Cryptocurrency exchanges have been at the center of attention in the world of digital currencies throughout 2017 and 2018. While these exchanges benefit greatly from new people flooding into the crypto markets, they also suffer significant scaling-issues, both on the operational and technical side. Let’s assess the biggest issues that currently affect most of the leading crypto exchanges.
1. Liquidity
The number of cryptocurrencies and exchange platforms is increasing each year. Currently, there are 218 exchanges (according to coinmarketcap.com), compared to 70 exchanges 3.5 years ago.
This fragmentation in the crypto 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 beginning of this year.
However, as crypto valuations are decreasing in the past months, so does the liquidity on (especially small) exchanges. A recent study reported that 36% of crypto traders are upset with the problem of liquidity on prevailing exchanges.
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 liquidity, 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 cryptocurrency exchanges with large liquidity. Some major exchanges now charge up to $1 million to get tokens listed, essentially selling liquidity to the token projects.
2. Security
Not just since Coincheck was hacked, resulting in $500 million in lost funds, do we know about exchange being a single point of failure. 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 adopt to them due to liquidity and user experience concerns.
3. Trading fees
A recent Encrybit survey reveals that traders see fees as one of the most crucial issues with crypto exchanges, with fees regularly ranging between 0.25% to 3% of a single trade.
Trading fees on crypto exchanges are sort of a two-edged sword. While low or no fees can significantly increase liquidity of an exchange, it also allows large investors to manipulate crypto prices more easily and cheaply. On the other hand, cryptocurrencies 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.
Counterintuitively, it seems that exchanges or broker-dealers offering zero-fee trading usually have a business model that is not necessarily good for retail investors. At least that’s what recent revelations about the zero-fee trading platform Robinhood show.
4. Trading pairs
Today we have almost 2000 individual cryptocurrencies 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, 100 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 sufficient liquidity, tokens are usually only found in X/ETH or X/BTC pairings. So trading from token A to token B requires two trades and leads to double the amount of fees necessary in order to convert the tokens.
Additionally, most exchanges do not support fiat currency pairs which means traders are forced to buy ETH/BTC from another on-ramp service, such as Coinbase, transfer the coins to an exchange and trade it for the desired token. This process obviously takes time and results in high exchange fees.
5. Customer support
Rarely have companies seen the amount of growth that crypto exchanges have enjoyed in the last 12 months. But with rapid growth, comes the potential for companies being unprepared to scale their customer service operations in order to meet heightened consumer demand. Rapid growth, combined by the complex and 24/7 nature of the cryptocurrency industry, can be difficult for even the most established organizations to service, leading to huge backlogs of customer support tickets. Staggering 90-day wait periods are now normal for some exchanges.
Conclusion
The recent bear-market is definitely a good opportunity for exchanges to put their heads down and address the above issues in order to be ready for the next wave of market participants coming into cryptocurrencies. However, we could also see other solutions such as decentralized exchanges or broker-dealers being the go-to platforms for crypto traders in 2019.
About 1Konto
1Konto (German for “one account”) is a cryptocurrency broker-dealer enabling access to multiple exchanges from one account in order to provide custom currency pairs, arbitrage and an intuitive dashboard. 1Konto saves traders time, money and headaches by bringing simplicity to the management of cryptocurrency portfolios and managing individual exchange liquidity.
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