Buying Bitcoins the Efficient Way
Using a Bitcoin exchange is similar to using a brokerage account (like E-Trade or Ameritrade). If you've done any online equity trading, most of the information in this section should be familiar.
At a currency exchange, you can deposit money in one currency and offer to exchange it for another currency at a rate that you choose. For example, you could offer to exchange $1 for 100 bitcoins, but you might find few takers. Other users who already own bitcoins might be equally generous and offer to trade their bitcoins for $100 million. Neither party is likely to have its offer satisfied. However, by raising your bid and other users lowering their ask, you will eventually meet in the middle and an exchange will take place. At popular exchanges, at any given moment, thousands of bids and asks are submitted for a wide range of offered rates. But the official rate is usually a number in between the highest bid and the lowest ask.
The more users involved in the offering, the closer the bid and ask rates tend to be. But it's theoretically possible for the highest bid to be $200/BTC and the lowest ask to be $300/BTC, in which case it is difficult to say what the real exchange rate.
Many Bitcoin currency exchanges are available to choose from, so which one should you register with? The currency exchanges make their money by charging a small fee for every trade (usually less than 0.5 percent), so basing your choice on the fee structure is one possibility. However, more important than fee structure are security, regulatory compliance, and trade volume. Many Bitcoin exchanges have been running successfully without issue for years, but some exchanges have been hacked (i.e., robbed) in the past or pressured by government authorities into shutting down for not obeying financial regulations. Trade volume is also an important factor to consider when choosing an exchange. The larger the trade volume, the more likely you are to get a fair price for your bitcoins, and the more bit-coins you are able to buy and sell per day. A small currency exchange that trades only 10 bitcoins per day on average will not be able to fill your bid orders quickly if you are trying to buy 100 bitcoins. Large trade volume is also indicative of the trust in and security of the currency exchange.
Of the three factors to consider when choosing an exchange, only trade volume information is easy to find. Table 4-2 lists exchanges that have reasonably high volume. In lieu of concrete information about a currency exchange's security practices and regulatory compliance, it is advisable for beginners to do business only with exchanges that have been operating for several years. The reason is that presumably, any issues with security or regulatory compliance have already been resolved or the exchange wouldn't exist. This statement may seem unfair to new exchanges, because they might even offer better security than older do exchanges. But when it comes to matters of money, being cautious is justifiable.
Table 4-2: Bitcoin Exchanges with Reasonable Volume
* It is not exactly clear which country BTC-E is located in, because this company maintains a certain level of anonymity. If you're thinking to yourself, "Why would I send my money to a company if I don't even know what country it's located in?" then we think you're asking a very sensible question.
The country in which you live and the currency you want to exchange for bitcoins are also factors in choosing an exchange. Some exchanges facilitate only USD to BTC operations, whereas others offer multiple currency pairs.
You might notice that some Bitcoin currency exchanges offer currency pairs you have not heard of—for example, LTC, FTC, TRC, PPC, XPM, and so on. These other digital currencies—called alternative coins or altcoins— were created after, and largely inspired by, Bitcoin. To learn more about such digital currencies, check out "The Strange World of Altcoins" on page 181.
Many exchanges also have different BTC/USD exchange rates! This means you can sell bitcoins at a higher price on one exchange and buy them for a lower price on the other exchange. So this is free money, right? Well, yes and no. If the price difference is substantial and you are the first person to notice it, then indeed you have an opportunity to make some free money. However, you do need to keep in mind the amount of work it takes to transfer non-Bitcoin money in and out of exchanges; your time and effort aren't free. But more than likely, others will have noticed this difference before you and will have seized the free money opportunity, which is known as taking advantage of arbitrage. Any remaining difference in price between exchanges reflects the costs, due to trading fees and transfer fees (and other factors beyond the scope of this book), of moving money from one exchange to another. If one Bitcoin exchange rate is substantially different from all the others, it may indicate an underlying problem and probably should be avoided.
Additionally, it is important to remember that a currency exchange is not a bank. You should not leave significant amounts of money, whether fiat currency or bitcoins, sitting your exchange account. After purchasing bit-coins, transfer them to your personal Bitcoin wallet for safekeeping.