Digital currency in the eyes of economists: the glory of the king (exchange articles)
【Editor's note】Faced with the new challenge of digital currency, economists are divided into two categories. One class scoffs, thinking that digital currency is a speculative bubble that is not worth mentioning; the other class accepts it cautiously and starts cutting-edge exploratory research. As digital currencies grow, more and more economists join the second camp.For this reason, Uncle Kai launched a series of articles on "Digital Currency in the Eyes of Economists", which is currently the most comprehensive review of digital currency literature. In terms of classification, market, exchange, price, risk, and supervision, it summarizes the cutting-edge theoretical research on digital currency by global economists, and provides a useful reference and reference for interested researchers.【Editor's note】
Faced with the new challenge of digital currency, economists are divided into two categories. One class scoffs, thinking that digital currency is a speculative bubble that is not worth mentioning; the other class accepts it cautiously and starts cutting-edge exploratory research. As digital currencies grow, more and more economists join the second camp.
For this reason, Uncle Kai launched a series of articles on "Digital Currency in the Eyes of Economists", which is currently the most comprehensive review of digital currency literature. In terms of classification, market, exchange, price, risk, and supervision, it summarizes the cutting-edge theoretical research on digital currency by global economists, and provides a useful reference and reference for interested researchers.This article is the third exchange article in this series of articles, and the next article is the price article, so stay tuned.Maybe we still have a lot of controversy about the classification of digital currency, but there is no doubt about one thing: in the digital currency industry ecology, the core non-digital currency exchange is none other than.
Digital currency exchanges play three core roles: facilitating transactions, price discovery, and providing liquidity.
However, there are many obvious differences between digital currency exchanges and traditional exchanges: inherently borderless, 24/7 non-stop trading, low barriers to entry, etc. In-depth research will find that due to the particularity of trading objects, digital currency exchanges present many very interesting and sometimes contradictory characteristics, such as: centralization, no supervision, opacity, etc.
Digital currency exchange is the earliest service in the digital currency industry. According to statistics, after the explosive growth of digital currencies in 2017-2018, there are 244 exchanges with real trading volume in the entire market, trading 2112 digital currency trading pairs every day, with a total market value of 139 billion US dollars (as of March 20, 2019 day).secondary titleDevelopment of digital currency exchanges
From 2010 to 2016,The digital currency exchange was born and developed into a bridge connecting two worlds: one connecting the traditional financial world with strict regulation, and the other connecting the wild digital currency system world.Most users buy digital currency with fiat currency on digital exchanges. With digital currency, it is possible for users to use digital currency, or purchase goods and services, or invest in a company (usually a blockchain project company), or do nothing, holding digital currency in anticipation of value-added. If the user wants to exit the digital currency market, he also needs to sell the digital currency on the exchange to obtain legal currency. The digital currency exchange has become the entry and exit gateway of the digital currency industry, and is the intersection of the traditional financial system and the digital currency industry.
Regulators remain highly vigilant against digital currency exchanges,
Only a few countries (such as Japan and South Korea) officially issue digital currency trading licenses, most countries are still studying how to regulate, and a few countries (such as China) even ban exchanges. All countries implement strict anti-money laundering and know-your-customer regulations for banks and payment companies that are associated with digital currency exchanges. This has caused most financial institutions to shy away from digital currency exchanges for fear of getting into trouble and risks, and only a very small number of banks and payment companies are willing to provide financial services to digital currency exchanges.
Beginning in 2017, as the price of Bitcoin began to skyrocket, and with the ICO (new currency issuance, a method of rapid financing in the digital currency market), a large number of alternative currencies (Altcoins) emerged. The focus of digital currency exchanges has also begun to shift from the original fiat currency and digital currency transactions to digital currency and digital currency currency transactions. Currency trading was originally a tiny business, but according to diar's report, by 2018, the business of currency trading has grown to 66% of all exchanges' business volume. The reason why currency transactions can grow so fast and become the absolute leader in transaction volume is related to the characteristics of currency transactions. Currency transactions do not involve legal currency, and there is no need to connect with traditional financial institutions. The exchange of digital currencies from one currency to another does not make any difference to the regulators, so the regulators will not supervise such transactions. Because of this, Binance, Huobi, OKex, and Bifinex, the major digital currency trading platforms, have jumped to the top exchanges in the world in terms of trading volume due to the growth of currency trading.secondary title
Digital Currency Exchange and Regulation
A distinctive feature of digital currency exchanges is that they are unregulated and opaque
. There is no unified regulatory policy in the world, and most countries are still exploring and observing, waiting for the implementation of US regulations to follow suit. The U.S. regulation is mainly divided into four parts according to the four characteristics of digital currency:
First, the monetary attributes of digital currencies are managed by FinCEN. If digital currency is used as a currency, the exchange is an institution that operates currency transactions. Therefore, the exchange needs to apply for registration as a Money Service Business (MSB), which is under the jurisdiction of FinCEN.
