The Problem With Exchanges

Virtual Currency Reality Manipulation

How Cryptocurrency Exchanges Operate

Within the digital currency universe there exists two forms of medium of exchange: cryptocurrencies, which are either derived from (in the case of tokens) or a part of themselves (in the case of coins), a technological protocol called a Blockchain, and virtual currencies, which are visually represented on a piece of software and derived from the imagination of the issuer. In the case of cryptocurrencies, the medium of exchange is decentralised. This means that the way in which the medium of exchange is configured is done in such a way that no one person or entity can manipulate the source of value ascription that is the core utility of the medium of exchange — that being its supply.

In the case of virtual currencies, the opposite is the case: virtual currencies are highly-centralised. In fact, virtual currencies depend upon a centralised form of governance in order to operate. Today a paradox exists which may be serving to undermine the nature of evolution of the digital currency market.

That paradox is this: whereas nearly all digital currencies are cryptographic decentralised mediums of exchange, when they are traded on “cryptocurrency exchanges” they most often immediately become units of virtual centralised exchange, subject to the absolute control and power of the governors of the exchange.

To understand this more clearly, let’s look at how a typical cryptocurrency exchange operates. In Fig. 1, the difference between decentralised cryptocurrencies and centrally-issued virtual currency units is easy to see. First of all, a cryptocurrency holder sends in a cryptocurrency to the exchange’s “storage wallet”. Once inside the storage wallet (often ascribed variously with what look like individual addresses so that the virtualisation of the cryptocurrency is masked), someone running the exchange (often manually) ascribes the unit of virtual currency to the appropriate account holder’s virtual currency wallet.

There is not necessarily any correlation between the accounts held in the cryptocurrency wallet and the virtual currency wallet, however. What this amounts to is that the cryptocurrency holder submits control of the decentralised medium of exchange to become a holder of a centralised unit of value ascription. When he does so, he is in direct competition with the issuer that ascribed him this unit of virtual currency.

Unlike in the case of the decentralised cryptocurrency, the central processor managing the creation of the virtual currency (i.e. the exchange) can at will create as many of the virtual currency units as he wants to. Further, in the same way, the central processor is in control of all aspects of the virtual currency, given that he was the one who created it in the first place. This means that, for the purposes of representing the virtual currency on a live trading platform, the exchange is control at all times of the representation of live and historic orders, live and historic trades, the sums of virtual currency held in different wallets and pretty much everything pertaining to the virtual currency’s status as a medium of exchange.

Challenges For Exchanges

A number of challenges exists with respect to running digital currencies exchanges. These challenges are:

1. An easily-replicable business model with little-to-no customer loyalty

2. Volatile preferences for various digital currencies making for erratic order-flow

3. The necessity of enough cryptocurrency to cash out / collateralise orders

4. Low fees / low margin business

5. Improper governance of competing exchanges creating competitive corruption

6. Advertising and marketing the exchange with a unique value proposition

In nearly all industries, the problem of high competition, little value differentiation, low margins and high capital expenditures are a cause of a very small number — often as little as one or two — dominant players with very little in the way of effective competition. Almost never does such an industry involve a more evenly distributed spread of competitive market entrants than this.

It is notable and extremely surprising therefore to find such a large number of competing digital currency exchanges on offer., a data and information provider, lists 230 of such exchanges. Out of the top 100 digital currency exchanges, the adjusted (for “accuracy”) daily volume on Monday, December 17, 2018 for the Number 1 market incumbent (OKEx) was $465.8 million with the Number 100 exchange posting $1.45 million of daily average volume. Between the first and the one hundredth placed exchange, an average of $65.9 million of average daily trading volume was posted, with a standard deviation (average variation) of around $98.5 million between each exchange’s average. While the standard deviation, at 149%, may seem very high at first glance, consider that in competing industries, with similar sorts of challenges, there are only one or two properly-established marketplaces of comparable functionality. In the United Kingdom there are five main exchanges: four are part of the Financial Stock Exchange Indexes, and one is separate, called NEX. Among these five exchanges exists a cumulative daily volume of approximately half a trillion British pounds (about $750 billion) wherein 87.8 billion British pounds of average daily volume is present per each exchange varying by approximately the same amount (98%) per exchange. This is across just five exchanges however. If we are extrapolate the digital currency exchanges data and apply it to the London Stock Exchange and vice-versa, we would naturally assume that with just 100 digital currency exchanges on offer, the average standard deviation should be about 20 times as high. In other words, were the volume data to be in any way real on any of the digital currency exchanges, we would expect to see the largest digital currency exchange producing $9.3 billion of average daily volume and the smallest of the 100 producing just $72,500 of average daily volume. This would of course, necessitate a situation similar to that of the London equities indexes, where only 4 or 5 digital currency exchanges were in existence.

