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January 11, 2022

How does swapping tokens actually work?

How you exchange one token for another.

Let’s say you own a significant amount of one coin, and want to swap some of it for another coin – for example exchange Ethereum for Bitcoin.

How does that actually work?

Think of it like trying to swap Amazon Gift cards for Apple Gift cards – you will have to find someone on the other end of that trade who's interested in it.

That's what large exchanges help with. They have so many users that a lot of those swaps – called “trade pairs” by the insiders – are possible, because there is always someone interested in any of the many different combinations. What exchanges do here is called "market making" - they bring people together to facilitate a swap.

But what if you want to trade a very exotic pair, say Lizard Coin for Doge Coin? Then your best bet is to go through "fiat", meaning real currency or well-known crypto. First, you'll have to exchange Lizard Coin for US Dollar or Bitcoin, and then take those and exchange them for Doge Coin. That's what we call an imperfect market and the two step process is often more expensive.

And now that you know the basics of how markets are made, we'll talk about liquidity pools next time.

Disclaimer: This podcast references our opinion and is for information purposes only. It is not intended to be investment advice. Do your own research and seek a duly licensed professional for investment advice.

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