Second, regarding the asset attributes of digital currency, the IRS of the U.S. Taxation Bureau believes that digital currency is a personal asset like a house and needs to pay property taxes. Therefore, the exchange has the obligation to provide the user's transaction information to the tax bureau. On November 29, 2017, Coinbase, the largest digital currency exchange in the United States, lost a lawsuit against the IRS and was sentenced to provide the tax bureau with the transaction information of 14,355 users for the IRS to collect taxes.
Third, in view of the commodity attributes of digital currency, the CFTC US Commodity Futures Trading Commission has determined that Bitcoin is a commodity, so Bitcoin futures are under the jurisdiction of the CFTC. In 2017, the CFCT approved the Chicago Mercantile Exchange CME and the Chicago Mercantile Options Exchange COBE to start trading bitcoin futures.
Fourth, regarding the security attributes of digital currencies, the SEC believes that except for Bitcoin and Ethereum, most digital currencies are securities and need to be regulated by the federal securities laws. For digital currency exchanges, the SEC believes: "If a platform provides trading services for digital currencies that are considered securities, then this platform is an exchange as defined by the federal securities laws. Such exchanges need to be registered with the SEC as a national securities trading platform, or apply for an exemption."
From the perspective of exchanges, their attitudes towards regulation are contradictory: on the one hand, they hope to be regulated as compliant exchanges, so that they can connect with traditional financial institutions to receive financial services, and at the same time, they can create more Digital currency products to meet the needs of more people and open up a larger market; on the other hand, most of the current exchanges are operated and managed by non-financial teams, and their practices are very irregular, such as falsely reporting and exaggerating transaction data and manipulating the market , Using internal information to trade in advance to make profits, etc., all violate the existing financial regulations. Therefore, if the regulations are complied with, the exchange will lose a large amount of existing revenue sources.So we see an interesting phenomenon about exchanges: some exchanges turn to unregulated currency trading, only a few adhere to the compliance route, and most of the others are avoiding supervision.
In fact, the main income of the top-ranked exchanges comes from unregulated currency transactions. For some exchanges, companies are registered in places with no supervision or loose supervision. For example, Binance, one of the top three exchanges, was forced to move its registration from China to Japan, Hong Kong, China, and finally registered in Malta. Huobi’s registration place was forced to move from China to Singapore, and OKEX was forced to move from mainland China to Hong Kong, China. They do this to avoid regulation and possible prosecution.
Some exchanges have always adhered to compliance and legal operation, so the types of transactions provided are very limited, and at the same time they undertake huge compliance tasks. For example, the well-known old American fiat currency exchange coinbase, registered in California, applied for licenses from most states in the United States. According to the supervision of the corresponding state, the trading volume only ranks around 20 in the world, and the trading varieties provided are only 7 digital currency and USD trading pairs. Until recently (April 2019), currency trading was not opened, which is in line with other top rankings Compared with about 300 kinds of transactions at every turn, it is obviously at a disadvantage, but its advantage lies in compliance, and investors and institutions are more at ease.This also allowed Coinbase to win the entry ticket to participate in the Libra Alliance launched by Facebook, becoming the only digital currency exchange among the members of the Genesis Alliance.The digital exchange business in most countries is not supervised and does not require a license, so the entry threshold is very low. As long as a trading website is equipped with a trading system, the basic functions of the exchange can be operated. On the coinmarketcap website, 220 exchanges that provide transaction statistics are listed. but,
Digital currency exchange is a winner-takes-all market,
Although there are so many exchanges, there are only a few dozen or so leaders that really stand out and have relatively real and stable transactions, because it is not easy to operate a successful exchange. According to statistics, among the 220 exchanges, the top 20 exchanges account for 45% of the trading volume. Moreover, the trading volume data of the disclosed exchanges is not reliable. For example, some exchanges use robots to trade with each other to create fake trading volume. It has been estimated that two-thirds of the trading volume reported by CoinMarketCap is fake. The lower the ranking of the exchange, the more inclined it is to falsify its trading volume. According to the real trading volume, the proportion of the trading volume of the top 20 exchanges can reach 75% of the total trading volume.secondary title
Security of Digital Currency Exchanges
Security is the core and key of the exchange.
Digital currency is a string of 01 numbers. Most people put it in the wallet of the exchange, and a small part is transferred to their own private digital wallet. Therefore, the wallet of the exchange is a treasure trove and naturally becomes the preferred target of hackers.
