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Comment by anticristi | Hacker News Reader

Pardon for living under a rock, but why are crypto exchanges affected by the mood in the crypto market?

I thought that a crypto exchange functions like a currency market: I put an offer to sell 10,000 EUR for 1 BTC and someone else puts an offer to buy 10,000 EUR for 1 BTC. When orders cross, a transaction happens and the exchange gets a fee, whether in currency or crypto units.

What are crypto exchanges fundamentally doing differently that they are suddenly losing money?

Surely a drop in transactions would make them lose fees and require them to fire some staff, but I expected a "Facebook-like" downsizing, not a full-blown bankruptcy.

What am I missing?

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Firstly, people keep their Crypto with the exchange for trading purposes and because it is easier than self custody. This means if the exchange goes bankrupt they potentially lose their money.

Secondly, as it is an unregulated space, we have instances such as FTX where they were using clients funds which should be segregated. This arguably crosses into fraud, and we do not really know which exchanges have been doing this and which ones have been properly segregating client funds. Coinbase is probably the only one we know for sure as they are an audited US publically traded company.

Finally, we also have situations where exchanges are doing things such as not matching client deposits to their reserves 1-1, or hold those reserves in less liquid investments. This could range from another fraudulent situation to good practice, but leaves them very exposed to situations where everyones wants their money back now.

Re point #2 - this is one of the crazy things for me. When you work in finance, in the UK at least, you get it drilled into your head what "client money" is, what that implies, what you can do with it, and notably you get reminded during any training session the size of the fines that get imposed on people who fuck with client money.

So to me it suggests that they simply don't employ anyone with any experience in banking or compliance, if they did those people would be raising hell or at least leaking or whistleblowing

Well, yes, it was a startup by a bunch of twentysomethings with no real banking experience. There was no partitioning.

> the size of the fines that get imposed on people who fuck with client money.

This is crypto, law doesn't apply here.

Well, that's the marketing pitch at least. So far a lot of exchanges and such like have gone bankrupt or been blatently stolen by their operators and nowhere near enough people have gone to jail.

I should say that what surprised me wasn't that a bunch of kids started up a company and during that process skirted, if not regulations, at least common sense. But that once serious money got involved and they grew into the millions and then billions of assets under management, nobody was around who could tell them that this was reckless and dangerous

All of the modern startups have skirting laws as a selling point to investors, they want them to be like that. Look at the Greyballing Uber was doing when it was a multinational billion dollar corperation. They actively don't want to play it the right way, they're going for the money.

On the contrary, they were being touted as a shining example of responsible crypto. They paid for a good reputation by donating to the “correct” causes and politicians.

3.5 years at Jane Street Capital. No excuse really...

It's worse than that. FTX's regulation and compliance officer was previously the legal representation for a shady online poker operation that used a bunch of offshore shell companies and whatnot to avoid US law for years. It's clear FTX's posture was to maximally avoid regulation.

That might explain a lot of what went down

I’m sure some of the people working there raised alarms, only to be shut up by the owners of the exchange, who skirted regulations on purpose.

You have to look at the business model of the exchange. They way you describe it is how it SHOULD work. The exchange makes money directly from you through transaction fees or just account fees. They would not need to "invest" your crypto in anything, because they have other ways to make money. This is (I think) the way Binance and Coinbase operate.

But a lot of these exchanges have attracted customers by offering interest (rather than charging a fee) and/or free transactions. But then how can the exchange make money and keep the lights on? Well they have to "invest" the customer's money. Then the investments go bad and it all blows up.

Minimum 4% interest here:

Each coin offers anywhere from 4% annual percentage yield (APY) to 20% APY. There are also limited-time-only offers, which can go as high as 60% APY.

https://www.aax.com/en-US/invest/savings/

> What am I missing?

That most of them, not all of them but, by very far, most of them are downright scams, planned as scams from day one, just like in the FTX case. Evidence is mounting quickly that both Alameda Research and FTX were mounted as scams (despite the narrative that's going to be sold that it was bad luck / bad trades that sent them in a death spiral).

There are people who warned about the very scam Alameda and FTX were putting the very day FTX launched.

For FTX, turns out they called themselves "crypto exchange" but lent the money just like a bank, making them, surprisingly, vulnerable to bank run, which happened.

Unfortunately, this is common, just like $LUNA called themselves "stable coin" but it was stable only against assets in the crypto that were not stable at all.

Live by "Do your own research" and die by it. I guess.

