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Comment by kristjansson | Hacker News Reader

Why is it apparently so difficult to run a solvent crypto exchange? On the face, it shouldn't be too hard, just take deposits, stick them in a wallet, and swap client balances in a database.

Is the temptation to maintain a reserve ratio < 1 just too great? Do operators try to earn small, low-risk return on client funds only to find there are no low-risk, positive-return assets in crypto? Are the extending margin to clients or explicitly stepping in as counterparty, and get exposed to losses as prices move?

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Probably the insolvent exchanges are able to offer lower costs and better promotions to users. For instance Coinbase has always charged way higher fees than FTX for simple buying and selling of coins.

Sometimes they offer to cover withdrawal fees too. Still it seems like they should be making money hand over fist.

> Why is it apparently so difficult to run a solvent crypto exchange?

Running a stock exchange is a hard business too; you are the market maker, you set the spread, and the most sophisticated investors in the world are trying to arbitrage you. Any mistake can potentially ruin you. If you do you job right you take a tiny sliver of profit from each transaction.

Now consider crypto, where your ability to pause the market or unwind clearly-erroneous transactions is reduced or removed.

Sounds excruciatingly hard to me.

That's why you get outsiders on your exchange to make markets and you just charge commissions and access fees.

> Running a stock exchange is a hard business too; you are the market maker, you set the spread, and the most sophisticated investors in the world are trying to arbitrage you

Normal markets aren’t as centralised as crypto. The exchange and market maker are separate.

It's pretty uncommon for exchanges to do all their market making directly, and many of the ones that do still rely on outside market making.

FTX was almost the exception since Alameda spun out of it IIRC

> pretty uncommon for exchanges to do all their market making directly

Point is, in real finance, it's pretty uncommon for exchanges to do any of their market making. Largely to ensure they can project confidence in crises. Market makers blow up. Exchanges shouldn't.

Do exchanges in real finance even have long term customer deposits?

> Do exchanges in real finance even have long term customer deposits?

Not really. They used to! (A hundred+ years ago.) But we learned that an exchange blowing up is a hell of a lot worse than a bank or broker. So most systems segregate the functions. (It's also not great to have an exchange making markets and thereby having a vested directional interest.)

Alameda was founded first.

This is just not the case. At least on Binance there are number of market makers other than Binance itself and there is a lot of tech built around this. I guess every major crypto exchange after MtGox is as complex as normal markets.

> Now consider crypto, where your ability to pause the market or unwind clearly-erroneous transactions is reduced or removed.

These should be quite possible, no? Exchanges have mainteinance pauses now and then, however if they had them regularly that would drive customers away. Unwinding transactions inside crypto exchanges is also not unheard of I think.

The majority of crypto exchanges failing has been due to them being hacked or assets stolen. It seems to be an ongoing problem. It's kind of inherent to crypto transfers not being reversible. In a regular stock exchange if a crook tries to transfer the assets somewhere you can freeze or reverse the transaction. Crypto not so much.

The FTX issues seem to be something else - it's a bit unclear what exactly at the moment.

I've got some assets with FTX so I'm curious. As well as holding crypto they do futures trading on it and I wouldn't be surprised if Alameda Research, their privately held prop trading fund is a counterparty to some of those and may have gone bust.

Storing money costs money: at least the bank fees, if not the negative interest rates.

Processing money costs even more money: operations must be scrutinized, international movements require validation and communication, and various AML/CFT/Fraud procedures must perform investigations etc. You have accounts in various currencies, perform conversions to maintain liquidity…

So I can see why they would start dipping their toes into investments. Once they start, they probably don’t consider enforcing Basel III to their procedures, and things just unfold.

Running a reserve ratio < 1 is a convenient way of funding advertising to get more people to use your exchange.

So the question you should be asking is: if there is a solvent crypto exchange, how would I ever find out about it?

Presumably transaction fees, market data fees, etc. would provide enough revenue to fund advertisements?

Advertising is a market, you see ads for whoever is willing to bid the highest. It seems like Coinbase had to raise money to get big. FTX arrived to the scene later. It would be hard to compete by bootstrapping from organic growth.

Taking outside money doesn't preclude solvency

The reason FTX got to #2 exchange in only 3 years is because they were using customer funds and leverage to grow rapidly. If they hadn't done this they might have been much smaller. There are hundreds of exchanges now, most work exactly as you describe but don't make headlines because they don't grow rapidly then collapse.

Asset heavy. The computer systems to run one are expensive. Compliance is expensive. Your return on assets are probably lower than 5% in a regulated market.

If you don't take extra risks to spruce up returns, you lose money.

FTX offers leveraged products so they are borrowing assets from somewhere to fund these trades.

This is only true for covered leverage with physical delivery. If you match a buyer and a seller, they can agree to settle in fiat.

Faking the liquidity.

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