The reward-to-risk ratio of stealing digital currencies from exchanges is simply too tempting: digital currencies are highly valuable, anonymous, difficult to trace, irreversible in transactions, and generally not yet protected by national laws. Now hackers stealing the digital currency of the exchange has changed from a lone ranger behavior to a group operation mode, and has changed from an occasional incident to a normal hacker attempt to attack.
But in fact, the number of hacking exchanges is more than the public knows, because there are many hacking incidents, and the exchanges try their best to conceal them and not disclose them to the outside world. Security is so important that any smudges in this area will cause users to worry, which will affect the business. This is also the downside of unregulated exchanges - users and the general public can only know what the exchange wants everyone to know.
In order not to be hacked and lose assets, large exchanges spend huge sums of money every year to compete with hackers on security. But there is a relatively simple way to prevent intrusion, called cold wallet. A cold wallet is a physical wallet that stores digital currency, while a hot wallet is a virtual wallet connected to the Internet. The cold wallet is physically isolated from the network, thus ensuring that hackers cannot intrude through the network. The price is that when the exchange frequently needs to adjust the amount of digital currency stored in the cold wallet according to the customer's transactions, compared with the hot wallet, the cycle required by the cold wallet will be greatly longer, and the efficiency will be greatly reduced. This requires a balance between security and efficiency. Most exchanges store about 60%~90% of digital currency in cold wallets, and put the rest in hot wallets. Of course, the proportion of transaction volume stored in hot and cold wallets is constantly changing with market transactions.
Even if the digital currency is stored in a cold wallet that is completely disconnected from the network, it is not necessarily foolproof. At the end of 2017, the CEO of an exchange registered in the United Kingdom was kidnapped in Ukraine and released after paying the equivalent of $10,000 in bitcoin. Cryptocurrencies are used by criminals as a tool for money laundering and crime, and even those who work in them have been targeted for kidnapping, making the profession a high-risk option. This also partly explains the strange phenomenon that exchanges rarely reveal too much information about institutional management addresses and teams in addition to transaction volume and price. There are quite a few exchanges, even top-ranked exchanges, where users cannot know their real office addresses and management team members. This peculiar phenomenon can only be encountered in the digital currency world.secondary title
Liquidity, monopoly and decentralization
Therefore, trading liquidity has become another key to attracting users.
highThe biggest problem faced by new or small exchanges is the lack of liquidity, the user's transaction cannot be completed, or the user needs to lose a large part of the profit in order to complete the transaction. The diversity of products lies in the fact that users hope to be able to trade the desired currency on one exchange. Therefore, in addition to mainstream currencies like Bitcoin and Ethereum, exchanges also need to continuously provide new potential new currencies in the market.The established large digital currency exchanges, with their accumulated brand benefits, obviously have advantages over small exchanges in terms of security, liquidity and products, and are easier to attract new users, which in turn allows large exchanges to further consolidate their leadership status. In addition to the average transaction fee of 0.1%, the income of large exchanges also includes the listing fee of Singapore currency on the exchange and investment income. The listing fee on the exchange on the new currency is the handling fee required for the newly issued digital currency to enter the exchange listing exchange. Beginning in 2019, a new digital currency issuance model endorsed by the exchange has emerged, called Initial Exchange Offer. The exchange has passed strict review, selected good projects, and used the platform advantages of the exchange to help issue new digital currency. Large exchanges have the advantage of traffic entry, so new digital currencies will try their best to be listed and traded on well-known exchanges, so the listing fees have also risen, and the listing fees for trading on well-known exchanges once exceeded one million dollars. The investment income is the return obtained by the exchange by virtue of its own advantages, investing in the upstream of the digital currency industry, such as the mining industry, or downstream, such as digital currency application projects.
highThe handling fees brought by the huge trading volume, the high listing fees and the high return on investment made the exchange a very profitable company for a time.Take Binance, which ranks first in trading volume, as an example. It only had 200 employees in less than a year after its establishment. In the second quarter after its establishment, that is, from October to December 2017, its profit reached 200 million US dollars. In contrast, Deutsche Bank, a world-renowned investment bank, is also the largest bank in Germany and a leading financial institution in Europe, with a profit of only US$140 million in the first quarter of 2018.
The top exchanges expand arbitrarily in the unregulated digital world.It not only provides the business of the exchange, but also involves the formulation of trading rules and rating services for digital currency, and provides a series of financial derivative services such as digital wallet depository, digital currency investment, digital currency investment bank and brokerage, becoming the core and absolute of the digital world overlord.
It is very ironic that digital currency has always advertised itself as a representative of decentralization, but exchanges that provide transactions for digital currency are highly centralized and form a monopoly trend.
