Happy Friday to those experiencing a Friday at the time of reading this.
For everybody else, adjust accordingly.
Crypto Gordon Freeman here with thoughts on the state of crypto exchange platform fees, what they say about our priorities, and 'theirs'.
There are a few things in crypto that never cease to amaze me. For those who have yet to enjoy their morning coffee, that means I'm surprised crypto is still in the dark ages on some of the more important and economically impacting issues we face. That includes the understanding of the affect of volume and liquidity, the impact of derivatives and ETFs, and for today's lesson, the impact of fees.
- Fees can be used as a form of market manipulation or suppression, whether intentional or as a byproduct of 'common practice' in the industry.
- Fees can offer a false sense of incentive for those who need discounts, instead rewarding those who very possibly aren't seeking fee discounts.
- Our priorities should match our stated values.
And now, for the Gordon thoughts
Fees can be used as a form of market manipulation or suppression, whether intentional or as a byproduct of 'common practice' in the industry.
This isn't hard to understand, but for whatever reason, the standards in competitive fee structures make it so you pay on average around 0.2% on the lower side of market maker fees, meaning you're placing a limit buy or sell order that adds liquidity to the order book. Many exchanges want to encourage you to up your monthly trading volume, by reducing your fees when you hit a certain tier level. Other exchanges have their own token, I like to call platform coins, because they are specifically designed to be used to lower fees in trading. Many exchanges allow the user to enjoy a combination of these two for even better savings, or simply to double-up on the requirements for fee reduction.
Since the value range for tiers can be very different, I'll just give a generic example.
Let's say from 0-$100,000 monthly volume, you pay the normal maker fee of 0.2%. Not uncommon.
From $100,001-$200,000 m/v you pay 0.15%.
$200,001-$500,000 = 0.1%
On up to $10,000,000 to get 0.05% and on.
There are two primary possibilities:
1) the user has a lot of money to trade with, and it won't take them much to reduce fees...
2) the user who cares the most about trying to reduce their fees is very unlikely to have enough funds to reach the monthly volume requirements, meaning they will be forced to accept selling for profit at a minimum profit percentage higher than anyone else with larger circulation who trades on reduced fees.
In the case of #2, this means that the user with less funds must sell at a higher % than the user who can afford to reduce their fees, meaning that smaller accounts automatically take higher risk, and have fewer opportunities to enter positions because they have less money.
This is not a hippie 'equity' lesson or a push to make equality in finance by shaming rich people. It has nothing to do with that. This is about the structure of incentives. It is a fact, that people with less money shop bargains and bonuses a lot more than people that are after a different strategy with large accounts.
This is counter-productive and counter-intuitive on so many levels, but for now I'm just covering the potential manipulation that occurs.
The incentive from the exchange's point of view is that people like 'deals', bonuses and discounts. Customers who are shopping discounts aren't always savvy on other important factors that affect their outcome, namely volume and liquidity. They may seek out an exchange with lower-than-industry-standard fees only to find it is really hard to get in an out of positions due to low volume, meaning not many people selling at the price they want for profit.
On the other hand, more importantly, the exchange's incentive for tiered levels is to invite whale accounts and market makers.
Whales have the funds to provide larger liquidity, and like most customers, they're looking to make a profit. Buy low, sell high.
Whales more often than not, are not actively trading high volume or using bots for the same, and rather are looking for 1%-20% profit depending on personality. Whales can be normal traders with bigger funds, or they can expect someone to handle their automated trades for them, so the range is wide. But, the point being they are less focused on grabbing a savings on fees, but are likely to hit a higher target tier anyway, because most exchanges offer significant savings in the $10,000,000-$50,000,000 range of monthly volume.
Once a whale is grabbing a few significant sells throughout the week, they will essentially be able to sustain the volume needed to always operate at lower fees, but it is very unlikely they will adjust their strategy to shift the profit structure they hope to gain from it. There are numerous reasons for this, but let's not kill the flow of the theme here, eh?
