Why can’t professional traders access the liquidity of the global cryptocurrency market?

Original link: https://cointelegraph.com/

Author: Apifiny CEO Haohan

Currently, the cryptocurrency trading market is in its early stages, and regulation plays a key role in a fragmented market.

Fortune magazine believes that Coinbase's IPO plan is a "milestone event in the crypto industry." Like Netscape's IPO plan that marked the legitimacy of the Internet, Coinbase also sends a signal to the general public: in the eyes of the U.S. Securities and Exchange Commission (SEC), cryptocurrency trading is legal, compliant and safe. Investors will have the opportunity to hold shares of the largest crypto trading platform in the United States.

Many people see investment in Coinbase as an investment in the future of the cryptocurrency trading industry. Coinbase is the largest cryptocurrency exchange in the United States, with a trading volume three times that of the second largest exchange in the United States, and even leading the international level. However, the size of the cryptocurrency trading market is still far from that of the traditional trading market.

In order to better understand the nuances of the crypto exchange market, it’s best to first look at some of the current state of the industry.

The table discusses important factors that affect market maturity and are also the problems currently faced by cryptocurrency trading institutions. Currently, there is no single exchange that allows traders to access global liquidity, discover cross-border prices, and obtain the best global prices.

Today, the cryptocurrency trading market remains highly fragmented with no dominant player.

The trading volume of the world's top five cryptocurrency exchanges accounts for 41% of the global total. Among them, the trading volume of Coinbase, the largest exchange in the United States, accounts for only 2.1% of the global trading volume, ranking only 19th in the world. In the global market, there is no mature market leader as we expected.

According to the above data, the NYSE's share of global stock trading volume is more than 12 times that of Coinbase's share of global digital currency trading volume. The daily trading volume of the top two US stock exchanges accounts for more than 50% of the global daily trading volume, while the trading volume of the top two US crypto exchanges accounts for only 3% of the global trading volume.

Compared to traditional stocks, the cryptocurrency market is highly fragmented. The world’s two largest stock exchanges account for 51% of global daily stock trading volume, while the world’s three largest cryptocurrency exchanges account for only 27% of global daily cryptocurrency trading volume.

Lack of a unified global trading market

The cryptocurrency trading market is still in its infancy. In our communications with institutional traders and independent professional traders, we learned that institutions are still looking for platforms that meet institutional-level trading capabilities, and these requirements cannot be achieved on a single platform. For example:

Global Price Discovery – Access to normalized prices in local currencies across global markets.

Global best deal quotes – global order book, normalized by exchange rates and fees in local currencies.

Global liquidity access - Access to liquidity from global trading markets, not just one exchange.

Each exchange is now its own trading “inland lake” with no “canals” connecting them. In the U.S., traders can only trade with 2.1% of the world’s users, and their order books are completely different from other U.S. exchanges, such as Coinbase and Kraken.

Currently, “global volume, liquidity, and price discovery” is only possible for users who can manage multiple exchange accounts in multiple countries and regions, a difficult task that occupies both legal and technical resources.

Clearly, traders will benefit from a global order book based on a single currency, as well as access to the best global prices and the liquidity required to execute large trades. The industry is in urgent need of a “crypto solution” equivalent to the National Best Offer (NBBO) for traditional securities.

Centralized exchanges are only part of the trading landscape

Binance and Coinbase are centralized exchanges that match orders from buyers and sellers and execute trades and settlements. Users’ cryptocurrency assets are held by the exchange, and users can only trade with other users on the same exchange. Even in terms of total volume, centralized exchanges cannot capture the total trading volume of all digital assets.

All this is due to the rise of decentralized exchanges, which enable peer-to-peer transactions. Decentralized exchanges usually enable direct exchange of assets between traders without knowing the customer information. In 2020, Uniswap's trading volume once exceeded Coinbase. Decentralized exchanges may be on par with centralized exchanges. Therefore, if you don't understand decentralized exchanges, you can't fully understand the situation of the crypto trading market.

Figuring out how to incorporate price discovery and liquidity from decentralized exchanges into centralized exchanges will have important advantages.

Decentralized exchanges are growing, but lack the infrastructure to scale

Decentralized exchange volume accounts for approximately 15% of all cryptocurrency trading (based on CoinMarketCap data as of February 16). Decentralized exchange volume has been growing rapidly, with Uniswap’s volume even surpassing Coinbase in 2020, a feat that was surprisingly achieved with only 20 employees. Today, Venus’ volume is on par with Binance, which leads the market in 24-hour volume at the time of writing.

Professional traders may value decentralized exchanges more for the security of “wallet-to-wallet” or “peer-to-peer” transactions. However, two problems remain. First, institutional traders cannot trade on decentralized exchanges without KYC of counterparties. Second, the public blockchain technology that supports decentralized exchanges is slower and more expensive than centralized exchange transactions.

Institutional investors need decentralized exchanges with faster speeds, lower fees, and sound KYC procedures. Therefore, decentralized exchanges must be built on faster and cheaper blockchains to attract institutional traders.

