What is the difference between a traditional prop firm and a challenge-based prop firm?

Traditional proprietary trading is a capital business. The firm puts real money at risk through a broker or exchange membership, traders often work on site or under contract, and the firm keeps most of the trading profit. It needs substantial capital, risk staff and, in most countries, regulatory permissions.

Challenge-based prop firms are an evaluation business. Revenue comes from the fees traders pay to attempt a challenge. Accounts are usually simulated, and funded traders are paid from the firm's revenue according to its payout terms. Some firms mirror their best traders into real markets, but that is a risk decision, not a requirement of the model.

For a founder, the challenge model needs far less starting capital and no exchange membership, which is why most new firms choose it. The trade-off is that trust, clear rules and dependable technology decide whether traders buy a second challenge.

Which one you are building

If your plan involves selling evaluations to the public and paying successful traders from that revenue, you are building a challenge-based firm, even if you later trade some capital. That decides your technology (a simulator with a rule engine rather than an exchange connection), your legal questions and how you talk about the product.