Digital Exchanges: 5 MAJOR CHALLENGES
Digital currency exchanges serve as a platform for Digital enthusiasts to carry out their transactions with their Digital currencies. It provides a service to its customers to exchange their traditional assets. Such as Fiat currency or any other asset into the Digital currency and vice versa. Most of the Digital currency exchanges operate from outside western countries. They do so to prevent the regulations that can be imposed by the financial authority of the country. But, ironically, they operate mostly on the currencies of the Western countries only. For a certain amount of Digital money, the Digital currency exchanges may accept payment in various forms. Such as credit cards, wire transfers, or any other form of payment.
As of 2018 most of the financial authorities of various countries remain unclear about the categorization and jurisdiction of the Digital currency space along with the Digital currency exchanges. As of March 2018, reports by Bloomberg stated that Binance, which is operating from Hong Kong is the largest Digital currency exchange.
Digital currency exchanges enable and power the ability to make a profit in the digital currency space. In other words, the whole Digital currency space is revolving around Digital currency exchanges. Hence, they must maintain their sanity. Most of the Digital currency exchanges around the world are highly equipped. They handle vast amounts of daily transactions, and the market never closes.
Digital currency exchanges have been at the center of attention in the world of digital currencies throughout 2017 and 2018. Digital transactions benefit significantly from new people flooding into the Digital markets. But they also suffer significant scaling-issues, both on the operational and technical side. Let’s assess the most significant issues that currently affect most of the leading Digital exchanges.
1. Liquidity
The number of Digital currencies and exchange platforms is increasing each year. Currently, there are 218 exchanges (according to coinmarketcap.com), compared to 70 transactions 3.5 years ago. This fragmentation in the Digital exchange market wasn’t initially a problem. As this development was in line with a significant influx in new retail and institutional investors joining the markets and providing liquidity. The entire market size has risen from a mere $90 Million in 2013 to a staggering $800 billion. However, as Digital valuations are decreasing in the past months, so does the liquidity on (especially small) exchanges. A recent study reported that 36% of Digital traders are upset with the problem of liquidity on prevailing exchanges.
Problems
Lack of liquidity is a significant problem among the various Digital currency exchanges. Because the market itself is so new and volatile, making it difficult to exit at the right time and price. The fact is not being denied that the trade volume has been increasing with more number of users using the Digital currency exchange, but that is not bringing in the desired effect. For instance, in the Bitcoin market, the lack of liquidity is due to Bitcoin holders who are holding their Bitcoins to gain profit from it as its value rises. And many other users are holding onto the Digital currency until it reaches a certain level of profit. Due to this, we are experiencing large market price swings and higher volatility, which subsequently is flooding the market. This is the point of time where the future markets come into the picture. They prove provisions of selling the Digital currencies which the seller does not hold.
Solution
The Contract is designed to be sold, which are bought at lower prices after some time. This might bring some stability to the Digital currency market. Also, the price slippage in the Digital currency exchanges is caused by them when the users are made to wait for several minutes for their transactions to get confirmed. The lack of liquidity results in two significant problems in the Digital currency exchanges. Due to the lower number of buildings on the Digital currency market, which is thin, large spreads on the compact market is bound to happen along with the inefficiencies caused by the difference in the demand and supply. Secondly, the price slippage due to the highly fluctuating Digital currency market. And hence the trades do not occur at the expected price.
Liquidity is a vital element for any of the market. A lack thereof creates an imbalanced environment, and things go out of control. Due to the decreased liquidity, orders are not placed/executed on time, and the doors are open for large holders to manipulate prices. Additionally, with a lack of cash, markets become more volatile and see more price slippages. A secondary issue of reduced liquidity is that it puts the power into the hands of Digital currency exchanges with high liquidity. Some significant exchanges now charge up to $1 million to list tokens. Essentially, selling cash to the token projects.
2. Security
The Digital currency exchanges centralized significant in a sense that a single authority wholly owns, operated, and maintains them at an only place. Hence, they become an easier target for hackers. The best example for the centralized failure of Digital currency exchange was Mt. Gox. Where almost 650,000 Bitcoins were stolen and resulted in the most massive Digital currency hack of all time. Mt. Gox later filed for bankruptcy. Another similar hack occurred at the Digital currency exchange Bitfinex where attackers stole almost 120000 Bitcoins. Also, the immutable nature of the blockchain technology makes the transactions is revocable. Further, the hacking of Coincheck resulted in $500 million in lost funds. The Coincheck breach was only the latest instance of a series of notable exchange hacks and security flaws in the past years.
While the most prominent one is still the devastating hack of the Mt. Gox exchange, we now count more than 30 major cyber hacks resulting in more than $1 trillion in lost funds. Plus, unexpected security-related shutdowns often lead to hours or even days of the exchange being inaccessible to its users. While decentralized exchanges promise to mitigate the security issues of their centralized counterparts, users have so far been slow to adapt to them due to liquidity and user experience concerns.
3. Trading fees
A recent Encrybit survey reveals that traders see charges as one of the most crucial issues with Digital exchanges, with prices regularly ranging between 0.25% to 3% of a single trade. Trading fees on Digital transfers are a two-edged sword. While low or no fees can significantly increase the liquidity of exchange, it also allows large investors to manipulate Digital prices more quickly and cheaply. On the other hand, Digital currencies inherently promise to disrupt the financial sector by making transactions far more inexpensive, so having centralized institutions taking a cut of every trade seems against this philosophy.
4. Trading pairs
Today we have almost 2000 individual Digital currencies or tokens (1,944 according to coinmarketcap.com). That leads to significant problems if you want to trade one token for another, as the number of possible trading pairs strictly follows Metcalfe’s Law. So, with ten coins, you end up with x=n(n-1)/2=45 possible pairs. One hundred tokens already lead to 4,950 pairs and today’s 1,944 currencies add up to a staggering 1,888,596 possible trading pairs. As most of these trading pairs would most likely not receive enough liquidity, we usually find these tokens in X/ETH or X/BTC pairings. So, trading from token A to token B requires two trades and leads to double the number of fees necessary to convert the tokens.
Additionally, most exchanges do not support fiat currency pairs, which forces traders to buy ETH/BTC from another on-ramp service. Then transfer the coins to the transaction and trade it for the desired token. This process takes time and results in high exchange fees.
5. Customer support
According to some business analysts, the current technology that Digital currency exchanges are incorporating concerning the amount of trading volume they handle doesn’t match. The analysis of the opinion that it might cost almost 10 million USD to build and operate a technological setup for Digital currency exchange. The better the technology in Digital currency exchanges uses, the lesser it is susceptible to the fraudulent activities and market manipulations.
Rarely have companies seen the amount of growth that Digital exchanges have enjoyed in the last 12 months. But with rapid growth, comes the potential for companies not preparing to scale their customer service operations to meet heightened consumer demand. Rapid growth, combined by the complex and 24/7 nature of the Digital currency industry, can be painful for even the most established organizations to service, which leads to large backlogs of customer support tickets. Staggering 90-day wait periods are now standard for some exchanges.
In conclusion, it can be observed that the new market is an excellent opportunity for exchanges to put their heads down and address the above issues to be ready for the next wave of market participants coming into Digital currencies. However, we could also see other solutions, such as decentralized exchanges or broker-dealers being the go-to platforms for Digital traders in 2019.
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