3 Problems Exchanges Must Solve for Wall Street to Embrace Cryptocurrency

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Updated: Mar 4, 2019, 13:22 GMT+00:00

Cryptocurrencies exchanges are the widest platform to buy and sell coins and although exchanges constantly evolve and improve, there are challenges ahead and problems to solve.

Cryptocurrency is here to stay and there’s not much that skeptics and pessimists can do about it. Bitcoin, the poster boy of cryptocurrencies delivered 1,420% gain in 2017 to obliterate gains traditional assets such as gold, stocks, and bonds on Wall Street. Bitcoin has since retracted its steps from its $20,000 high trading price, yet the cryptocurrency is still holding steady despite all the noise about a how the cryptocurrency bubble is about to burst.

Nonetheless, the resiliency of cryptocurrency in the face of unmistakable persecution from traditional financial institutions does little to hide the fact that many of the current exchanges are not making it easy for traditional investors to come on board.

A cryptocurrency exchange is simply a platform where you can buy sell or exchange one cryptocurrency for another or fiat currency. A cryptocurrency is usually the first point of participation for people that want to trade/invest in cryptocurrencies. Hence, an exchange is an important link in the cryptocurrency industry. This piece examines some of the biggest challenges facing cryptocurrency exchanges with insights on how they can solve the problem to encourage increased participation from Wall Street.

Lack of liquidity is pushing volatility

One of the biggest problems facing cryptocurrency exchanges is an endemic lack of liquidity. The lack of liquidity, in turn, makes it hard for traders and investors to exit the market at profitable prices. When trading cryptocurrency, traders often have to up their sale and wait for the order to be filled. However, the fact that many exchanges don’t have a reserve pool means that traders must wait until there’s a willing buyer on the network before their order is filled. Hence, many traders often find themselves trapped in the market beyond the timing of their exit signal.

Unfortunately, many people buy cryptocurrency for speculative purposes; hence, the buy and hold in the hopes of selling at a high price. When speculators “agree” that prices have risen enough, they tend to make the decision to sell at about the same time. The lack of liquidity to fill orders often causes massive price swings that in turn reinforce the notion that cryptocurrencies are crazily volatile.

A smart way to solve the liquidity problem for cryptocurrencies is to support the growth and development of the futures market. If traders can short sell coins that are held by investors, there will be an increase in trade volumes, and the increase in trading volumes will, in turn, engender price stability.

Lack of regulations engender market manipulation

Cryptocurrency exchanges currently function in uncharted territory; hence, regulations guiding their operations are practically non-existent. The lack of regulation that could ensure fund security, verifiability, and fairness has, in turn, kept institutional investors out of the market. The lack of institutional investors, in turn, makes it hard for cryptocurrencies to break the liquidity barrier (see1).

New exchanges such as Legolas, are adopting a hybrid solution that incorporates a decentralized ledger within a centralized structure. Legolas’ approach is different from the setup of current exchanges, which is mostly centralized to leave room for market manipulation. A hybrid exchange will neutralize front-running in cryptocurrency trades and ensure transparency, inalterability, and temporality of the order book to provide all market participants a level playing field.

Legolas is also forging strategic alliances with stakeholders in the cryptocurrency industry and traditional financial institutions to ensure that traders can push transactions between crypto and fiat and between different cryptocurrency on different exchanges.

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Current exchanges are lacking in security for investor funds

In February 2017, Bitcurex, Poland’s oldest exchange disappeared into thin air – about 2,300 Bitcoin also disappeared with the company. Traders who had Bitcoin on the platform have since given up hope of recovering their assets because all the traces of the company, its owners, including social media accounts have been deleted.

In 2015, a Hong Kong-based exchange, MyCoin shut down and about $386 million worth of cryptocurrency disappeared with the company. GBL, a cryptocurrency exchange based in China went offline in November 2013. Traders and investors initially gave the exchange the benefit of the doubt that it probably suffered a hack, until investigations revealed that the company had a bogus office address and the $4.1 million worth of Bitcoin in the exchange are gone forever.

The common thread with the aforementioned events is that a dishonest cryptocurrency exchange could disappear into thin air with the funds of investors and traders. Cryptocurrency exchanges will need to break down the skepticism of potential investors by adopting strategies that ensure the safety and security of assets. For instance, exchanges may want to consider secure wallets that let you control coins such that no one else other than you can spend the coins.

The adoption of smart card based hardware and wallets will, in turn, make it easier for traders to trust the exchange because no one can spend your assets even in the unlikely event that the exchange goes under water.