There are no real centralized exchanges — only real brokers

To further confuse matters, today’s crypto exchanges act more like regional brokers than true, global exchanges. Take trading Apple (AAPL) on E-Trade and Bitcoin (BTC) on Coinbase, for example.

Professional traders in the United States who want to trade BTC can only participate in a small part of the global trading market through Coinbase. Price discovery and liquidity are only obtained through the BTC/USD order book on Coinbase. In other words, more than 97% of the world's supply, demand, price discovery and liquidity are only available through hundreds of exchanges.

To summarize, comparing selling AAPL at E-Trade and selling BTC at Coinbase:

E-Trade places orders on Nasdaq and captures nearly 100% of AAPL spot transactions.

Coinbase, placing orders on its own order book, only gets 2.1% of all global trades.

The reality is that there is no real "global cryptocurrency exchange market" in the world, but only hundreds of smaller local markets. If the current situation of the global cryptocurrency market is analogous to the traditional exchange market, it is selling AAPL on more than 300 different exchanges, each with its own buyers and sellers.

This problem is two-fold. First, trading on centralized exchanges takes away many of the advantages of decentralized assets. Second, cryptocurrency trading is fragmented into hundreds of decentralized trading “inland lakes,” each with its own local fiat and cryptocurrency supply and demand.

Centralized exchanges manage token listing rights, custody, order matching and execution, and brokerage services. When users trade on centralized exchanges, they give up a lot of control.

This centralized power brings security and compliance risks, which has caused criticism in the market. In fact, traders in the Asia-Pacific region have launched multiple withdrawal campaigns to express their resistance to CEX trading. The younger generation is very disgusted with centralization and dares to challenge it, as evidenced by the recent short-selling war of American retail investors. Decentralization ensures that no one entity can fully control cryptocurrencies.

Centralized exchanges are severely limited in their access to global markets. While exchanges like Coinbase and Gemini only accept users (US only) with limited regional fiat currency trading pairs (USD only), E-Trade opens the door to numerous exchanges, stocks, ETFs, etc. for its traders. In contrast, centralized exchanges close the door to all other exchanges, severely limiting price discovery and liquidity, which leads to higher spreads, lower fill rates, higher slippage, or what is commonly known as market inefficiency. The concept of best bid and ask does not exist in the crypto world, as the BBO on Coinbase is not the same as the BBO on Gemini, Binance, or Huobi.

Services for professional traders are not yet complete

From the perspective of professional traders, the current market does not have sufficient maturity and global trading capabilities. The segmentation of the cryptocurrency trading market is still in its infancy, and the needs of professional traders have not yet been met. The main reasons are as follows: (1) the inability to efficiently access the global market; (2) the inability to obtain the best prices in the global market and the inability to obtain institutional-level liquidity.

In addition, due to the lack of KYC process, it is not feasible for institutional traders to participate in decentralized exchange transactions. However, ordinary traders on Uniswap are very active. Uniswap users are completely on-chain transactions, open and transparent, and its 300,000 users have more trading volume than Coinbase, which claims to have 35 million users. This shows that the entire whale market is traded outside of centralized exchanges, which completely subverts the market's understanding that "Uniswap and decentralized exchange users are mainly retail investors."

No trading market can truly cover the world, retail and institutional traders cannot access a truly global market, and there is no trading market that provides institutional-grade DEX trading.

Asset digitization will drive industry growth

The industry generally agrees that the continued digitization of assets is inevitable. Bitcoin and Ethereum (ETH) are native blockchain tokens. Currently, the main trading volume in the cryptocurrency trading market comes from these two mainstream coins, but the market value of cryptocurrency is less than half of Apple.

The stock market is almost negligible compared to the untapped digital asset market. Although there is a huge opportunity, it is too early to predict the results.

Numerous exchanges expose traders to compliance risks

Some of the world's leading exchanges allow a large number of controversial tokens to be traded, and many exchanges have inadequate anti-money laundering regulations. Although some exchanges claim to have licenses in some countries, it is difficult to imagine the legal compliance of providing derivatives trading to global users by using a single country's exchange license. These compliance risks have brought severe challenges to the stability of the status of some exchanges. Not long ago, BitMEX was sued, resulting in user loss and a decline in trading volume, and the market landscape of derivatives has changed rapidly.

Innovation in institutional-grade trading technology has yet to become widespread. Current volume rankings only tell the story of the present, and the future story will be told by trading markets that provide true, global best bid and ask price discovery, institutional access to DEX pricing and liquidity, and the ability to execute global trading strategies on a single platform.

About the Author:

Haohan is the CEO of Apifiny, a global liquidity and financial value transfer network. Prior to joining Apifiny, Haohan was an active investor in the stock market and a trader in the digital asset market. He holds a bachelor's degree in operations research and a minor in computer science from Columbia University.

Original article, author: Apifiny. For reprint/content cooperation/seeking coverage, please contact [email protected]; illegal reprinting will be subject to legal prosecution.