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Last Notes

2025-01-20 01:05:47 UTC

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Welcome to Nostr Ian! Great to have you here.

2024-08-11 16:38:50 UTC

On February 2nd, 2024, the Bank of Canada (BoC) published an analytic note titled “Market structure of cryptosasset exchanges: Introduction, challenges and emerging trends”. I’ve read all 30 pages so you don’t have to.
⬇️Read on for a brief summary and some thoughts.⬇️
Analytic notes are “short articles that focus on topical issues” that are “produced independently from the Bank’s Governing Council”. All 4 authors work for the Bank of Canada.
Summary
The note offers a brief introduction on how cryptocurrency exchanges work and their difference from traditional financial (TradFi) markets. The authors disregard the growing market share of decentralized finance (DeFi) crypto exchanges, but note that they account for about 15% of spot crypto trading volume.
They reveal the difference between the accounting ledger on an exchange, where your assets are traded with other cryptocurrencies (or fiat currencies) and the blockchain ledger of the tokens you hold on the exchange (say, Bitcoin). They rightly point out that the exchange ledger is mostly where troubles arise with fraud, hacks and mistakes that may compromise the holdings of an account.
Crypto exchanges and traditional financial (TradFi) exchanges differ in several key aspects. Crypto exchanges often provide a wider range of trading instruments, including numerous crypto-to-crypto trading pairs. Additionally, they offer unique products and services that are not typically found in traditional exchanges, such as issuing their own native tokens, managing their own blockchain networks, distributing stablecoins, and providing staking services. Staking allows users to pledge (stake) certain tokens to earn financial rewards. Furthermore, crypto exchanges are more interconnected than traditional exchanges, as they often provide liquidity, market-making, and arbitrage opportunities to each other.
In some ways, cryptocurrencies and their exchanges have created a more level playing field amongst the ultra wealthy, institutions and the everyday person. The BoC note considers that the barrier to entry for crypto exchanges is low - most people can make an account. Many crypto exchanges also offer more complex trading alternatives like leveraged trading and options. In TradFi, there are many jurisdictions that only allow those alternatives to be offered to an ‘accredited’ investor with a minimum net worth, or net income.
The note also explores the market microstructure, comparing traditional exchanges and cryptoasset exchanges. Unlike their traditional counterparts, crypto exchanges typically handle the entire transaction process, from start to finish, taking on the roles of both broker and dealer. This means they manage the clearing and settlement of transactions, effectively controlling the entire lifecycle of the transaction.
The authors present three facts about cryptoasset exchanges:
1. Crypto exchanges vary in size, location and design. Curiously, this is where they choose to highlight wash trading (trading within an exchange to make volume and liquidity appear greater than it is) and point out its illegality in regulated markets.
2. Cryptoasset exchanges often are custodians of user funds.
3. Funds custodied by cryptoasset exchanges may be at risk of theft from hackers.
The note goes on to explore crypto exchange regulations in Canada, the US, Japan, the UK and Europe. In Canada, regulation “includes enhanced commitments for the custody and segregation of clients’ cryptoassets”. All of the countries examined include the crypto travel rule which comes from the FATF (Financial Action Task Force) Recommendation 16 adopted June 1, 2019. It stipulates that personal data about the sender and recipient accompany transfer of crypto assets with a value over a specified threshold (in the US it is $3000).
Finally, the BoC note looks at emerging trends and challenges. The authors posit that “the market is becoming more resilient by relying more on dedicated custodians.” They recognize that DeFi exchanges address the problems associated with centralization by executing trades directly on the blockchain of the native token and within the trader's own cryptocurrency wallet. The note points out the current drawbacks of using DeFi to trade including: longer trade times, greater transaction cost, knowledge barrier to access and the fact that you cannot trade BTC.
Conjecture
While BoC analytic notes are ‘produced independently’, I find it difficult to believe that 4 employees of the bank write something that is independent of the thought culture there. More likely, the note represents where current thought is at, or where the bank would like it to go.
The theme that jumps out at me is decoupling crypto exchanges and custody of cryptoassets. This seems to solve a problem that the BoC purports to care about: security of investment for the investor. A third party can hold your tokens so that if your exchange of choice blows up (metaphorically) the risk to your investment is minimized. Your assets are protected (for a small fee, of course).
However, this solution comes in the shadow of a greater debate that is going on around the world: Central Bank Digital Currencies (CDBCs). Most of the western world’s central banks are doing research and/or trials with CDBCs - including the Bank of Canada.
CBDCs are the ideal solution for technocrat bankers. Centralized and controlled by central banks, these digital currencies promise to provide all the metadata necessary to keep the central bank informed of subtle shifts in the economy, in real-time. Some fear that this will lead to overt monetary control at the individual level. Imagine your digital currency is turned ‘off’ when you try to purchase a plane ticket because you’ve surpassed your monthly carbon allotment.
That dystopia, while possible, is unlikely in my view. The 21st century is all about data, we’ve learned. The largest corporations don’t use data in an overtly punitive way. They use it subtly, to gain their ends without alerting the consumers they target. When the mechanism of manipulation is known, it becomes much less useful. In the same way, I believe the banks would wield their powerful CBDCs with a light touch, using the data trove to nudge the economy this way, or that way.
You can decide whether central banks are benevolent leaders, machiavellian conspirators, or somewhere in between. Regardless, should they have this power to begin with? What checks and balances will they adhere to, particularly when the power is wielded in an opaque way? How much responsibility do they owe to us?