Cryptocurrency exchanges occupy a precarious position in a unique field of technology. Despite their undisputed role as fiat-to-crypto gateways that are beneficial to many people across the world, they face endemic hacking problems and distrust by core cryptocurrency proponents. Inevitably, this draws from a balancing act between conventional finance and a disruptive market — attempting to capture as much value as possible. 

But cryptocurrency exchanges aren’t going anywhere soon. 

Decentralized exchanges (DEXs) continue to tarry behind in user-friendliness and liquidity, while institutions and regulators are assuredly looking for more familiar structures like centralized exchanges to service retail clients — at least compared to their decentralized counterparts. 

With global regulatory regimes fragmented on their cryptocurrency positions, the onus has largely fallen on exchanges to take the initiative themselves to fix problems facing the industry. From South Korea to Japan, we are beginning to see the cooperation between exchanges necessary to convert regulators to the view that crypto markets can adequately mature. The result, hopefully, should be more standardization of practices, less market manipulation, and the facilitation of both liquidity and technological advances. 

Crypto exchanges are a pivotal component of pushing mainstream cryptocurrency adoption forward. And here are 5 reasons why we need more interconnected crypto exchanges. 

Compliance/Wash Trading/TransFee Mining Management 

According to Bitwise’s report on cryptocurrency trading from earlier this year, roughly 95 percent of crypto exchange volumes are fake, expounding many criticisms of the relationship between exchanges, token issuers (i.e., ICOs and IEOs), and coin rankings sites. Many smaller, obscure exchanges directly engage in wash trading and trans-fee mining to achieve a perceived increased liquidity, which ostensibly attracts projects to list more tokens, and traders to gravitate to their platform. 

Dubbed the “Dark Underbelly of Cryptocurrency Markets” by Nic Carter, such practices have not dissipated. 

Cryptocurrency markets are esoteric to the mainstream and regulators, and until exchanges take action amongst themselves, regulators are unlikely to be swayed on their legitimacy until they can prove the market is not rife with manipulation. 

Non-Custodial Assets Swaps 

Amongst the more promising developments concerning the underlying technology of cryptocurrencies is trust-minimized asset swaps, without intermediaries. Commonly referred to as “atomic swaps,” these transfers of tokens can take place seamlessly via standardized protocols intra-network (i.e., Cosmos) and inter-network with some advances such as submarine swaps with the Lightning Network. 

For exchanges, the path towards more non-custodial asset swaps is inevitable. Decentralized exchanges offer much better security because there is no inherent third-party risk, which has repeatedly made large custodial exchanges honeypot targets for hackers. 

And we are already seeing some innovation in non-custodial swaps of exchanges. 

For example, Binance’s DEX is rapidly gaining traction, and from a broader perspective, it is reflective of the sentiment that centralized exchanges need to keep pace (and capture value) from the DEX market. Additionally, firms like Ernst & Young are pioneering privacy-oriented asset swaps with protocols like Nightfall, which are enticing to major financial institutions.

Minimizing custodial risk is paramount for exchanges to remain relevant as DEX’s grow in popularity, and therefore, exchanges working on standardized, non-custodial protocol swaps should help bolster innovation in the field. 

Self-Regulation 

More of a regulatory relationship than technical interconnection, self-regulatory initiatives for exchanges are a necessity. The lack of a transparent regulatory framework in many regions of the world is hindering the development of standardized security and other practices. 

Under scrutiny from regulators, several exchanges in South Korea and Japan have proposed and worked towards self-regulatory organizations amongst themselves — cracking down on market manipulation. 

Similarly, many prominent exchanges have joined CoinMarketCap’s (CMC) DATA Alliance, which was created to define stricter order book reporting guidelines, diminishing the ability of smaller exchanges to inflate their trading numbers if they want to remain listed on CMC’s rankings site. Many smaller initiatives, like the Blockchain Transparency Institute, also help to expose market manipulation via inflated order book numbers, adding pressure to exchanges. 

With regulation highly fragmented currently, self-regulation among exchanges could also provide the spark that ignites regulators to make more definitive guidelines. Similarly, their purview of crypto may become more friendly as they view self-regulation as a maturity marker for the broader industry. 

Facilitate DeFi & Institutional Entrance 

One of the emergent trends in crypto of 2019 is DeFi, and its broader implications on the financial sector. Exchanges have significant potential to play a pivotal role in the development of DeFi, and subsequently, institutional entrance into the market. 

For example, Coinbase is already offering Staking-as-a-Service to clients, and many smaller firms are originating out of a demand for DeFi services. BitMEX, the leading Bitcoin perp swap platform, is even planning on rolling out fixed income products for its users. 

Should larger institutions take favorable stances on the push by exchanges to incorporate DeFi services, albeit more hybrid versions than something like MakerDAO, funds could pour into the sector. There are already numerous DeFi startups spearheading some cool technology, but institutional funding would light the sector into a full-blown hotbed of technological incubation. 

Better Liquidity 

Liquidity is the ultimate goal of any exchange, and interoperability among exchanges would only serve to fuel better liquidity, which begets more liquidity. Combined with standardized, non-custodial asset swaps, and the complete entrance of institutions would likely be preceded by a confluence of self-organized and interoperable exchanges. 

But advantages wouldn’t be strictly relegated to institutions either. 