The disadvantage of this is that the exchange is in an absolute advantage over project parties and investors. In the absence of supervision, monopoly and unfair market operations are prone to occur. At the same time, centralized exchanges also have the potential danger of being hacked. In view of this, many entrepreneurs and technicians have been trying to provide decentralized digital currency exchanges (such as Paradex, which was acquired by Coinbase in 2018), but in the current state of technology, decentralized exchanges have not been very successful. They are still far from meeting the needs of trading customers in terms of transaction execution and clearing speed, as well as liquidity and products, and it will take a long time to develop.
Since centralized exchanges have such a high return and such a special status, many traditional exchanges are also eager to enter the digital currency exchange industry. Of course, compliance and supervision are the biggest obstacles for traditional institutions to enter this industry. In 2017, one of the most eye-catching events in the field of digital currency was the approval by the US CFTC for the introduction of Bitcoin futures trading by CME and COBE (COBE did not launch the current Bitcoin futures contract in March 2019 due to insufficient liquidity). This is a great endorsement of Bitcoin and also provides a very powerful investment tool for traditional institutional clients to invest in managing Bitcoin investments. NASDQ is also preparing to launch bitcoin derivatives trading varieties.
secondary title
Exchange Academic Research:
Because of its core position in the field of digital currency, exchanges have become an important object of digital currency research. Unfortunately, the current academic research on exchanges is very limited. The main reason is that the information of digital currency exchanges is not transparent, and many data are not disclosed, or the disclosed data (such as transaction volume) are not reliable enough. At present, academic research on digital exchanges is mainly limited to legal compliance, security technology and operations, and organizational structure. These are obviously topics that exchanges are very concerned about, but they are not in the scope of our series. We mainly focus on economics and finance. To study the exchange.The current research on exchange finance belongs to the field of Market Micro Structure. The main achievements in this field are concentrated on exchanges such as stock futures and foreign exchange, and there is still a blank in digital currency exchanges. The only valuable academic research is Brandvold's (2015) research on the price discovery of Bitcoin exchanges. He constructed a mechanism that can study how digital currency exchanges affect digital currency prices and price when the outside world fluctuates. Discover.
As the industry matures, more and more exchanges will be regulated, so the transparency and quality of data will increase significantly. Academic research on digital currency exchanges in the field of economics is most likely to focus on the following areas:First, price arbitrage across digital currency exchanges.
In theory, the exchange is global without borders, and transactions can be carried out anywhere on the network in an instant, so in theory, the same currency price on each exchange should be equivalent. However, in reality, the same currency will have a large currency price difference between each exchange, which has created a new profitable business model, and some professional traders specialize in earning cross-platform price differences. The mechanism development of these price differences and their impact on pricing are worth studying.Second, the impact of digital currency derivatives transactions on the industry.CME and COBE’s bitcoin futures have had a profound impact on the digital currency industry. But this is just the beginning. Many traditional exchanges such as NASDAQ and digital currency exchanges such as OKEX, HUOBI, and BIXMEX have begun to launch derivatives transactions. ICE, the parent company of NYSE, plans to launch Bitcoin Swap. Can these derivatives exchanges help price discovery, reduce price fluctuations, provide good hedging like the appearance of derivatives exchanges for other assets, or encourage market speculation?Stablecoin is a special digital currency whose price is anchored in legal currency, and the price of digital currency is kept stable through a certain mechanism. Stablecoins have become the most basic means of valuation in the world of digital currencies, just like the US dollar in the financial system. The digital currency industry has a huge demand for stablecoins, because digital currencies themselves fluctuate greatly and cannot be used as a measure of value. At the same time, the connection between digital currency and the traditional financial system has received a lot of supervision, so there are many obstacles. The stable currency can solve the function of value scale and exchange. The most famous and widely used stablecoin is Tether (USDT) launched by the Bitfinex exchange, which is anchored to the U.S. dollar at 1:1. Bitfinex claims that as many stablecoins as it issues, it will deposit as many U.S. dollars in the bank for endorsement, but its authenticity has never been verified. been verified. Another stablecoin called USDC, which is also anchored to the US dollar, was launched by the famous exchange Circle. Circle's shareholders include Goldman Sachs, Baidu, China Financial Investment Corporation and Bitman (the world's largest mining equipment manufacturer). There are also dozens of stablecoins in the market, and the competition among stablecoins is fierce. Due to the dominant position of the exchange, the stable currency launched by it has a high success rate of being accepted by the market. What is worth studying in the future is the factors that determine the success of exchange stablecoins, and how these successful exchange stablecoins affect the industry and ecology?
In short,What kind of competition and cooperation will there be between stablecoins on exchanges and stablecoins launched by Internet giants? Is it possible for Libra to unify the stablecoin market?
===References:====
· Brandvold, Morten and Molnár, Peter and Vagstad, Kristian and Valstad, Christian, Price Discovery on Bitcoin Exchanges (November 16, 2015).Journal of International Financial Markets, Institutions and Money, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2691456
