Just as you cannot trade stocks without an exchange, the same is true for Bitcoin and other digital currencies. This is what made crypto exchanges an important—and oftentimes problematic—element of the fast growing world of digital currencies. On the surface, they resemble stock markets, matching buyers and sellers and posting prices. But they are significantly different in any ways as well seeing that they potentially expose investors to risks they may not completely understand.
What’s the difference between cryptocurrency and stock exchanges?
They both share a key function, which is to provide a platform for trading assets. However, the similarity ends there. Crypto exchanges hold both charge brokerage commissions and investors assets—both of which are normally separated in the world of stock trading. This alone makes most exchanges highly lucrative, added to the fact that the fees they charge are bigger than traditional bourses’. Japan’s second-largest crypto exchange, Coincheck, for example, was almost as profitable as Japan Exchange Group in 2017. Another notable difference is that stock markets are heavily regulated whereas cryptocurrency, so far, has very little to no supervision in most countries.
What risk does this difference mean for investors?
To put it simply, the protections and laws implemented in the stock-trading world do not exist for cryptocurrencies. The biggest potential risk for an investor would be losing an entire investment, whether by theft from hackers or by the exchange running out of business. Take for example the recent Coincheck hack, where nearly $500 million worth in digital tokens were stolen in January. More than half a dozen exchanges have failed since mid-2014, some due to a hack, and others due to being shut down by authorities. As of May 3, there are approximately 217 major crypto exchanges based on data from CoinMarketCap.
How Can Investors Protect Themselves?
One thing that investors can do to protect themselves is by storing their digital tokens offline instead of keeping them in an exchange. However, in reality, this can be a bit impractical for frequent traders who prefer to spread their holdings across numerous exchanges. Some platforms, like Gemini Trust Co., are trying to raise standards. The exchange company hired Nasdaq Inc. to monitor potentially abusive Ether and Bitcoin trading.
How about government oversight?
Authorities all over the world are slowly catching up to the opportunities, as well as risks, presented by crypto trading, and so far there has been a lot of mixed responses. Japan, for example, embraced the crypto revolution by introducing a licensing system for digital-asset exchanges last year. However, China, which was once considered the global center of crypto activity, is now doing its best to crack down on exchanges and mining farms. In the tiny Island of Malta, on the other hand, the government is compiling a framework seeking to regulate the sector to establish itself as a global crypto hub.
What are Regulators Doing to Protect Investors?
So far, regulators have released widespread and repeated warnings to investors on the volatility and risks involved in crypto trading. Most regulators have also warned against listing tokens considered securities under local laws. In March, Bank of England Mark Carney announced it was time to end crypto “anarchy” and to hold the industry in the same regard as the rest of the financial system.
How Are Exchanges Responding to Regulation?
Exchanges are responding by changing. A new generation of exchanges is emerging and it is one that is more in tune with blockchain’s original libertarian ideals and one that also threatens to change the crypto industry.
Decentralized cryptocurrency exchanges are new platforms that do not hold client assets and leave the actual transactions of the trade to investors. It basically runs on a peer-to-peer system and will be more transparent compared to the current exchange model.
Does this Tell us About the Future of Crypto Trading?
The answer depends on whom you ask. For example, Airswap strategist Sam Tabar who opened a decentralized exchange in April foresees traders moving to the new model this year and it will create such a huge noise in the industry. However there are others like Chia Hock Lai, Singapore Fintech Association’s president, who says the new types of exchanges are rife with their own issues such as inferior user experience and poor customer support. David Lee, author of the Handbook of Digital Currency, however, says that decentralized exchanges will become the main trading platform for cryptocurrencies in five to ten years.