Applying this 20x scaling principle backwards however to the digital currency exchanges reveals that the true state of volumes is a somewhat different picture to that depicted on OKEx, the largest player, seems to be generating approximately $890 million of exchange volumes, manufacturing more than $16 billion of daily average volumes. Why is there such a large extent of volume manufacture here? Commenters have suggested that the manufacture of volumes by digital currency exchanges is primarily to obtain a higher ranking on, a leading source of data for the cryptocurrency industry.

Manipulation of Virtual Currency Assets

This explanation is significantly less likely to be the case than the possibility that most digital currency exchanges are attempting all the time to out-manoeuver the reality that they have considerably less (it would seem, about 95% less) cryptocurrency in their storage wallets than virtual currency that is represented on their platform interfaces. In such a situation, one would be compelled to constantly reduce price increases, hot performing cryptos, or even to manufacture winners so as to manipulate the amount of collateralised virtual currency in the control of their customers’ hands.

Fig. 2: December 17, 2018 (Source:

If it is in fact the case that digital currency exchanges were manufacturing volumes in order to obtain the cryptocurrency of their customers while leaving such customers with virtual currency units those customers often abandon on exchange, or remove in the form of heavily-premined (and hence cheaper to obtain) cryptocurrencies that the exchnage can easily cash out, we would expect to see a situation in which volumes increased and prices decreased. This situation, whereby an exponentially higher amount of cryptocurrencies are traded at falling values, is indicative of market manipulation.

Fig. 3: December 17, 2017 (Source:

First, people do not come in increasing quantities to a game where losses are amounting up. Second, orchestrating such increases in volumes traded is the only way in which digital currency exchanges would be able to represent virtual currency losses over such a short period of time as was required to obtain some sort of higher-value unit of decentralised currency such as bitcoin.

In the present day, that is, at the end of 2018, cryptocurrency prices have declined approximately 85%. Meanwhile, volumes as a portion of total market capitalisation stand at about 11%. Bitcoin gives us a great example however of what is really going on. On December 17, 2017, the volume for Bitcoin was around $14 billion on a market capitalisation of $284 billion.

One year later, despite a price reduction of 82%, volumes stood at $4.3 billion on a market capitalisation of $59.9 billion. In other words, whereas volumes for Bitcoin stood at only 4% of market capitalisation in 2017, despite falling in price over four fifths in total, the volumes as a percentage of market cap increased nearly three-fold, to around 9%. Such a scenario is simply impossible to consider as being caused by anything other than deliberate downward price manipulation. It supposes that despite the collapse of Bitcoin, over two times as many market participants were drawn to invest in bitcoin. The two scenarios are logically incompatible.

The cause of this behaviour is clearly that running an exchange is by and large, an extremely cost-intensive, highly competitive, low-margin business, which holds next to appeal for entrepreneurs wishing to cash in on the new digital gold rush. Instead then, such entrepreneurs manufacture cryptocurrency volumes in the form of virtual currency trades represented uncollateralised on their exchanges, in the hope of obtaining (stealing) the majority of their customers’ cryptocurrency over time.

To do this, there is a clear incentive to direct prices sharply downwards after they hit a peak, so that the customer perceives a lack of point in removing the digital currency from the exchange. This, in turn, gives the exchange the affordable luxury of simply taking the remaining cryptocurrency that the majority of its customers have removed from exchange, cashing it into fiat, and putting it in its owners’ bank accounts.

Community Capitalism by Zurbank

Financial Art For Tomorrow

Daniel Mark Harrison

Written by

Chairman & CEO of DMH&CO and author of The Currency Revolution ( You can reach me at

Community Capitalism by Zurbank

Financial Art For Tomorrow

More From Medium

Welcome to a place where words matter. On Medium, smart voices and original ideas take center stage - with no ads in sight. Watch
Follow all the topics you care about, and we’ll deliver the best stories for you to your homepage and inbox. Explore
Get unlimited access to the best stories on Medium — and support writers while you’re at it. Just $5/month. Upgrade