The fast-growing, billion-dollar crypto-exchange industry is quickly becoming a business avenue as huge as the blockchain sector, as they represent a major part of the cryptocurrency market, in the form of providing a platform that facilitates quick buying/selling of digital assets.
Crypto Markets and Equity Markets Have a Huge Fundamental Difference
It’s evident that crypto-exchanges are near traditional exchange platforms regarding security, scalability, and accountability. However, crypto-exchange owners are seriously looking to amp-up their offerings, in order to prevent any regulatory crackdown.
As opposed to traditional equity or derivative markets, which are backed by real-world physical assets in a separate location, cryptocurrency exchanges hold both the private keys and digital assets of the investors – making this a fundamental security flaw!
To illustrate this point, if an investment firm offers its investors a financial investment, of say, aluminum, the company is bound by law to have the actual metal stored in a highly-secure, insured warehouse, such that any unfortunate case of theft is immediately paid for by insurance. Investors trade a “derivative” of aluminum, and not the metal itself.
To operate similarly, crypto-exchanges must use the assets present in the investor’s wallets, and provide a “derivative” of the total amount of assets held. Instead, the “real” coins are traded and are not secured by any backed-up digital assets. This makes repayment a huge issue in case of exchange solvency due to an unfortunate hack, as evidenced by Mt. Gox’s 2013 bitcoin hack which hasn’t repaid the investors lost funds after five years of the mishap.
Due to this, are heavily coming down on the sector, all in a bid to protect investor funds.
Exchanges Amping Up Security
While most exchanges resort to the minimum industry-standard of holding all tokens in a cold-wallet, others are taking advanced measures and ensuring total compliance with authorities.
An example is the Winklevoss brothers-owned Gemini Exchange, which was a security on April 12, 2018, covering a detailed system that aims at securing digital transactions via a complex time-stamped hash network
In addition, the exchange its partnership with NASDAQ on April to monitor any suspicious trading activity.
While not completely opposed to cryptocurrencies, the U.S.A famously warned exchanges in 2018 about offering any tokens that constitute as “securities,” alongside warning investors about the highly volatile nature of digital assets.
In April 2018, 13 U.S.-based crypto-exchanges a letter from New York State Attorney General Eric Schneiderman, asking them to provide information about the security measures they have implemented to protect investor funds. In response, Jesse Powell, CEO of Kraken, the attorney’s efforts, adding “licensing, regulation and market manipulation doesn’t matter to most crypto traders.”
The Rise of the DEX
In the wake of regulatory controversies, and affirming to blockchain’s decentralized ethos, a new wave of decentralized cryptocurrency exchanges, or , are emerging.
As a fundamental practice, DEXs do not hold investors assets, instead of providing a peer-to-peer platform for connecting buyers with sellers, closely mimicking a “swap,” as is famous in the traditional finance markets. DEXs also run on their own blockchain, allows investors and regulators alike to view all transactions and trading taking place on the platform.
The advent of DEXs has the cryptocurrency community divided, with some lauding the concept and others bashing its supposed inferiority.
AirSwap’s strategist Sam Tabar believes that traders migrating to the new (DEX) model will be “this year’s big crypto story.” As by BTCManager on April 29, 2018, the DEX platform traded north of $1 million on its opening day.
Echoing his thoughts is the author of the Handbook of Digital Currency, David Lee, who ascertains that “decentralized venues will in five to ten years become the main avenue for trading cryptocurrencies.”
However, Chia Hock Lai, president of the Singapore Fintech Association:
“The new types of bourse have their own particular issues, such as an inferior user experience and lower levels of technical support.”
Nations Remain Divided On Crypto
While the massive revenues raked in by cryptocurrency exchanges directly equates to tax earnings by governments, not everyone is proceeding with this narrative in mind.
In 2017, Japan introduced a mandatory licensing system for cryptocurrency exchanges, and , in March 2018, appealed for crypto-businesses to set up shop in the island country.
Not all nations display a friendly disposition though, with and placing an indefinite blanket ban on the crypto industry in 2017 and 2018 respectively.
The magnitude of a hack is massive as well. In January 2018, Japan-based Coincheck was targeted by hackers who made away with $500 million in stolen XEM tokens; a digital currency ranked fourteenth largest by virtue of its total market cap. Hence, exchange security and token holding is a serious issue in this sector.
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Hedge funds that focused on cryptocurrencies are indeed thankful for April 2018, and they have all the right to be. The digital currency sector recovered considerably and in the process, ended a two-month losing streak.
Hedge Funds Mark Recovery
Recovering from the 34 percent decline in March 2018, the Hedge Fund Research () Blockchain index a 47.1 percent leap in crypto funds’ performance in April 2018. Thanks to this, crypto’s year-to-date (YTD) losses are now narrowed down to 19.3 percent.
