Early 2021, the US’s largest Crypto exchange Coinbase went listed on Nasdaq, a traditional stock exchange, through a direct listing process. In this article, we will shed some light on the development of crypto exchanges, and some concerns regarding their liquidity and legal risks.
Decentralised exchange and centralised exchange
Crypto exchanges have two different types: centralised exchange and decentralised exchange . A centralised exchange shares similar functions with a stock exchange, where they trade tokens instead of shares, with a central authority managing the platform. A decentralised exchange (DEX) instead is an application impacted by decentralised finance (Defi), solely acting as a non-custodial marketplace where peers can freely exchange cryptocurrencies. The first cryptocurrency exchange emerged in 2009, where people can trade bitcoins with different currencies. Some well-known centralised exchanges today are Coincase, Binance and Gemini (Arora, 2021). As for the decentralised exchanges such as Uniswap, they only facilitate crypto exchanges but not trading with fiat currencies.
Concerns and risks
While choosing which exchanges to trade or list their tokens, investors and companies need to pay attention to the liquidity of different exchanges. Companies can issue tokens instead of shares as a method to raise capital, however, not all exchanges are liquid enough to benefit investors and fund raisers. According to incomplete research, over 500 crypto exchanges are competing in the market (Schueffel, 2019). Concerns are that liquidity figures of each exchange are self-reported with insufficient evidence and audit to prove their authenticity. For example, if an exchange claims to have two million users, no trustful document can provide the genuineness of this figure.
In addition, not all exchanges are regulated, choosing unregulated ones could be riskier for both companies and investors. An LSE blog (Mosioma, Walker, 2021) pointed out that only four of the largest crypto exchanges are significantly regulated. Although regulated, the focus is on anti-money laundering and due diligence matters rather than trading (Mosioma, Walker, 2021). Therefore, investors are not yet protected by existing regulations.
Overall, unlike traditional stock exchanges that are legally scrutinised and well-structured, the crypto exchanges are still immature and subject to controversy. With the Chinese government officially banned cryptocurrency trading, it is worth investigating whether the crypto exchanges will take actions to build a more transparent and trustworthy trading environment.
References
Arora, K., 2021. Centralized and Decentralized Cryptocurrency Exchanges | Analytics Steps. [online] Analyticssteps.com. Available at: <https://www.analyticssteps.com/blogs/centralized-and-decentralized-cryptocurrency-exchanges> [Accessed 1 October 2021].
Walker, M. and Mosioma, W., 2021. Regulated cryptocurrency exchanges: sign of a maturing market or oxymoron?. [online] LSE Business Review. Available at: <https://blogs.lse.ac.uk/businessreview/2021/04/13/regulated-cryptocurrency-exchanges-sign-of-a-maturing-market-or-oxymoron/> [Accessed 1 October 2021].
Great article Amanda! I am big fun of investments and I have a differentiated portfolio between stocks and cryptos! The introduction of Crypto exchanges and blockchain was one of the most popular tech revolutions and have become one of the hottest potatoes of our days. For less than 20 years market capitalisation of global crypto-currency markets has been growing with an enormous speed reaching approximately 2.5 trillion in 2021! Even Messi, one of the best footballs players in the world, signed a contract with PSG this summer and accepted to be paid in some of the French club’s cryptocurrency fan tokensBut along with the integration of crypto exchanges in our everyday lives and transactions, great risks raise, as the ones that you already mentioned in your article, with regulation issues being very important and need to be resolved. Furthermore crypto exchange platforms face security issues a any other online business. One of the biggest challenges faced by them is a distributed denial of service (DDoS) attack; A victim of a DDoS attack is overwhelmed by bogus requests that are directed by the attacker towards it’s network infrastructure. Hence, the attack leaves the website unreachable to the desired users, degrading its performance (Reinoud Joosten et.al ). In addition cryptocurrencies are still very vulnerable and depend on their acceptance by big conglomerate companies (Tesla announcement that will stop accepting Bitcoins cause the plunge of Bitcoin) or countries (as the one you talked about). To put it in a nutshell, wherever there is danger, there lurks opportunity and this is the reason that companies try to adopt these change as Deloitte does by having created a new department called Blockchain Risk Management
Very interesting article and important sub-topic, which needs to be further investigated on the risk-management perspective. In my opinion the asset class “cryptocurrencies” in general has developed, from a more exotic class after the financial crisis around 2009, to meanwhile a more general and accepted asset class. Before the big bitcoin crash around Christmas 17’, primarily retail investors were invested into cryptocurrencies, further the decentralised exchanges were more favourable. Although back then investing via DEX seemed to give one’s portfolio a high rate of liquidity and low transaction costs, there was a high legal risk component. First, the fact that these assets are traded decentralized has given rise to an opportunity of money laundering, as well as commercial trade within the dark net. (Take for example the several Russian hacks on governments and large corporates within the last 2 years, all to be paid in bitcoin, since it is not traceable.) One the one side, the central banks and authorities aim to promote democratizing digital currencies, i.a. for the support of access to digital payments in rural and underdeveloped economies (e.g. Salvador being the first country to accept Bitcoin as legal tender). On the other hand, central banks know, and at some point, will intervene to keep influence on the money supply and retain financial stability. A further legal risk is how cryptocurrencies are defined by legal authorities rather as property, instead of currencies. Hence, different taxes apply and the complexity for financial reporting increases, especially since decentralised products lack of information. The liquidity risk has also been increasing over the last years. The shift from only DEX to more centralised platforms, as well as the ability to invest into certificates and funds invested into several cryptocurrencies. Mining e.g. more bitcoins every year might increase the supply, yet the asymmetry among costs and information among several types of exchanges as well as the growing discrepancy among institutional- and retail investors, increases the risk of liquidity massively. Lastly, the volatility and hence Value-at-Risk of this asset class per se, remains high. Myself and the majority of retail investors worldwide view cryptocurrencies more and more as an attractive opportunity for diversifying one’s portfolio. Past performance is not an indicator for the future itself, yet low interest rates and bonds becoming less attractive and the increase access to information, make the rise of cryptocurrencies a self-fulfilling Prophecy. The importance of cryptocurrencies and especially the underlying technology of blockchain will rise, there is no doubt. Yet, the management of the underlying risks will need receive the proportional attention.