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Analysis of the Cryptocurrency Exchange Landscape

With the recent price surge in cryptocurrencies, it is no surprise that trading Bitcoin, Ethereum, Ripple and other crypto assets has become a mainstream obsession. Retail and institutional investors alike are increasingly gaining exposure to cryptocurrencies for different reasons. Many buyers require a safe haven from inflationary fiat currency, some desire a hedged asset which is uncorrelated with price movements of traditional financial instruments like stocks or bonds, and others just display FOMO (fear of missing out). In 2017, Bitcoin’s market capitalization increased 15x and the total crypto asset market grew from approximately 17.5 billion to 612 billion, a 3,400% spike. So yeah, you could say this market is getting pretty serious.

Exchanges

Many new speculators and “investors” are unfamiliar with how digital currencies are traded and how price discovery actually works. Unlike stocks, cryptocurrencies are traded 24/7 globally on different exchanges with few barriers to entry and minimal censorship. The price is determined by a free floating market exchange rate that is established by buyers and sellers on different exchanges around the world in different currencies and trading pairs.

Cryptocurrencies can be traded against fiat currency, alternative crypto assets and market pegged cryptos which track the value of external real-world “things” (gold, USD, HK stock market). Many cryptocurrency exchanges are similar in structure to stock markets, in that traders can set limit orders, market orders, stop loss orders, and act as either a market maker or market taker. Very few exchanges offer lending, margin trading and short selling features. A large concern in the crypto market is the lack of shorting capability, leading to a one-sided long hodl or sell mentality. Now that Bitcoin Futures have launched on CME and CBOE, there is an opportunity for large institutional investors to short the Bitcoin market in a regulated way, which should improve volatility and price stability over time.

Because the same crypto tokens are traded on different exchanges meaning different price discovery markets, there is often price discrepancies across exchanges. For example, GDAX may trade LTC/USD at $300 while Bittrex trades it at $250, and therefore an arbitrage opportunity is created. In this case, a trader would purchase Litecoin with USDT on Bittrex, transfer it to GDAX and then sell it for USD to earn a profit. Because cryptocurrencies can be transferred around the globe cheaply and quickly (well not bitcoin), profitable arbitrage is possible and exchange prices quickly even out. If anyone has an arbitrage bot hit me up ;)

In this article I want to discuss the different types of crypto exchanges that exist and the best trading platforms for each. I will be focusing on the main exchanges that can be accessed by investors in the United States and the benefits and costs associated with them. Full disclaimer: I am not a day trader and do not pretend to be, this is just my personal view on the exchange landscape and is not investment advice. This article is meant to be an educational tool for those unfamiliar with the crypto investing ecosystem.

The first type of exchange is the bread and butter “Fiat to Crypto Exchange”. This platform allows users to purchase digital assets with fiat currencies such as U.S. Dollars or Euros, usually with a bank account. Many beginner investors use these centralized exchanges as a way to introduce themselves to the crypto ecosystem. Most fiat/crypto markets allow customers access to a limited amount of cryptocurrencies such as Bitcoin, Bitcoin Cash, Ethereum and Litecoin. For security and compliance reasons, these exchanges require users to perform unpleasant tasks to sign up and verify their identity. These include submitting a driver’s license photo, linking a bank account and giving away detailed personal information, all of which are extremely invasive. The exchanges usually set limits on the amount of digital currency you can buy and your verification level (determined by willingness to share personal info) determines the quantity you can purchase.

Advantages

There are several advantages to using a fiat/crypto model. First, the platform executes the trade for you, and therefore requires little technical trading knowledge. By clicking a few “Deposit” and “Buy” buttons on the exchange’s site, your wallet will be automatically funded, so long as you don’t use Mt. Gox or Bitcoinica. Second, by placing your trust in the established exchange to make the trade you are guaranteed the best market rate for your trading pair. Instead of becoming a market maker yourself and offering a bid price, the process is done on the backend by the exchange.

Disadvantages

If you are interested in purchasing digital coins with cringeworthy paper “money”, the following exchanges are a few good places to start →

Kraken has recently suffered from DDoS attacks that have created performance issues for the exchange. As a result, user trust has taken a big hit, however, Kraken is still currently trading about $396 million USD per day on the exchange. Maker trading fees range from 0.00% to 0.16% based on monthly volume, and taker fees range from .10% to .26%. Kraken is the largest BTC/EUR exchange in the world and therefore euro volume accounts for a large portion of the exchange’s trading. Bitcoin/euro 24h volume is currently $75 million and Ripple/Euro volume $65 million. Although they have certainly had their struggles, Kraken will continue to be a high volume exchange because of a lack of alternative liquid EUR markets elsewhere.