Better liquidity across a multitude of exchanges would ensure much wider access to crypto assets by the public, including in many developed parts of the world. Bitcoin’s accessibility is currently one of its weakest assurances, largely because of the inability of many people in more oppressive political and economic arenas to gain access to the legacy cryptocurrency. 

Conclusion 

Interconnected exchanges are paramount for a swath of intercorrelated reasons. The crypto market desperately needs to mature if it wants regulators and institutions to take it more seriously. Blending self-regulation, asset swaps, reduced market manipulation, DeFi products, and better liquidity is an optimal path to reach that end. 

2019 has marked the entrance of institutional investors in cryptocurrency. Fidelity Digital Assets launched in May and several banks have announced plans to get involved in the space.

However, many institutions continue to wait on the sidelines. Why would they do this? 

It’s hard to ignore the fact that Bitcoin has been the best-performing asset class in the world for the majority of its existence. So why the hesitation from the traditional investment community?

Here are six factors affecting the appetite of institutional investors in cryptocurrency.

Custody Concerns

Anyone following cryptocurrency markets have seen the headlines about the latest exchange hack. At some point in the future, there will certainly be a bigger hack than the one the industry just experienced. What this leads to is a confidence crisis, especially amongst the uninformed. ‘This must mean all digital assets are insecure,’ they might reason.

Cybersecurity is an issue that’s not unique to the crypto asset class by any means. But it does have an extra sense of importance in the space because people have a hard time trusting something they don’t understand. 

While some companies have made progress toward a solution, figuring out a way to securely hold digital assets remains a primary concern among institutional investors in cryptocurrency. 

High Volatility

In general, volatility has an inverse relationship with security. Volatile assets are seen as high-risk while stable ones are seen as low-risk. Newer, small-cap stocks tend to be volatile while government bonds tend to be more stable, for example.

While exceptions do exist, this is one of those tried-and-true principles of investing that many people can’t seem to get out of their heads. Just because an asset is volatile doesn’t make it higher risk than less volatile assets, although as a general rule volatility is a good way to assess risk. 

Fiat currencies like the Turkish Lira, Argentinian Peso, and Venezuelan Bolivar were all stable for long periods of time before entering free fall. But most big investors would still rather risk losses in an asset class they know than take a stab at an asset class they don’t. 

Basic Lack of Awareness

Digital assets as a class has only existed for little more than ten years. Many have yet to see its full potential realized.

It can be difficult to comprehend the total paradigm shift that has occurred with the invention of blockchain. The implications are vast, and often overwhelming for even seasoned traders. 

This explains why a handful of the biggest traditional investors in the world are hesitant to go ‘all-in’ with cryptocurrency, for now. Some big names have been very vocal with their criticisms of Bitcoin, often relating it to some of the financial mechanics that started the 2008 financial crisis. These criticisms often demonstrate a fundamental ignorance about the technology upon which cryptocurrency is predicated – distributed ledger technology, or blockchain.

Immaturity of the Industry

Let’s face it. Trusting an asset class that’s only a decade old isn’t easy. The space has been plagued by bad actors and mishaps. And the industry as a whole has a branding problem, with negative misconceptions abounding. 

These misconceptions might be the least tangible of the six factors but also the most difficult to overcome. The problem is purely cognitive in nature. As more traditional financial players continue to educate themselves with regard to blockchain, however, this should change. 

Technological Know-How

Some traditional financial institutions have struggled to keep up with the fast-moving blockchain industry. With the smartest talent garnering an extremely high level of competition, the barrier to entry is enormous, to say the least. Some companies even attempt to circumvent the head hunting process by attempting to train their staff to learn crypto, which hasn’t proven successful for many companies. 

Most people at financial institutions probably don’t know what the term “cold storage” means, for example, and much less how to implement it. This knowledge barrier creates an inconvenience for organizations which can be intimidating, leading to further segmentation of opinions about the industry. 

Regulatory Uncertainty

The majority of the world’s most important international regulators have been more than vague in their guidance toward the crypto asset class. Some say cryptocurrency is an asset in the same way that property is, others say some coins are securities, while others claim digital assets are commodities. 

This is a nightmare scenario for institutional investors in cryptocurrency. It’s even a headache for small retail investors. 

To be fair, regulators have begun clarifying their stance toward crypto, as the industry continues to mature and increase in adoption globally. However, due to the fast evolving nature of the industry, this factor will continue to impede adoption by legacy financial investors. 

Institutional Investors in Cryptocurrency are Still Learning

What we have seen this year continues the movement towards mainstream adoption of cryptocurrency and blockchain. One day, market participants will look back on 2019 as the year it all began for institutional investors in cryptocurrency. The entrance of a few big players in the space will likely precede a gold rush to the gates. 

Axon Trade’s commitment to bringing many of the traditional financial instruments to the world of crypto will prove instrumental in luring in many of the legacy investment institutions to this industry. XTRD’s creation of familiar products like a FIX protocol for crypto and a Single Point of Access for traders have already attracted many hawkish investors to the market. The XTRD model will bring higher liquidity, lower fees, and combine platforms, in an effort to increase returns for traders. 

Factors like custody management, regulatory uncertainty, and cybersecurity are slowly becoming less and less of a concern. Through the new crypto instruments that Axon Trade is bringing to market, these apprehensions are becoming irrelevant. Given the pace of developments in the space, who can say how fast those obstacles might be overcome?