From Mt. Gox to FTX, the landscape of crypto exchanges has undergone some cataclysmic seismic shifts. As trading platforms evolve from scrappy startups to bank-like behemoths and decentralized alternatives; we try to examine the evolution of crypto exchanges and their radical differences from traditional exchanges, growth challenges, regulatory frameworks, stablecoin partnerships, and outlook on decentralization.
Some crypto exchanges have slowly turned into bank-like giants, and others seemed too big to fail but did. This evolution both good and bad, is seen as a progression rather than regression when we look at it from our little niche perspective. This transition brings legitimacy to the crypto exchanges rather if we like it or not. By becoming one of the banks, these exchanges can plug directly into the payment system and potentially solve issues where crypto was made for.
Why Do We Need a Counterparty (Risk)
First of all, a little recap: counterparty risk refers to the potential risk associated with one party in a contract not meeting the obligations they have agreed to. In the context of our beloved crypto exchanges, this could mean that the exchange fails to fulfill its obligations towards the traders and simply disappears, together with our money stored on the exchange.
The current trial of one of such centralized exchanges ‘FTX’ was for long periods of time one of the best-designed versions we could trade on, it has little to no explanation of what will happen if an exchange is mismanaged in a way it was.
Difference From Traditional Exchanges
Compared to traditional exchanges, crypto exchanges are “extremely” different. For instance, since the day of their launch, crypto exchanges haven’t gone offline for a single second, besides the ones who went bust of course. But the all roundness of the ones that did survive is worth mentioning.
In our fast-paced industry, they simply can’t afford to go offline even for a few hours or minutes. So, we see that all updates and patches happen in real-time, which is a totally different approach from what we see with for example the New York Stock Exchange, where they take a break every evening, and choose to not operate continuously.
The question often arises: Can other large exchanges come in and threaten the existing ones? The answer is that newcomers are welcome. The crypto space is still small and therefore, it’s important not to fight amongst each other. The goal is to collectively grow the space. If newcomers are targeting a market need, that’s fantastic. The focus should be on growing the space, not fighting against each other. This holds true among the centralized and decentralized exchanges as well.
The Importance of Regulation
In the sages we are now, at the brink of total adoption, regulation is more than crucial for the growth and mass adoption of cryptocurrencies, whether we like it or not. Crypto exchanges spend considerable effort interacting with regulators, not just to obtain licenses, but to help these regulators understand our crypto industry better.
The exchanges are not only seeking licenses, but they are also helping regulators understand the crypto industry to establish a reasonable legal framework that provides comfort for traditional financial markets and retail users who choose to enter the crypto space and don’t want to invest in thin air. Without this, mass adoption and the flow of traditional money into the crypto exchanges will be limited.
Crypto Exchanges and Stablecoins
Stablecoins have become a significant topic of discussion among regulators. This could be perhaps due to their tangible and relatable nature of mirroring traditional currencies. Or maybe because of their failed experimentation in the past, who knows?
What we do know is that crypto exchanges are the biggest issuers of Tether and we see that exchanges are taking effective steps to support major stablecoins. While the majority of their volume occurs on USDT (Tether) on their derivatives platforms we see that exchanges and stablecoin issuers have the largest stakes in the booming and busting of the cryptocurrency industry.
Growth and Evolution of Crypto Exchanges
What is challenging for currency exchanges is the influx of new users. As the hype knows new heights each cycle, we see that every time the number of registrations multiplies suddenly, forcing exchanges to adapt quickly.
The first area of adaptation is in the onboarding process which is now mandatory KYC. In the past, these were manual processes but had to shift towards automation, including automated KYC (Know Your Customer) and AML (Anti-Money Laundering) compliance checks. Now we see that there are only a few safe havens for non KYC exchanges left to look out for.
Similarly, if all these new people start trading, the exchange has to handle hundreds of thousands of transfers daily and this can become a challenge. We see that traditional banks with manual processes can no longer keep up with those high throughput demands, so it is a wonder that our beloved exchanges can.
Looking forward, the growth in the crypto exchange industry is set to continue, with exchanges constantly evolving to meet new demands and challenges. It is a feature of the industry to adapt and innovate as we see now with the rise of decentralized exchanges (DEXs) that are often touted as safer alternatives to centralized exchanges.
First and foremost, they eliminate the need for a central authority or intermediaries that could co-mingle with our funds. However, the mastery of the underlying technology, specifically smart contracts, is still a challenge. Also, the self-custodian aspect and the inability to roll back transactions on decentralized infrastructures raise concerns for security experts who could see newcomers be severely burned in the process.
Exchanges will thus vary and follow regulation, because crypto is a global market we see the fragmentation of exchanges, big and small. The localization of fiat ramps diversifies the ecosystem, which is a good thing. The all-around evolution is thus in any location different because decentralization is only due to language barriers, cultural differences, and the need to comply with local laws across 200 jurisdictions worldwide.
Diversification is the key strategy to prevent exchanges from becoming tools of state surveillance, having multiple exchanges in operation can mitigate the risk of an entire industry becoming subject to state control.
It’s crucial not to put all the “eggs” in one basket. Even if one platform becomes quite large, having others on standby allows users to shift to an exchange they feel more comfortable with if concerns arise.
As the crypto exchange landscape is rapidly evolving and these platforms grow into bank-like institutions or decentralized alternatives, their adaptability and ethics will shape their trajectory.
It’s important to note that not all exchanges are created equal and do not work with the same integrity, many are trying to work in the best interest of their users. It’s a platform’s responsibility that it can sustainably generate cash flow, but could never be their incentive to manipulate the market or trade against its users.
Key factors going forward are thus appropriate regulations that mitigate risks and offer a reliable and secure platform where we as traders can trade.