The market manipulation part of this
If thousands of users with $100-$20,000, let's say, are wedged in a very reasonable 0.2% fee, that means it costs 0.2% to buy, and 0.2% to sell. They are not in any profit until they are selling 0.41% higher than where they bought. You may think that doesn't matter at all, but first, the books hold liquidity based on the gap between the highest buy order and the lowest sell order. If there were nothing but small account traders, the likelihood that the books are always near a 0.2% spread is significantly higher than if you add the whales into the mix.
People aren't looking to lose funds to get out of an asset they believe in, and for over a decade that's Bitcoin at the top, where there tends to be plenty of volume to cover the spread. When there is a gap in the spread, there are fewer people getting the absolute best down-to-the-second real market price on Bitcoin, let's say, meaning for instance, if BTC is trading at $35K and you want to attempt to get enough trades in over 30 days to start enjoying a discount in fees, you may be paying 0.1-0.2% more to get in on a limit order than the real current price, but you may have to accept 0.2% less than the real price to sell.
This may sound insignificant, but it isn't.
It means that we rely heavily on whales and market makers, which are much smaller in numbers but massive in quantity of funds. They can close the gap on the order book for more profit, quicker, more often, because they technically do not need to earn as high a % to earn a profit. Again, when you have enough funds to trade enough volume for reduced fees, you don't have to adjust your trading strategy to enjoy the benefits either way.
The market can easily be manipulated by the amount of liquidity available at certain ranges, and how likely the vast majority of traders need to wait for the price to change by the % they require for profit. Let's say you did a $1M buy order at 0.5% profit, sold $1M, and did this 5-10 times, you've probably automatically reduced your fees in half, meaning you can enter positions at half the risk if you wish.
If there was a path for massive numbers of smaller accounts to enjoy lower, or zero fees for maker orders, there is more incentive for more buys and sells in between the larger target margins. Prices remain closer to the real current value at market, the more people trading at each price. If you have only large orders at significant intervals, let's say at significant psychological values like a round number, or exactly 10% up or down for instance, it can place incentives on whales to build up a buy or sell wall to keep the price where it benefits them the most. If thousands of smaller accounts had an interest near those same ranges, it would vastly reduce the impact a 'wall' can have on the movement of price.
So, the really important take away with how fee structure affects market movement, people with much more volume and value in the market largely tend to have a lot more knowledge about how their positions affect the market, thus they will use strategies that benefit them the most. Hey, I'm not knockin' it- I would do the same! Manipulation isn't about legality of fairness. In most cases, it is merely the byproduct of what happens when people have large sums of money to place at their desired price. There are significant numbers of individual whales in the crypto space who take an interest in making their own bids, because they are actually interested in the technology, and not just the profit.
Fees can offer a false sense of incentive for those who need discounts, rewarding those who very possibly aren't seeking fee discounts
The smaller account is often in the crypto space because they think they are going to find the next 10,000x coin and retire after 20 moves. Once they realize for the most part every small coin goes down 80% if they have already heard of it, they may make similar decisions as others, and start leaning more towards high ranking coins with less risk. When that occurs, they come to realize that they appreciate the value in smaller moves up and down, for the consistency in value.
There is less fear that chasing a 20% profit is going to land them in a -70% HODL bag with no guarantee it has any real future value. With Bitcoin, it may be a grand day when there is a 7% pump, but it's price hovers around certain averages sometimes for weeks at a time, so there is much less shock in price or a drop in volume affecting one's chances to sell at profit.
People who are chasing fees with the hopes of saving funds are affected the most by the difficulty in reducing those fees. You pay a fee when you enter into the position, so you have to have those funds available in addition to what you can afford for the actual position. There is almost always a minimum bid size, usually $10 or so, and this means that there are tens of thousands of small accounts that can only afford to place a few small trades, and it only takes being off by a few pennies to miss the chance for another small trade.
The only way for smaller accounts to get more opportunities, is to either risk smaller amounts per trade, or to take smaller profits over fees to get in and out of more potential positions. It gets interesting, because Gordon can tell you the reality of this stuff. I've made the absolute smallest trades thousands of times, and I've made some very substantial-sized trades thousands of times as well (okay, they seem big to me!).
