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Divided We Fall? – Why Crypto Exchanges Should Work Together

Industry InsightsAugust 12, 2021
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The widespread availability of reliable information is crucial to the efficiency of markets. But the information in the crypto sphere is fragmented and opaque. Cryptocurrency exchanges need to work together to change this.

In the burgeoning cryptocurrency market, traders are hampered by a chronic lack of information. Although transparency is often cited as a core benefit of the underlying technology, the actual market is so fragmented as to be almost opaque.

This problem needs to be addressed if digital assets are to gain mainstream traction since information moves markets and is the bedrock of finance. In traditional finance, trading decisions are based on hard data. Professional traders drill down into the numbers to understand and anticipate market movements. Depending on the trading strategy, that might mean studying the fundamentals: for a stock, they would study the business’s revenue, business plan, market conditions, and so on; for a currency, the political, social, and economic circumstances affecting that nation. Or they might focus on technical analysis, studying historical price movements to identify patterns and predict future moves.

Accurate liquidity data is crucial

As a new and developing asset class, crypto works differently. Cryptocurrencies like Bitcoin function as a store of value or means of payment, but since they are not attached to a real country’s economic or transactional needs, there are fewer fundamentals to analyze. As a result, much of the conversation centers on factors like asset price, hash rate, average block confirmation time, average transaction cost, and sentiment analysis.

This may change when asset- and equity-backed tokens gain greater prominence, but in the short to medium-term, most traders have no option but to rely predominantly on technical analysis. Essentially this means studying patterns of demand, which means that having accurate price and liquidity data is crucial. But that is exactly what is so hard to determine because although the crypto market is global, exchanges are not. Even within each region, liquidity (and hence information) is highly fragmented.

In traditional investment, principal exchanges such as the New York Stock Exchange (NYSE) offer a central point where supply is matched with demand. While crypto advocates may balk at the degree of centralization this entails, it does lead to efficient price discovery. Investors can get a view on the performance of an asset by checking only one exchange. As cryptocurrencies are less regulated and more decentralized, the same rules do not apply.

Diversity breeds complexity

Instead of using one principal exchange in each territory (like SIX in Switzerland or NYSE in the US), crypto traders operate in a highly heterogeneous market, with local brokers interacting with Binance, Coinbase, Kraken, and numerous other international exchanges. And none of these bigger players has achieved market dominance.

Whereas an exchange like NYSE accounts for over 25% of global equity trading, the largest US crypto exchange, Coinbase, only handles about 2.1% of global volume. Each of the many diffuse liquidity providers is driven by regional supply and demand, so none of them can offer an accurate view of the global valuation of an asset. With so many exchanges to check, it is also difficult to find the best bid and offer for a particular asset globally.

All this makes global price discovery highly complex, which drives potential investors away from the crypto market. Traders need to rely on estimates from chain analysis tools, such as Glassnode, which are limited in their ability to assess the depth of liquidity on a particular exchange or market. The alternative is third-party crypto analysis firms such as CoinMarketCap. These firms are unregulated and opaque, making it difficult to know what data can be trusted. For instance, one in six of the 300-plus exchanges listed on CoinMarketCap has a trust score below 1. Even more worrying, few of the top 20 by volume manage a score above 5 out of 10. That means that a huge proportion of the recorded activity is potentially untrustworthy.

Let’s work together?

Economic theory, not to mention centuries of real-world experience, tells us that information asymmetry tends to benefit the most powerful players in a market, leaving small and midsize actors worse off. Let’s be clear: this is not a problem that exclusively affects cryptocurrency, but as a nascent, relatively undeveloped market, it is particularly prevalent. Until traders can get a clearer view of the global cryptocurrency market, many potential investors will steer clear of the sector, limiting its growth. So what could be done to create a fairer, more efficient cryptocurrency market?

One option would be that cryptocurrency exchanges could set aside their rivalries for a moment and work together to create common industry standards for analyzing and monitoring liquidity, including verifiable safeguards against wash trading. In addition, such an association could also merge and analyze order book data to provide a more complete picture of average asset prices. This would create a commonly agreed set of industry metrics, enabling the exchanges to compete based on other factors such as the quality of their user interface, the speed of transactions, the range of assets and derivatives available, and the size of their fees.

Of course, the big problem here is that exchanges are likely to be wary of sharing potentially sensitive business data with key competitors, but this challenge could be addressed by using trusted execution environments (TEEs). A TEE is a secure enclave within a computer processor that is not accessible to any one actor, not even the system administrator. It enables data to be processed automatically to produce insights, without any individual having full access to the underlying dataset. Ideally, commonly agreed and open-sourced algorithms for gauging liquidity and average prices would run within such data enclaves, providing industry-wide insights, without compromising the data of any one exchange. Once it is verified that the code is run on a genuine TEE, the results of the analysis could be made available to the entire market. As a trader, you wouldn’t have to trust data aggregators like coinmarketcap or coingecko anymore. Insights would verifiably be the result of authenticated data sources processed by an audited analysis code with a remotely-attested footprint.

Multi-party computation offers a different route to a similar result – “secret sharing” allows shared computation to be performed on inputs from multiple parties without those inputs being visible to anyone but the original owner. So each exchange could contribute their data to the common analysis, without actually revealing that data. Only the outcome would be visible. However, while this is a plausible approach, it is in practice hard to implement a generic data analysis algorithm on MPC. A TEE solution could be implemented far faster.

To get a clearer view of the global cryptocurrency market, traders need to be able to see the wood from the trees. A unified source of trusted, industry-wide metrics and insights would provide reassurance to traders and benefit the industry as a whole.

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