Stalling Mass Adoption Vol. II Cryptoexchanges exert dramatic influence on the market
In our previous article we looked at areas in which crypto exchanges are arguably falling short.
Sometimes however, it may be tempting to think that such issues don’t matter, particularly if you are unaware of the historical losses investors have suffered at the hands of exchange negligence or fraud. Or it just hadn’t happened to you. YET…
These mishaps have helped to highlight that exchanges occupy a central and vital role within crypto. As such, it is important to recognize and understand why they are important and how their impact can be felt right across the industry.
1. Exchanges hold considerable amounts of crypto in their balances
A recent report estimated that 15% of all BTC are on exchanges, going on to note that “3.8% of the total bitcoin supply is currently sitting in the top 5 wallets…known to be managed by major exchanges”.
That is purely BTC held on exchanges — it is reasonable to assume that given retail investors make up a higher proportion of altcoin holders, the proportion of altcoins on exchanges is actually higher than this.
Despite the persistent threats of losses, users leave their funds on exchanges because they trust them initially, are unaware of the risks involved or have too little technical knowledge about hot/cold wallets and or custodianship.
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Being susceptible to hacking and malfunction cryptocurrency exchanges indirectly put user funds at risk of theft. As long these cryptoassets hold any value, dishonest intruders and cybercriminals are naturally attracted, even incentivized to try and break the exchange’s firewalls and grab the loot.
Given the somewhat anonymous architecture of crypto, the lack of international regulation and consumer protection policies — these digital coins constitute a perfect gateway for criminals to steal someone else’s money.
Already, there have been plentiful examples of that.
The biggest and one of the best-known events is the hacking of Mt. Gox, which continues to impact price in the space years after the initial hack and theft occurred. As we will look at in our next piece, this can be lead to dire consequences for both users and networks alike.
2. Impact on price and adoption
Much of the coverage of cryptoassets focuses on their speculative investment potential. Exchanges affect their price in a number of ways. They also have an an indirect effect on the sort of investors who enter the market, and on how regulators treat them, which in turn suppresses demand and, likely, the price.
Jerry Brito, the Executive Director at Coin Center, an American based crypto lobbying firm, noted after the SEC rejected an Exchange Traded Fund (ETF) proposal that “the Winklevoss ETF proposal was rejected because the SEC found that the significant markets for Bitcoin tend to be unregulated overseas markets that are potentially subject to price manipulation”.
Because exchange activity cannot be trusted — and because they can impact prices significantly — regulators have refused to approve ETFs which would open Bitcoin and other cryptoassets to a wider audience of institutional investors.
For cryptoassets to reach the same level of trading volumes that traditional asset classes such as stocks and commodities enjoy, institutional investors are a must. And for that to happen, exchanges need to be more trustworthy and regulated operations.
The entrance of such investors would likely in-turn legitimize crypto as an alternative asset class, ensuring ensure more attention and resources flow to the sector. However, without international regulation and protocols of conduct in place, it’s very unlikely that it will happen.
3. Gateways to crypto
Exchanges have also become the ultimate arbiters as to whether cryptoassets live or die. By refusing to list them, most cryptoassets are starved of attention and ultimately die, shorn of new investors, adopters and/or believers. This means that exchanges, with their large listing fees, play an outsized role in determining if cryptoassets succeed or not.
It also creates conflicts of interest — exchanges are incentivized to list cryptoassets they personally hold or are given as they can then profit from selling them on their own exchange. The impact of being listed infuses opportunities for insider trading, as announcements can drive individual prices 100% instantly, especially given the right circumstances. Hence, the urgent need for crypto regulation.
4. Exchanges as guardians
As Nic Carter opined recently at Baltic HoneyBadger 2018, users need to “encourage responsible behavior” of exchanges. They now act as ‘digital banks’ and, just like banks occupy a vital role in the financial system, so they exert great influence over the crypto environment.
It is not so long ago that banks, despite their ill-practices, were deemed too big to fail. It is possible that one day these digital banks become too big to fail; analyzing potential areas of improvement now could save much pain later and prevent retailers and regular individuals from getting, as the popular slang saying goes, rekt.
Our future articles will look at the ways these guardians are arguably coming up short, including analyzing the history of exchange hacks, trading manipulation, and liquidity issues.
Stay tuned to CoinStruction blog where we will continue investigating issues nacking the cryptocurrency industry and 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 while improving capital allocation. Through the facilitation of a transparent order book clearance, efficient trade execution and by aggregating liquidity, we believe we can solve most of the issues users currently face with exchanges.
This also allows us to meet the demands of corporate end users, rather than solely retail investors. Through this, we believe we will be able to solve many of the problems that currently exist, to the benefit of all market participants.
CoinStruction — the world’s largest crypto order book!
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