Over-the-counter cryptocurrency trading is another way users can purchase bitcoin and engage with the Bitcoin protocol. OTC trading is essentially peer-to-peer exchange; platforms connect you with trading counterparties and leave the execution of trades up to you. This means the trade does not occur in an actual market, but rather takes place peer-to-peer outside of the exchange. For reference, the OTC markets I refer to in this blog are not institutional OTC liquidity providers like Genesis Trading or Octagon. Instead, I will touch on P2P platforms that connect buyers and sellers of digital currency for small to medium sized transactions.

Advantages

The greatest benefit to using OTC platforms is the anonymity associated with transactions. There is no need to provide identity verification measures such as personal information or bank accounts. Money launderers and tax evaders are likely to trade OTC to avoid regulatory on-ramping and off-ramping of cryptocurrency exchange, especially since the IRS recently ordered Coinbase to report 14,355 users’ information. However, as I explained in my previous post, privacy is vital for crypto asset transactions, even for honest citizens. The second advantage to P2P exchange is zero counterparty exchange risk. OTC exchanges do not actually hold your tokens when you purchase them, but instead deposit them directly to your individual wallet from escrow.

Disadvantages

There is some downside to P2P exchange as well. Many decentralized OTC markets don’t have sufficient liquidity, mainly due to lack of convenience and awareness. New U.S. crypto adopters seem to be automatically drawn to Coinbase and do not even know that P2P exchanges such as Localbitcoins exist. The second drawback is the lack of fair price discovery. Because there is not an adequate order book market for cryptocurrencies on OTC exchanges, the price is unfairly set by the local seller’s ad. Often times in local area cash/crypto meetup trades, specifically in rural areas with little competition, buyers could end up paying upwards of 10% above the global market average. The final problem with OTC trades is fraud and credit card/Paypal/Venmo reversal. So basically all the reasons that crypto exists lol. This is more of a problem on the vendor’s side, as an inexperienced seller may sell bitcoins in exchange for a credit card payment and find out a month later that the transaction was reversed by Visa. Be cautious of this if you decide to sell via a P2P exchange.

Because Localbitcoins attracts a lot of scammers, I will give a few recommendations for using the platform. First, ensure the seller has a good amount of ratings and has “real name verifications”. If they are trying to stay anonymous from localbitcoin’s management that is a red flag. Second, any buyer advertisement that lets you sell 1 bitcoin for $50,000 USD in exchange for some gift card numbers is most likely a scam. Free money does not exist. Third, as a seller, it is much safer to transact in person and accept cash for bitcoins. This eliminates the possibility of chargebacks and credit card fraud. Localbitcoins is a great platform to interact with other bitcoiners and possibly save some exchange fees in the process, however, beware of fraudulent listings and obvious scammers.

Buyers on Bitquick can initiate a transaction from the seller order book which lists the seller’s exchange rate and bank account information. The buyer will then visit their local bank to deposit cash into the seller’s account and scan their deposit slip. After they provide proof of the deposit slip to the seller and Bitquick, the funds are sent from escrow to the BTC purchaser’s wallet within three hours. The seller fee is 0% and the buyer fee is 2%. OTC trades on Bitquick are great for users who do not wish to interact with sellers in person like you would see on Localbitcoins.

The fact that their F.A.Q. page states premiums range from 5%-50% is a huge red flag for me. Most bitcoin exchanges want to entice buyers, and it seems as if they are not even trying to hide the outrageous transaction costs which is quite odd. I have personally never transacted on Paxful, but it seems to be as expensive as using a Bitcoin ATM. Paxful is convenient and good enough for people experimenting with the technology, but is probably not well-suited for investors concerned with turning a profit.

So far in this blog post I have discussed fiat to “large-cap crypto” exchanges exclusively (BTC, ETH). Altcoins, the crypto maximalist term for “Alternative coins besides Bitcoin”, have captured the eyes of many investors in recent months, as the altcoin market cap has skyrocketed from $2.2 billion to $367 billion in 2017 alone. And no, that is not a typo. An initial coin offering (ICO) is a crowdfunding strategy that allows blockchain startups to bypass traditional VC financing by issuing digital tokens to a worldwide network of investors in exchange for Ether, Bitcoin and other large cap cryptocurrencies. This is how the majority of newly created cryptocurrencies are brought into trading markets. The ICO market has raised a whopping $5.8 billion this year and shows no signs of slowing down anytime soon.

