Crypto Exchange Problem

Surprising Revelations about Cryptocurrency Exchanges

With the very recent report released by Bitwise about cryptocurrency exchanges out in the public, this is the right time to talk about the primary issue with the system – transparency.

The relationship between exchanges, token issuers, and websites with the token volumes is already seen as doubtful despite the volatility issues that have been plaguing the crypto-markets. This three-way relationship gives rise to some very peculiar consequences, including volumes of cryptocurrencies, circulating in the market in such volumes that cannot be justified.

To add to this context, the report presented by Bitwise was submitted to SEC as a comment, which said that although Bitcoin’s strength has improved significantly in the past years, as much as 95% of volume figures cited by different crypto-exchanges were allegedly forged. The same findings were supported by an analyst from The Block, who also agreed that about 86 percent of the exchange volumes are fake (Vilner, 2019).

Bitwise stated in their report that Bitcoin is a mature product with an efficient market, however, the most striking conclusion is that there are only 10 exchanges that show real trading volumes on their website. The analysis included live web scraping by Bitwise on 83 exchanges, 73 0f of which could pass the evaluation. The report quoted, “10.5 billion dollars out of the 11 billion dollars in reported daily volume (or 95%) are either fake or wash trading.”

The analysis methodology carried out by The Block was a bit different. What they did was that they analyzed the monthly website traffic for 6 months to check if the number of trades is following the traffic being directed towards the website. The study was spread over 48 exchanges, out of which Binance and Coinbase were on top with 185 million and 143 million traffic hits over a period of six months respectively. This finding is in fact, not surprising, but supports a previous claim by the Blockchain Transparency Institute (BTI) that Binance and Coinbase are among the most popular exchanges with real volume. The Block however slightly disagreed with the approach adopted by Bitwise in their analysis. They pointed out that Bitwise ignored the real volume on hundreds of exchanges, thinking of it as fake figures.

No doubt, examining cryptocurrency trade volume is a very challenging task and no one can be sure as to whether the figures are legitimate or not. However, we are certain that the trading exchanges are full of fake figures, backed by the studies published by both Bitwise and The Block. One reason exchanges might tweak their real figures is to maximize the effect data aggregation websites like CoinMarketCap can have on the inflow of potential investors to their websites. The higher the crypto-exchange is listed on the listing site, the more investors it would attract, starting a wave of positive feedback within the crypto-community.

It was reported that during the unregulated ICO-phase, some listing fees for ICOs on exchanges soared to millions of dollars. There are not enough reasons or incentives for a smaller and newer exchange to engage themselves in inflated reporting and wash trading, but at the same time, some consequences that might appear later in the life of exchange are widely ignored, particularly the issue regarding the solvency of exchanges. While fake volumes, ICO scams and solvency issues of exchange may seem like an unfixable problem, it has been discovered that it is not!

In fact, more and more exchanges are trying to make their ecosystem as transparent as possible, by adopting measures like self-regulation via revenue reporting, proof of reserves, standard protocols, etc. The ultimate decision to choose a particular exchange for trade lies solely on the investor and is based on his research and knowledge about crypto-markets and their legitimacy.

Companies like BTI and Nomics have emerged on to the crypto-markets which provide data-driven metrics and analytics for exchanges, analyzing any inconsistencies between trading volume and website traffic. BTI even provides in-depth reports on exchanges, their legitimacy, and other issues.

The race to being the number one crypto-exchange also hinders many startups from publicly reporting revenue for fear of other competitors taking advantage of their transparency. A startup by the name of ArpaChain, while addressing this issue, has started to use a cryptographic technique called ‘secure multi-party computation,’ which allows function computation without revealing its independent inputs. Taking this context further, it could also mean that exchanges can join forces to self-regulate, without necessarily revealing any exact financial details of their own. For example, Kraken provides regular details of their ‘Proof of Reserves’ audit process to build on the confidence of their customers. Arwen Protocol, on the other hand, has devised a solution based on atomic swaps to deposit the crypto-tokens on to the centralized exchange.

Likewise, there are propositions for scaling Bitcoin through concepts like Bitcoin Bank, or at least an exchange or a financial institute that unmask risk to the users. It is a hopeful solution and a much-needed improvement to make up for the lack of transparency Cryptocurrency exchanges are gradually becoming notorious for. Investors are equipped with proper tools nowadays that can help them discern the truth for themselves, in a cryptocurrency ecosystem that can pose as both a challenge and a risk.

References

Vilner, Y. (2019, June 15). Forbes. Retrieved from Forbes: https://www.forbes.com/sites/yoavvilner/2019/06/15/new-report-illustrates-the-problem-with-cryptocurrency-exchanges/#5ec012446b60