Crypto Exchanges and their economic roles in transaction

Before starting of with Crypto Exchanges, just to recap, in the last session, we discussed the different ways of Bitcoin transactions in detail. Today, we take a close look at the role of the exchanges through which Crypto transactions are performed.

How Do Crypto Exchanges Make Money?

Crypto Exchanges make money by charging fees, just like your stock broker. Different exchanges charge different fees in different ways. Some charge withdrawal fees (e.g., if you withdraw $10,000, then they might send you $9,950, and you would receive even less than this because of bank fees). Others charge by taking a small fraction of every trade you do, usually by reducing the amount of whatever you are receiving.

For example, if you have $8,000 in your exchange account and use it to buy BTC at a price of $8,000 per BTC, then you will receive slightly less than 1 BTC, say 0.995 BTC. Trading fees are usually determined by how much trading you do, so if you trade more, the fee rate decreases according to a published fee schedule.

Crypto Exchanges
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Pricing On Different Crypto Exchanges

The price of any asset at a Crypto Exchanges depends on the participants using the exchange. Different exchanges can have different prices for each cryptocurrency, because of the different participants using the exchange and the different levels of supply and demand on those Crypto Exchanges. Usually the prices are within a few percent of each other. If they get too out of line, arbitrageurs step in and buy the bitcoins from the exchange where they are cheap and sell them where they are trading at a premium.

The extent to which arbitrageurs can keep doing this profitably affects how aligned the prices will ever become. To complete the circle of a successful arbitrage you need to move the fiat, and sometimes this will have costs and time delays. To buy bitcoins on the cheap Crypto Exchanges, you need to move fiat currency there, buy bitcoins, withdraw the bitcoins and send them to the more expensive exchange, then sell them, withdraw the fiat, and repeat the cycle.

Each step has a financial cost and may not be instant. Some countries have currency controls, which hinder cross-border exchange arbitrage. This is why there can be price differentials between exchanges for some time. In late 2013-14, the exchange Mt Gox traded at a premium to its competitor Bitstamp, because people found they couldn’t withdraw fiat from Mt Gox, so instead, they had to buy bitcoins and withdraw the bitcoins instead. This created artificial demand for bitcoins on Mt Gox, and the arbitrage of buying cheap bitcoins on Bitstamp and selling them on Mt Gox didn’t work because you couldn’t get your fiat out of Mt Gox!

Crypto Exchanges Regulation

Crypto Exchanges perform activities that may be regulated in their operational jurisdictions. The fact that the instruments involved are cryptocurrencies does not necessarily mean that the exchanges escape local trading and tax disclosure requirements. However, depending on how the legislation is written, and owing to regulatory uncertainty, the classification of Crypto Exchanges currently operates in a legal grey area, especially crypto-only exchanges that allow trades between cryptocurrencies but not fiat.


Suggested Topic

Working of Bitcoin Exchange in Deposits and Trade


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