However, there is a discrepancy between the figures shared by the HFR Blockchain Index and the HFR as the latter showed a higher number of returns at 48.52 percent and reported the YTD losses to be at 17.48 percent.
HFR president commented:
“Hedge funds extended gains in April to begin the second quarter and also extended the YTD outperformance of most equity market indices, with support and contribution from Energy and Volatility exposures.”
Additionally, the HFR Fund Weighted Composite Index a total of 0.38 percent which ultimately brought the year-to-date performance to a slight rise of 0.39 percent. This was opposite to the decline in year-to-date equity market standard S&P 500, DJIA, DAX, FTSE, and MSCI World indices.
Heinz provided additional insights:
“The process of developing better politics for transitions and economics for creating long and short opportunities across a series of specific exposure and industries is being continued. These industries are inclusive of fixed income/interest rate-sensitive equities, retail, M&A, technology, and blockchain. This is a sure-shot process that aims at driving unmatched performance throughout mid-2018.”
The two-fold rise of the total market volume in 2018 was predicted by earlier, based on the launch of various funds. The percentage gains of crypto-focused funds in April goes on to strengthen the prediction.
The study informed:
“Apart from being the fastest growing segment of the hedge fund industry, Crypto hedge funds were also amongst the top performing hedge funds in 2017.”
VCs Quickly Turning Attention Towards Blockchain
Shifting attention from the conventional digital asset fund, hedge funds, fintech VC firms are waking up to blockchain’s potential and are investing in the domain.
, for one, a relatively new enterprise in cryptocurrency, has received from Peter Thiel of PayPal. The firm aims at providing solutions to the many challenges faced in crypto trading to new investors, and serve as a reliable platform for institutional investors to get exposure to digital assets.
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The released a report on May 7, 2018, as part of their Economic Letter detailing the impact that the launch of the bitcoin futures market had on the price of bitcoin. Researchers at the SF Fed carried out a detailed study on the rise and fall of bitcoin prices in 2017. Their overall conclusion is that the emergence of caused the decline in the prices of bitcoin.
Not a Coincidence: Futures Launch and Price Decline
The proximity between the launch of the futures market and the sharp rise and fall of the pioneer cryptocurrency in late 2017 was no coincidence, says the report. Reiterating the fact, the four researchers responsible for the study wrote that:
“The rapid run-up and subsequent fall in the price after the introduction of futures does not appear to be a coincidence.”
of $19,783 on December 17, 2017, the same day the its bitcoin futures trading. Researchers believe that there exists a chain of causality between the two events that can be proven beyond reasonable doubt by looking at the evidence on offer.
The report also bases its conclusions on the fact that bitcoin behaved like other assets when a futures trading market was introduced.
The arrival of futures contracts meant that for the first time since the inception of the market, people could comfortably bet on the decline of bitcoin prices.
While futures trading might have been recorded as an increase in trading volume bottom-line, they had the opposite effect on the value of bitcoin.
The effect of pessimistic trading instruments seemed to be even more profound in the case of bitcoin, given the unprecedented volatility of the market. Futures trading enabled the introduction of purchase and sales contracts at lower delivery prices than the current price at the time the trade was initiated.
As the volume of such “negative” trades increased, downward pressure was being exerted on the . Thus, bitcoin futures began to cause a drop in the spot price, and once this happened, the bears had further incentive to fuel short selling which forced prices even lower.
Gradual Decline vs. Instant Collapse
The Fed report addressed what would potentially have been a glaring issue in its analysis if left unexplained. If the premise is accurate and futures caused bitcoin prices to drop then why was it a gradual decline and not an instant collapse?
To answer this question, the report explains that the Cboe bitcoin futures trading began a week earlier than that of the CME. However, trading was thin as there seemed to be a general reluctance to enter the market at inception. This reticence did eventually give way to more active futures trading within a few short weeks.
NYSE Parent to Adopt bitcoin
There have been that more institutional finance players are looking to enter the bitcoin market. Even on Wall Street, where the default narrative has always been that bitcoin is unregulated, things are beginning to change. Goldman Sachs recently announced that it would soon open a , becoming the first Wall Street bank to do so.
Intercontinental Exchange (), the parent company of the New York Stock Exchange () has also on May 7, 2018, that it too is planning to launch a bitcoin trading service.
With all of these mainstream financial behemoths coming into the market, some crypto purists are worried that cryptocurrency is being taken away from its libertarian roots. According to them, the pioneers of the system wanted to create a financial ecosystem that could do away with banks in favor of a direct relationship between the two participants of a transaction.
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