The thing that you are missing is that crypto transactions are slow and expensive. When I say slow I mean hours to complete a single transaction. That's why people keep their money on the exchange, it's far more efficient and usable. Of course it's also risky because exchanges do rug pulls all the time. Knowing when to pull your crypto and bail is a trick. If you're seeing news articles about "minor irregularities" and "temporarily suspended trading" it is too late. Your money is gone.

Okay, so if I replace the word "exchange" with "Ponzi scheme", then all "crypto exchange" news make a lot more sense to me.

Thanks!

Name one Crypto chain that takes hours to confirm a transaction. Bitcoin has a blocktime of 10 minutes and Ethereum is 10 to 20 seconds. More modern networks process transactions in orders of magnitude less time, eg. Solana has a slot time of 0.5 seconds and time to finality being 1 or 2 seconds.

Last time I bought something with Bitcoin (admittedly a couple of months ago) it took 7.5 hours for the transaction to clear. This wasn't with a bottom barrel transaction fee either, although it also wasn't exceptionally large. The transaction fee ended up being about 40% of what I spent on the whole thing.

All things are liquid if the transaction fees are big enough

> Solana has a slot time of 0.5 seconds and time to finality being 1 or 2 seconds.

When it's not down. Which seems to happen once a month these days.

Most of them are committing massive fraud. Gambling with customer funds. Misreporting trading volume via wash trading, and using that to create false impressions in the market that they can trade on. For instsnce, using their own tokens or "stablecoins" and then juicing the numbers for those.

As far as I know, Coinbase works this way. They don't transact, trade, or create derivatives of the crypto coins they manage. They simply make a profit by charging a fee per trade. They are regulated and a publicly traded company (which means certain standards of accounting) so they might be one of the only ones standing when this thing is done falling down.

These other exchanges are doing far more exotic things like creating their own coins to grant status on their exchange and creating derivatives so traders have more leverage and therefore action. Coinbase would be considered boring to these users since it is a vanilla exchange.

Crypto exchanges also function like banks (holding customer deposits, making loans/investments with customer funds), just without reserve requirements or FDIC insurance. The protections against bank runs that we have in place in TradFi are largely lacking in crypto, and the whole sector seems to have reached 1929 in its speed run of modern economic history.

Well, a lot of people will keep some $$$ and some cryptocurrency in their account at the exchange. Maybe because they want to play the day trader, being able to buy and sell at a moment's notice.

So the exchange ends up with a big account of client funds containing cash, and a big wallet of clients' cryptocurrencies.

If a bit of that money goes missing, they can cover it up for a long time, if cryptocurrencies are growing and there's net more money flowing in than flowing out. You just pay departing customers' withdrawals from new customers' deposits.

It is only when the tide goes out we find out which swimmers have lost their trunks.

And once a company's demise becomes inevitable, perhaps insiders decide to help it along. If you've already been hacked for $10 million, why not make it $100 million given the company's going under anyway and you'll be the prime suspect?

Even if an exchange doesn't start out as a scam, it might become insolvent due to a partial hack, or losing a wallet by accident, or some other screwup.

An exchange can be technically insolvent for a long time without anyone noticing, and try to fill the hole with money from fees etc. All will look normal from the outside... until too much money gets taken out too fast.

Bingo.

The only way to be profitable is to fee transactions.

There are a magnitude more ways to be unprofitable, however, and because of rampant incompetence, the the scales are clearly favoring the bold/gullible holding large bags of those who have fleeced.

From a legal perspective there are no required internal controls on the flow of crypto going in and out. Apparently when there is a couple of hundred million worths of crypto sitting in a wallet, it becomes real tempting to go to the racetrack so to say.

Also, most of these exchanges have their own tokens which they control the supply of and keep as "assets" on their books. In doing so they can use these self printed tokens as collateral for loans. Add to that some nicely leveraged positions in all kinds of shitcoins and you start to understand how we got here.

Crypto exchanges always have lots of money because plenty of people keep their money inside. Those lots of money are getting withdrawn by owners and spend. It would be stupid not to do so. Free money yo. It works as long as exchange grows (more money to spend) or at least does not shrink. It stops working when lots of people want to withdraw their assets which are already gone. Time to hide.

> What are crypto exchanges fundamentally doing differently that they are suddenly losing money?

Fractional reserve banking. Exchanges now offer traditional banking services such as savings accounts and loans.

They are unregulated banks with none of the insurance and government protections to bail them out. They cannot resist the temptation to gamble with the vast amounts of money they are sitting on. Only a matter of time before they lose it all and people can't withdraw their cryptocurrencies because there's no money in the reserves.

I think they are more like a bank, when everyone wants to withdraw at the same time, bad things happen.

crime.

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