Quantum key distribution (QKD) provides a method of ensuring security using the laws of physics, avoiding the risks inherent in cryptosystems protected by computational complexity. Here, the authors investigate the feasibility of satellite‐based quantum key exchange using low‐cost compact nano‐satellites. The first prototype of system level quantum key distribution aimed at the Cube satellite scenario is demonstrated. It consists of a transmitter payload, a ground receiver and simulated free space channel to verify the timing and synchronisation (T&S) scheme designed for QKD and the required high loss tolerance of both QKD and T&S channels. The transmitter is designed to be deployed on various up‐coming nano‐satellite missions in the UK and internationally. The effects of channel loss, background noise, gate width and mean photon number on the secure key rate (SKR) and quantum bit error rate (QBER) are discussed. The authors also analyse the source of QBER and establish the relationship between effective signal noise ratio (ESNR) and noise level, signal strength, gating window and other parameters as a reference for SKR optimisation. The experiment shows that it can tolerate the 40 dB loss expected in space to ground QKD and with small adjustment decoy states can be achieved. The discussion offers valuable insight not only for the design and optimisation of miniature low‐cost satellite‐based QKD systems but also any other short or long range free space QKD on the ground or in the air.