In the past few years, the world has witnessed the unprecedented rise of cryptocurrencies.
From drug money, to internet phenomena, to bank disrupting tech.
And while the ideology behind cryptocurrencies was to create a decentralized, border-less future, it did the impossible and created a parallel universe.
A universe with its own citizens, regulations, ethics, and businesses.
The creators never saw this coming. Yet, the unknown happens all the time and this industry was not be sparred. With the growth in the number of cryptocurrencies, entrepreneurs decided that it would be a nice idea to create a parallel framework, a trading framework.
Holding, (HODLing), is a boring endeavor. Wallets ? Ah, who needs those! I want to take advantage of the price differences. I want to create a trading market. A market which runs 24*7. A market where crypto rules. I want to create the……
STOCK MARKET 2.0
-Unknown Entrepreneur during his eureka moment.
And then, the multi-billion dollar stock market 2.0 industry was born.
The Crypto Exchange Industry.
CRYPTO EXCHANGE BASICS
In its simplest meaning, a cryptocurrency exchange is a marketplace for buying, selling, or shorting digital assets. Based on the market demand and supply, prices are set and change all the time.
To trade, the exchange uses a sophisticated trade matching software, which connects buyer and seller, and facilitates the trade between them. And because it gave you a platform to do so, they charge a small fee per trade.
The market also comes with its own jargon.
There’s “limit orders”, which mean buying at a certain price.
There’s also “shorting”, which is essentially borrowing money to purchase digital moolah.
So far so good.
Right?
No.
No?
Absolutely NO!
THE ELEPHANT IN THE ROOM. CONFLICT OF INTEREST.
Anyone with a basic understanding of blockchain technology, and cryptocurrencies, is sure to know their USP — decentralization.
And exchanges are essentially a centralized entity, possibly the governmentof the cryptocurrency world.
In the past few months, widespread news reports of exchange hacking, false liquidity, poor customer service, and poor trade matching have surfaced.
Yet, the industry is entirely on the mercy of manipulated prices, as well as whales, who I believe might be the exchange owners themselves.
Thus, as a centralized point of sale, exchanges are a single point of failure.
OK — So exchanges are centralized and that’s a problem for you, Joe.
Hmm true, enough of assumptions from my end. Let’s move on to some more technical issues.
Some real alarming points.
Oh, wait. Did I add that there is no legal framework to protect you in case you lose your money?
Not so assuming now, aren’t I.
Technical Issue 1 — Settlements
The first thing to note here is — cryptocurrencies are still unregulated, meaning there are no limits, no assumed risks, no regulated laws meant for fund clearance.
This means, exchanges only settle your trades cause it in their interests, not because they are obliged to do so.
In contrast to the traditional markets, your bank, or your stock exchange, is required by law to settle the money it owes you. Meaning if it goes bankrupt, or has no money on a certain day, the law has made it mandatory for the stock exchange to take a loan from another institution to pay you back.
Back to crypto-exchanges. Settlement risks are high, and if the exchange runs out of BTC, ETH or DOGE one day, it can’t pay you back. It won’t pay you back.
And due to the beauty of this market, it isn’t obliged to take crypto-loans from another player.
Your exchange, in business terms, isn’t anything more than a third party that arranges trades between buyer and seller.
The most you can do during such a time is gather your Reddit-army, while the local police station takes a long sip from a glass of I told you so.
Technical Issue 2 — Liquidity
One of the major reasons of the severe price volatility that the market sees is due to the nature of traders and investors in this market.
From anecdotal observation, crypto-players sit on the sidelines until Reddit and Twitter ask them to buy/sell. This makes liquidity a bitch in this market, as the exchanges heavily depend on their customer’s trades to pay other customers.
Even thou over the years the crypto-market has risen from a mere $90 Million in 2013 to a staggering $250 Billion as of April 2018, the majority of investors have no formal trading background.
During a bull market, investors may find it difficult to take profits, cause there’s simply no one selling. It’s kinda ridiculous to see a bitcointalk originated HODL meme to have become an actual strategy.
But for the exchanges, this is a huge problem.
Such trading behavior contributes to a misleading price spread, even thou the volume of coins traded will significantly be low.
Furthermore, when a whale drops his large bad of BTC on the market, the price will escalate so high that traders miss their stop-losses (price slippage).
Technical Issue 3- Technology
In the cryptocurrency world, absolutely no trading exchange is anywhere close to the technology used by Wall Street institutions, which have server systems that run into millions.
These systems are not only fast, robust, and dependable, but they also offer a very important feature — Security.
The systems used by financial hubs across the world automatically detect market manipulation, bot activities, and other malpractices.
All of this certainly begs the question “Why do people use crypto-exchanges despite so many issues?”
Well, lack of choice is one possible explanation.
Second, in the event of a catastrophe, people know who to catch hold of, who to blame, and who to screw. Centralized bodies mean the CEO, place of registry, and company details are well known.
Third, exchanges allow for fiat-to-crypto trading, which makes them very accessible for the average person to use.
This point can’t be emphasized upon more. The world runs on fiat. You use it, I use it, and the average person uses it. And when the media hypes bitcoin one fine day, a hoard of people rush towards exchanges to purchase BTC from their dollars.
This bunch is typically risk-averse, has an get-overnight rich mentality, and is known for messing up the fragile bitcoin address.
Finally, the user interfaces of centralized exchanges are largely good, with an intuitive sitemap and some level of customer support.
Where Do We Go From Here?
Nice question. Not so simple answer.
Inventing a completely decentralized crypto-exchange, which is self-governed and regulated and run smoothly, is a near impossibility. Specifically in this day and age.
For one, the fundamentals of such an exchange are difficult to achieve, and two, who the hell would take responsibility for all those millions of dollars in trade-matched transactions?
Especially when the centralized competitors match trades in less than ten seconds! (90% of the time)
But.
There’s hope.
Water finds a way, and a completely decentralized world shall soon invent an exchange that runs on nodes, catches fraudulent and manipulated trades, and possibly limits whales from pumping the market.
Plus, how many exchanges really run on the technology they advocate?
You think Binance uses the blockchain, to facilitate blockchain (currency) ?
Furthermore, with every transaction registered on the public ledger, developers would at least have access to any hacker accounts.
I don’t have the answer. But I am searching wide and far, and in case you have some ideas for how a decentralized, self-governed exchange shall run, let’s have a discussion in the comments?
After all, no amount of fiat or crypto can buy the transfer of thoughts and ideas.
Knowledge isn’t tokenized.
Fin.
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If you are reading this — Congrats! you made it till the end of my little article.
I am not a developer or coder or Satoshi Nakamoto. All thoughts here are my own unless otherwise mentioned.
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Featured Image Courtesy — CryptoIncome