While trading activities are being conducted on crypto exchanges, investors are usually oblivion of the identity of whoever is on the other end of the trade against them neither are they aware of the person on the other end of the buy and sell orders authorized by them.
Based on different regulations and geographic restriction of various exchanges, the person on the other end might be someone living in the same neighborhood in cases of local exchange, but for the multinational exchanges, the other person might be on the other side of the world.
However, studies have proved that though subject to the type of cryptocurrency exchange different investors cum traders use frequently, there is strong likelihood that such trader is trading against an agent of the cryptocurrency exchange itself.
The “Virtual Markets Integrity Initiative Report”
The above are parts of the discoveries of the “Virtual Markets Integrity Initiative Report,” which was published by the Office of the New York Attorney General (OAG) on September 18, 2018. It was reported that the OAG sent a comprehensive questionnaire to about 13 cryptocurrency exchange including those claiming not to have a customer base in the state, this questionnaire is a sort of probe into the internal policies and internal operations of these exchanges.
Though several of these exchange responded to the questionnaire, there are some like Kraken who refused to respond to the inquiries, in the list of the participants, about fifty percent of the exchange admitted that they have engaged in proprietary trading on their platforms.
A brief description of propriety trading is when an exchange employee authorizes buy and sell orders on behalf of the company instead of matching buyers and seller which is the conventional trade activities. A proprietary trade places the exchange operators in the position of trading with its own customers.
An Insight into Proprietary Trading
According to the “Virtual Markets Integrity Initiative Report,” by the OAG, it can be deduced that proprietary trading is a common phenomenon in the traditional securities markets and it is usually owing to several factors. An exchange may choose to engage in this practice on a basic level, an exchange’s trading desk may be seeking to turn a profit for the company.
On retail-focused exchange platforms, proprietary trading is usually a suitable option simply because professional traders will be given the avenue to match themselves with much less experience.
Also, crypto exchange implores the proprietary trading idea to improve the rate of liquidity on the platform, most especially in markets are rarely traded. To achieve increased liquidity, the trading desk will place both buy and sell order to make it comfortable for customers to execute trades on the platform.
The consequence of this is that it will not only help the venue serve existing users but also to help entice new customers into such an exchange platform, this will, in turn, translate into organic growth and a customer-driven volume.
Based on the report of a self-reported statistics, the rate of propriety trading is not the same amongst exchanges as it greatly varies. The OAG “Virtual Markets Integrity Initiative Report,” discovered that Coinbase engaged in the most proprietary trading as this practice singlehandedly accounts for about 20% percent of the platform’s total trading volume.
BitFlyer USA also has a top position in the ranking of the exchange engaged in proprietary trades; it has almost ten percent of its total volume from this trade activity.
Circle claimed that propriety trade is responsible for about one percent of the trade volume on Poloniex, the United States-based exchange it bought in Q1. Other cryptocurrency exchanges that admittedly engage in propriety trades are Bitfinex and Tidex.
However, companies such as Bitstamp, Bittrex, Gemini, and HBUS have answered in the negative when the question of whether or not they engage in proprietary trades was posed. We also witnessed itBit cryptocurrency exchange refusing to proffer an answer to this question.
The most important aspect of this report is that cryptocurrency exchanges that engage in proprietary trading stating that their traders do not have any advantage over its customer as customer protection is ensured. The report stated that;
“Trading platforms that engage in proprietary trading on their own venues uniformly told the OAG that their trading desks had no informational or other trading advantage over customers.”
OAG: Report Raises ‘Serious Questions’
According to the AOG, serious questions arose from the report stating that the high rates of proprietary trade on some exchanges are questionable as questions about the hidden risk that customers are exposed to when using the platform are questions that need to be answered.
OAG made a comment on these finding saying that: “Such high levels of proprietary trading raise serious questions about the risks customers face on those platforms. As a general principle, when a significant percentage of the volume in one or more assets on a venue is attributable to one source, customers face the risk that the availability of liquidity in those assets could change, without notice and at any time, including when liquidity is needed most – namely, in times of market volatility or rapid price movement.”
The report further stated that;
“That certain platforms themselves account for such high levels of activity on their own venues also calls into question whether the natural market for virtual currencies on those platforms is as robust as customers might believe it to be.”
Various attempts are being made to make these exchange engaging in proprietary trade to educate the public as to the underlining though hidden risks of the propriety trade so as to ensure that it is not a form of public exploitation or at the detriment of investors cum traders.
In response to this report, Coinbase published a blog post to claim that it does not engage in proprietary trading.