The explosion of blockchain interest in 2017–2018 has led to crypto exchanges taking up a vital role in the fintech industry. The business of providing shovels for those digging gold proved to be highly rewarding.
Crypto asset price movements are largely driven by exchanges in some manner — be it a token listing or delisting, wash trading, bot manipulation, or, in rare cases, even getting hacked. It’s a rollercoaster ride which can infuse vertigo for any dedicated token holder.
Their influence is inescapable, yet many do not understand the central part exchanges play in all things crypto. This article is the first in a series that will look at why exchanges matter and how they can be improved.
Why do we need exchanges?
Before looking at why crypto exchanges are crucial to the crypto ecosystem, it is worth looking at traditional exchanges more widely, why they are important and how are crypto exchanges different.
Although there were primitive exchanges as far back as the 16th century — and more rudimentary forms date even earlier — stock exchanges really only began to flourish with the emergence of joint stock companies. They arose alongside the development of the East India companies, sponsored by the French, the Dutch and the British governments. Ownership shares were sold in these companies that paid dividends on the proceeds from their voyages.
As stock exchanges developed into more sophisticated and larger enterprises, they have come to facilitate:
- Liquidity. Pooling together of investors who wish to buy/sell shares greatly increases liquidity. This has evolved to investors worldwide being able to access shares and other financial instruments from areas they would previously never have been able to.
- Efficient pricing. A regulated exchange allows for efficient price discovery as demand and supply are more easily matched (this should not be confused with the market being rational).
- Safety. Because stock exchanges are heavily regulated, companies wishing to have their shares traded on such venues are vetted and scrutinized to ensure they are both legitimate and operate according to the industry procedures. Although there are numerous cases of publicly traded companies acting fraudulently, regulation helps to reduce the number of such events.
- Capital allocation. Exchanges match capital between investors and companies, encouraging economic development. They also tend to facilitate capital flows towards the strongest companies at least in long-term avoiding the waste of investments in unproductive companies.
Cryptocurrency exchanges: still in school
Crypto exchanges in their current form fulfill only a small part of these functions.
They do provide liquidity to the system as they have enabled a 24/7 trading dimension in which thousands of crypto assets are available for trade no matter where people live. As long as you have an internet connection, you’re good to go.
However, as we will later analyze crypto exchanges may also be presently suppressing liquidity by deterring market participants from entering the space.
While it would be fair to say they provide liquidity (at least in some cases), with other functions, there is less certainty. Liquidity aids to facilitate efficient pricing but only when there is no market manipulation occurring.
No stock exchange can ever be wholly free of market manipulation, future articles will analyze how crypto exchanges, in particular, are plagued by practices which make pricing distinctly inefficient. The sad thing is that unknowing retail traders are the ones who cover the costs…
While crypto exchanges may provide a venue for two investors to securely transact, they are again lacking when it comes to safety measures. Since crypto exchanges first sprung up, many have been run by inexperienced, under-resourced or opaque teams — a far cry from the transparent and professional operators of normal exchanges. Naturally, it leads to insecure practices which can put investors at risk.
Capital allocation is harder to scrutinize. While exchanges have certainly afforded investors access to a plethora of crypto assets, many of them have no formal listing process other than simply to charge a listing fee.
The fees are often extortionate, sometimes reaching as high as $5M depending on the exchange. This far-right utopian environment enables fraudulent projects to be listed without any due diligence made, the sale of non-compliant tokens that are subsequently delisted, ‘pump and dumps’ of thinly traded assets and other issues which can render large losses to holders, as well as cause setbacks to the industry in general.
It is natural that crypto exchanges do not match up to their traditional counterparts yet. They are new, have largely existed without external regulation and provide means to exchange an asset which, even now, few fully understand.
However, they have grown so big already, that it is impossible to ignore them.
Stay tuned to CoinStruction blog in which we will continue investigating issues nacking cryptocurrency exchanges. We will not stop until we get to the bottom of it. Why? Because we want to do and be better. And for that learning from the mistakes of others is crucial.
About the author:
At CoinStruction, we are focused on providing liquidity and efficient pricing to improve capital allocation practices. Through the facilitation of transparent order books and clearance, efficient trade execution, and liquidity aggregation we believe we can solve most of the issues users currently face with exchanges.
Moreover, it also allows us to meet the demands of corporate end users, rather than solely servicing retail investors. By doing this we will be able to solve many of the problems that currently exist in the market and bring benefit to all market participants.
CoinStruction — the world’s largest crypto order book!