders.

A thoughtful approach to business

No matter how small you start you need to remember that you only succeed if you manage to gain and keep the customers. Having the best platform and the fastest matching engine might not be enough. After you set up an exchange, you need to plan how to address the non-technology issues. 

Customer Support – handling tickets and helping clients solve problems. Also providing KYC verification.

Marketing – responsible for promoting the exchange to attract new customers and partners. 

Custody – managing the assets of the exchange, booking deposits/withdrawals which comes to managing hot and cold wallets. Although the separation of operating the crypto exchange and managing funds is not mandatory, it is a good practice that will increase the confidence of customers in your exchange.

Also, if you decide to have an in-house developed exchange you need to maintain an IT crew that will solve current technical problems that will certainly arise. For White Label, it’s usually enough to report a problem to the technology provider to resolve any encountered issues.

It’s time to start

No matter how small you start you need to remember that you only succeed if you manage to gain and keep the customers.

The chosen business model determines how the exchange will be managed. For example, the local crypto exchange will have higher fees, but fewer users, while the global exchange may, due to the bigger scale, reduce fees compensating it by higher turnover.

As mentioned at the beginning, the cryptocurrency market is currently slowing down, so when opening the crypto exchange keep in mind that you need to attract new customers. A good product alone with professional service may not be sufficient and additional marketing activities may be needed. The outbreak of ICO scams from a year ago caused restrictions in Facebook and Google policies, which were the most effective media to reach retail clients. However, as little as keeping your Social Media profile active can make a huge impact cause it’s the young people, who make up the vast majority of cryptocurrency supporters. Consider describing your crypto exchange on BitcoinTalk or ask a Blockchain technology portals or influencers to review your exchange. And remember, you work in the digital environment so in addition to the platform itself, create a professional website that will not only be your business card but will also increase the level of user confidence in your exchange. Adding Live Chat or another support system will facilitate communication with the client and increase the quality of service. Soon it will pay off resulting in higher user satisfaction and more customers.

This text was originally prepared for e-Forex Magazine

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