What is interesting about altcoins is that many of them are not freely traded with fiat currency, but instead trade against large cap cryptocurrencies like Bitcoin and Ether. Many traders believe this restricts volume because the smaller cap altcoin must outperform the currency it is traded against, and everyone knows it is not easy to beat Bitcoin’s price performance. Many argue the solution to trading volatile cryptocurrencies is a stablecoin such as Tether, which provides a non-volatile pairing for a trade. Several altcoin exchanges have popped up over the past few years and I will touch on the main centralized ones. If you are interested in learning about decentralized altcoin exchanges like BitShares, EtherDelta, and others, check out @george harraps article discussing what makes a good DEX and where the future of altcoin trading is headed.

Binance currently lists 232 trading pairs, consisting of altcoins traded against BTC, ETH, USDT and BNB itself. The largest markets are currently XRP/BTC and XVG/BTC, although I am sure this is due to the massive speculation and gains both Ripple and Verge have seen in recent weeks. Top market cap coins such as NEO, Cardano, Ethereum, Bitcoin, Bitcoin Cash and IOTA all maintain significant 24h trade volumes above $60 million. Overall market liquidity has consistently increased since platform launch and total 24h exchange volume is currently $3.875 billion at time of writing. Binance fees are as follows: a constant 0.1% trading fee, free deposit fee, and set withdrawal fee based on cryptocurrency withdrawn.

Another interesting feature on Binance is the LaunchPad module. LaunchPad allows traders to directly invest in ICOs on the Binance platform with funds held on the exchange. Once trading commences on the Binance exchange, the trader’s account is funded with the corresponding amount purchased during the token sale. I expect to see them continue adding trading pairs, increasing user adoption and improving UI within the coming months (if that’s even possible). Binance FTW!

Daily Bittrex volume is hovering around $2.6 billion. The fee is .25% on all trades which is relatively high in the altcoin world, albeit deposit/withdrawal fees are free. Besides the semi-high fees, the other annoying problem I run into on the platform is signing in. Every time Bittrex identifies a new IP address associated with an account login they force the user to verify the login through their email and sign in again. Pretty irritating and time-consuming if you ask me. Anyways, once registrations open again I am sure we will see tons of new accounts being added daily and volumes to continue increasing.

The greatest competitive advantage Poloniex has is lending and margin trading accessibility. Poloniex is the only major altcoin exchange that allows users to trade on margin (yeah I know bitfinex offers it but they are sketchy). Margin trading means that customers borrow loans from other users to fund trades they make on the platform and pay interest to the lenders for borrowing the tokens. Margin traders can open short or long positions, a feature which opens up a two-sided market, not currently available on most cryptocurrency exchanges. Because borrowers incur forced liquidations on bad trades, there is virtually no risk involved with defaulting on loans and lenders should receive their money back at a minimum. Poloniex is a historical gem in the crypto community, but at this point the lending and margin trading functionality is what is keeping them relevant in my opinion. Updates to the UI and perhaps lower fees will allow them to gain some market share back from newcomers like Binance and soon to be Altcoin.io.

Closing Thoughts

The crypto investing space is an exciting ecosystem to be a part of right now, and I think most people realize this is a once-in-a-lifetime market. With that being said, investors must be careful and diligent not only about tokens, but exchange platforms as well. A lot of people asking me about investing in certain coins have not even read the white paper or token summary yet. Do not let yourself be the greater fool. Do some research, learn as much as possible, and get involved in promoting cryptocurrency and blockchain technology to others if you are passionate about the space.

Here are a few final thoughts I have regarding crypto investing:

2.) When dealing in centralized exchanges, always enable 2-factor authentication to log in to your account. I recommend downloading the third-party app the exchange uses, such as Google Authenticator or Authy. With the recent gmail phone number hacks it is probably better to avoid cell phones, but text verification is better than nothing at all.

3.) Do not invest more than you are willing to lose. This space is brutal and often times heartbreaking, so do not put your life savings into this crazy volatile market. Is it a bubble? No one knows, and if I did I would be writing this post from a beach in the Bahamas, not from my college dorm room. Anyways, be mentally prepared for your coins to go to zero at any time and invest accordingly.

4.) If you plan on buying into ICOs, make sure to do your due diligence. Read the white paper and get a feel for the project’s solution and problem it is trying to fix: “Is there a real-world problem this solves and if so, is someone already tackling it?”. Check out the development team to see if they are qualified to hit the roadmap objectives in a timely fashion and if they have been involved in successful projects before or have a live working product already.

Please don’t be a shitcoin shiller,

Spencer Applebaum

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