In light of the recent 104 page report from Bitwise that studied fake volumes on crypto exchanges, it is important to focus on one of the main problems of crypto exchanges which is transparency.
The link between token issuers, exchanges, and sites that cover exchange volumes and market caps is agreed as suspicious for investors in a market that’s characterized by volatility.
A striking consequence of the 3-pronged relationship, is the ridiculous volumes posted by several crypto exchanges.
For a clearer context, Bitwise’s report was submitted to the Security Exchange Commision as a comment, and they also noted that Bitcoin’s arbitrage strength and spot market have ‘improved dramatically,’ Bitwise restated how 95% of the volume of several exchanges is possibly fake due to wash trading.
The conclusion they arrived at was echoed by an in-depth analysis from The Block, who agreed to a certain extent, that false volumes among cryptocurrency exchanges were widespread (up to 86% of the exchange’s volume) but not as substantial as the earlier report from Bitwise.
Bitwise does disclose how the spot market of Bitcoin is much more competent than many people realize. The major takeaway in the perspective of prevalent exchange problems, is the conclusion they arrived that only 10 crypto exchanges have real trading volumes.
Bitwise examined non-economic and economic trading, between more than 80 crypto exchanges by collecting live trading data from all of them. They determined that 73 exchanges out of the 83 assessed exchanges failed at least one real trading volume test.
Bitwise described their discoveries as
“10.5 billion dollars out of the 11 billion dollars in reported daily volume (or – 95%) is either fake or wash trading.”
The Block’s study of 48 crypto exchanges used another approach. The approach zeroed in on monthly site traffic to crypto exchanges within a period of 6 months via SimilarWeb.
Of all the crypto exchanges they examined, Coinbase and Binance led the way with 143 million and 185 million unique visitors over a 6 month period, in that order.
This is not shocking, as data provided by BTI (the Blockchain Transparency Institute) and Bitwise back the notion that Coinbase and Binance are amongst a select group of famous crypto exchanges with real volume.
On the other hand, The Block differed with part of the methodology used by Bitwise in its study, describing how Bitwise overlooked the real volumes on hundreds of crypto exchanges that they consider having fake volumes.
Examining crypto exchange volume is obviously very challenging, but the inference that can be drawn from both The Block and Bitwise is that fake volumes and wash trading will keep going on at an alarming rate.
One reason that might make a cryptocurrency exchange influence its numbers, is due to the effect of data collecting websites like CoinMarketCap, which is extremely invaluable to distributors of prospective investors to new crypto exchanges considering more volume.
The higher a new crypto exchange appears on the website, the higher the possibility of investors checking it out, building a positive feedback loop for the crypto exchange’s volume at the expense of transparency for investors.
During the unregulated ICO phase it was stated that the listing fees for some ICOs on crypto exchanges was in the range of millions of dollars.
While the incentives for smaller and newer crypto exchanges to take part in wash trading and inflated reporting are manifest, some of the downstream repercussions are not as understood as it should be – for the most part concerning the solvency of crypto exchanges.
While the supposed fake volumes, exit scams, and solvency issues of crypto exchanges may appear like an unfixable challenge, that notion is becoming outdated.
Numerous crypto exchanges and outside projects are aiming at increased transparency in the crypto ecosystem. Either through self-regulation via proof of reserves, revenue reporting, or custodial protocols. Transparency among cryptocurrency exchanges is definitely going to improve.
For most investors, knowing which crypto exchanges to trade on depends on understanding and self-education of which crypto exchanges are genuine and those that are not.
Websites like Nomics and BTI offer data-driven metrics for genuine volumes on crypto exchanges, describing any irregularities between metrics like reported volumes and website traffic.
BTI even provides in-depth reports on crypto exchanges to avoid their ‘Wash Trade Status,’ which shows their percentage of total volume that is likely wash traded.
Proof of solvency creates a serious problem for some exchanges. For instance, a cryptocurrency exchange may not want to report fiscal details or revenue publicly because of the fear of their competition taking undue advantage of their transparency – a rational concern on their part.
ArpaChain depends on a cryptographic method called ‘secure multi-party computation,’ which lets several participants to compute a function without disclosing their independent inputs.
In the context of crypto exchanges, that means exchanges coming together to self-regulate, and to uncover exchanges that are solvent beyond a specific threshold without disclosing the particular financial data of each exchange.
Kraken offers comprehensive information on their ‘Proof-of-Reserves’ audit procedures to give investors adequate guarantees on the solvency of the exchange. In the same way, ‘Proof-of-Reserves’ is the name of a suggested protocol by Blockstream for regulating solvency proofs with Bitcoin.
Some solutions basically avoid the problem of solvency completely.
Arwen Protocol makes use of atomic swaps to avoid the need of depositing cryptocurrency assets on a centralized crypto exchange.
As an alternative, funds are stored through a combination of off-chain atomic swaps and on-chain escrows – the crypto assets are not stored on the said exchange, so there’s no need to worry over a fractional-reserve system functioning behind the scenes.
Suggestions for scaling Bitcoin also include the notion of ‘Bitcoin banks,’ and at least, financial institutions or exchanges that uncover risk to users – with unpredictable roles and consequences to play in the ecosystem.
It is clearly evident that the lack of transparency of crypto exchanges is a major problem, it isn’t a dilemma that has no hope of improvement.
Traversing the underbelly of the crypto exchange environment is full of risk and challenging, but at least observers and investors are better armed with sophisticated tools to detect the truth for themselves – giving credence to the maxim of “do not trust, verify.”