Crypto Markets Are Broken

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Cryptocurrencies are going to be a significant part of the financial landscape going forward and existing problems, lack of liquidity, outdated technologies, bad actors, need a solution.

Cryptocurrencies have captured international attention this year. Although trading currency is nothing new, it certainly feels like an ancient concept being renewed by novel technology. The rapid price increase of almost all digital tokens, which is most noticeable in Bitcoin’s 1,600 percent improvement this year, and their surprising integration into mainstream investment markets through futures contracts, has made crypto trading an appealing pursuit for many investors. In fact, with a total market cap of more than $400 bln, crypto trading is becoming one of the hottest investment opportunities available.

Unfortunately, many traders are finding that the technological advances or even basic trading needs found on traditional investment exchanges are utterly lacking on crypto exchanges. This could be a big problem.

While cryptocurrencies have never been more popular or more in-demand, the exchanges that are intended to facilitate the buying and selling of cryptocurrencies are subpar and inefficient. In their current state, they are the tangible manifestation of people’s worst fears about cryptocurrencies. In general, they lack equity between exchanges, they utilize embarrassingly outdated technology, and they are infused with bad actors.

It’s clear that cryptocurrencies are going to be a significant part of the financial landscape going forward, but these problems need a solution. Perhaps by better understanding how crypto markets are broken, we can begin to find answers for their shortcomings, so that they can thrive.

Lack of liquidity

Some of the very principles that make cryptocurrencies so appealing – mainly their decentralized and autonomous nature – also make them a liability when trading. When trading cryptocurrencies investors can choose from well over 100 exchanges, and prices fluctuate within those exchanges. The World Economic Forum examined price differentials across just three crypto exchanges, and they found “large differences between the prices of Bitcoin.” They list several factors for these price disparities, including time and value gaps resulting from exchanging Bitcoin to USD and back to Bitcoin, but ultimately, the pricing differences can be attributed to lack of oversight and regulation.

In traditional financial markets, the SEC mandated the Regulation National Market System, which ensures that traders are awarded an asset’s best price regardless of exchange. It’s sort of like a price match guarantee for investments, but it ensures that everyone is participating on an even playing field. Moreover, because all exchanges must offer the same prices, they are forced to compete with other exchanges by offering lower costs and better technology.

Since crypto exchanges don’t embrace this principle, the price of digital currencies varies wildly, and exchanges have less incentive to innovate their platforms. While cryptocurrencies continue to soar in value and become integrated into the mainstream financial system, they continue to operate in the financial wild west.  

Outdated technology

New investors are swarming crypto exchanges. These newcomers are immediately met with outdated trading systems that have the functionality of a simple website. As a result, a simple task like changing an order price or size can be prohibitively difficult. Cryptocurrencies are predicated on speed and technological innovation, so these restrictions hinder their ability to operate effectively.

Unfortunately, the outdated technology isn’t just related to investor experience. Algorithmic triggers that stop trading when dramatic price swings distort the market are insufficient or nonexistent on crypto exchanges.

CNBC reported that unlike regulated US stock exchanges, cryptocurrency exchanges aren’t required to have circuit breakers in place to halt trading during wild price swings. Even during this year of tremendous growth, Bitcoin has had four different instances of its price dropping by 50 percent or more. This is relatively common in crypto markets, so the lack of these mechanisms is particularly problematic.

Bad actors

The absence of regulatory oversight and the abundance technological limitations make crypto exchanges ready targets for bad actors.

Traders with deep pockets can manipulate crypto markets and make an outsized impression on the value of cryptocurrencies. One practice, known as “spoofing,” allows a trader to place buy or sell orders above or below the market value in hopes of manipulating a currency’s price in either direction. This maneuver is illegal, but without regulatory oversight, it’s difficult to enforce that standard.

In addition, when Mt. Gox made headlines because it was the victim of a hacking operation that stole $450 mln worth of Bitcoin, it was one of the first in a long list of egregious hacks that have cost investors hundreds of millions of dollars.

At this point, crypto exchanges are making promises to combat these issues; however, if they remain just promises, it may limit their potential to successfully meet investor demands.

What can be done?

Simply put, cryptocurrency markets need to evolve and the most efficient way to do that is to look towards it’s much older cousin: Wall Street. The technology and regulatory infrastructure that runs Wall Street are decades old but vastly superior to the fractured cryptocurrency marketplaces we have today. Emulating Wall Street would also provide crypto markets with structure and stability that would bring big institutional investors and trading houses to the table to help guide these markets as they mature in the coming years.

Alexander Kravets. co-founder of XTRADE.IO, a technology company looking to bring mature Wall Street technologies to the world of cryptocurrency. Before he served as Managing Director of a self-clearing broker/dealer that handled four percent of the daily trading volume on NASDAQ and successfully launched Sogotrade, a retail investing platform with over 100,000 clients.

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