Most likely, smaller accounts will continue to pay the highest fee tier, meaning they are held back in providing more liquidity more often. Lower fees are always shifting towards the people who are giving it the least thought; except for the market makers.
I am not against market making. I believe in making larger volume, lower risk trades while also providing the liquidity needed for people to get in at better prices. But, a zero maker fee and tiered structure for taker fees makes infinitely more sense, and would encourage a lot more people to provide a ton of more liquidity, than using incentives on the side of maker fee structure.
The real incentive for reducing fees should be for those looking to smash buy at the current price. It does them well to get a good HODL price or to take advantage of higher volume times with minimal slippage, meaning the price doesn't rise significantly while they're trying to buy at whatever current price.
It's even worse for exchanges that claim zero fees but are actually charging a premium on the spread, meaning that there is no actual trading fee, but you are paying too much when you buy, and selling too low, and they pocket the difference when placing the trade.
Either way, imagine if the incentive was placed on allowing smaller accounts to enjoy more volume and less risk, and thus getting the result the exchange was after to begin with; better liquidity on the order books. You make much more from thousands of people who can afford to get in and out of positions more often, than you do by increasing the maker fees on the same people, placing massive pressure for the current sell price to sit consistently higher than where it needs to move. Trust me on this; it's short-sighted for exchanges to keep playing things this way.
It surprises me fewer are considering things like what Phemex is doing, and Coinbase is considering; offer a subscription service for zero fees if you want to make it possible for larger volume at every price. It remains to be seen whether Coinbase will lure people in with a subscription, only to charge on the spread anyway.
Our priorities should match our stated ideals
With all of these things said, it is equally weird to me, that traders are liars. Publicly, so much of the crypto world supports KYC-free DEX trading, but other than brief pumps in swaps, DEX exchanges are still less than 1/20th the size of centralized exchanges. One of my favorites, Loopring.io, has zero maker fees, which helps their small volume tremendously, and they prevent the hit of gas fees, being an ETH platform, by using L2 once you're in their environment, and they use batches to move everyone in, and to get back out to your wallet. It's genius; we should all be using it ('cept for maxi's that hate Ethereum, which granted there's a solid case for why). People compromise on using KYC CEX or thinking VPN will protect them indefinitely. If people were sincere in the revolution of keeping trading private, they would be piling on DEX like mad.
The truth is that Loopring is doing it right, but zero fees won't provide the massive new opportunities for traders to get in and out of more positions, until the higher volume of DEX support scaling. If a person can place an order for the price they want, but it takes 20 minutes for someone to sell to them, it may not be the best price any more by the time they buy.
My hope is to see more DEX volume in coming months and years, but I think the opposite will hold true, that governments will continue to scare people more and more towards " KYC or digital ID, or you're a criminal" and that certainly will frighten enough users to avoid anonymity; sad but true.
So, if I were to dive deeper, I could back up these theories and fill in the cracks, but I think the bottom line is clear: if you don't have the funds to trade up your monthly volume to enjoy discounts, you are earning less, which means you will continue to trend in the direction of paying higher fees. If you have a big stack, you are going to accidentally stumble into really great price shopping and very likely won't even notice you are saving on fees. Meanwhile, the market makers are the ones who make the most on smaller profits at higher volume, and exchanges are happy to reward them for providing extra volume, thus liquidity. With that being the case, it makes very little sense not to encourage even more mass adoption by giving the tens of thousands of customers, or potential new customers, the incentive to actually save.
I have traded on exchanges that offer zero fee promotions, offer rebates on maker fees, and even in the case of a few that were not very impressive on their volume, I was able to trade substantially more and earn more consistently as a result. It did in fact push me to take advantage of a lot of smaller changes in price, getting in on positions I have to turn down all the time, because I know it will continue downwards within a short window of time.
Small accounts more than anyone, need the opportunities to take less risk, and to do so more often.
Exchanges know better than all of the rest of us, just how many accounts are very small accounts. If liquidity on the order books is the primary marketing tool for spot trading, imagine turning down the opportunity to have people bidding every size trade at every price available and doubling, if not quadrupling volume for top-ranked coins.
I, for one, would love to see this happen.
And on that note, Crypto Gordon Freeman, for now... out.