Exchange Coins Are Self-regulated Licenses to Print Digital Money

Bitcoin sprang from its anonymous creator’s desire to circumvent conventional finance’s untrustworthy intermediaries. Unfortunately, cryptoassets permit the continuation of questionable business practices.

This article explores how centralized exchanges use homemade assets to turn profits while undermining customer trust and security.

The global financial crisis of 2008 was a posterchild of central banking’s shortcomings. What’s more, all that monetary turmoil revealed something most of us already knew: central bankers have only their best interests at heart.

Not only that, but their self-appointed licenses to print cash are without repercussions. In other words, users of cash feel the sting of bankers’ greed and mistakes, while the system’s structure facilitates easy bailouts via cash infusions.

Perhaps meteorologist is the only other profession in which practitioners can be so wrong and somehow remain employed.

Exemplified by weather and seasons, the entire universe operates in cycles — and it’s only a matter of time before financial history repeats itself. However, next time the globe’s financial markets are floating in the gutter, we have alternatives in bitcoin and the peer-to-peer financial ecosystem it’s created.

But it’s not all good news. Here we are, more than 10 years after the world’s original cryptocurrency opened its digital doors, yet we still see the same monetary deception we’re trying to avoid.

You see, crypto traders still rely on central banking’s fiat onramps and offramps. Until blockchain’s P2P infrastructure widens, realizing profits from successful trades involves crypto-fiat conversion.

Plus, until decentralized exchanges stamp more significant footprints, the bulk of cryptoasset trading occurs on centralized exchanges (CEXs). And by creating customized digital assets, CEXs self-mint stacks of coins to play games with user funds.

Let’s look at how CEX operators can manipulate crypto markets to fatten their bitcoin wallets — while draining those of unwitting userbases.

4 Steps of Market Deception

Centralized exchanges draw many similarities to central banks. Customers make deposits, withdrawals, and account transfers, and the exchange takes custody of depositor funds.

And just like traditional banks, exchanges make far more on deposits than they give back to customers.

Central banks also print bills — backed by nothing but the hot wind of politics — whenever the need arises. And CEXs steal a page from bankers’ playbooks by minting their own digital assets, which they later convert into bitcoin and cash.

Major exchanges within the cryptosphere eventually create a native asset that, as we’ll discuss later, offers discounts to holders. Traders gain benefits by adding bitcoin to an exchange, then trading that bitcoin for the exchange’s native cryptoasset.

And like the central bankers before them, exchanges hold a steering wheel allowing exclusive navigation of asset direction.

Central banks and centralized exchanges drive self-created currencies all throughout financial markets, hitting the gas and pumping the brakes at will.

Here’s a profitable series of events exchanges can use to siphon bitcoin from the market:

Step 1: Tokenized cannibalism

The laws of trading dictate that when there are more buyers than sellers, an asset’s price rises. Stocks, bonds, crypto, houses, rare coins, whatever.

To bend those laws in their favor, CEXs slowly buy their own coin. Little by little, the price rises. And because a CEX is nothing more than a database, consumer deposits are mere numbers on screens.

Step 2: Cross-pollination

Once prices rise to self-chosen levels, exchange coins migrate to other exchanges. But not just any exchange.

For the scheme to produce maximum profits, exchange coins land on exchanges with leveraged trading. After all, why would CEXs want to mold markets at a 1:1 rate when they can do so at 100:1?

Step 3: Running long

As the exchange continues to purchase its own coin on its own platform, the price continues to inflate.

Upward prices lead to the opening of leveraged, long positions — betting that an asset’s price will rise — on specific exchanges.

Because the CEX can buy or sell its coin on impulse, winning trades never stray farther than a few clicks away.

Step 4: Stopping short

Since CEXs are unable to artificially inflate prices forever, the party eventually stops. And once it does, the CEX simply dumps its exchange coin back into the market, gaining even more bitcoin in the process.

But not before opening short positions on leveraged exchanges, however. As this article’s title implies, CEXs profit from bull and bear markets, green candles, and falling knives.

The failsafe

Because cash reserves are only a fraction of deposits, central banks can’t possibly pay depositors should everyone attempt to withdraw simultaneously.

CEXs encounter the same issue — but have already concocted a workaround. “Do we have more withdrawal requests than bitcoin in reserve? Damn! Umm… we’ve been… uh, hacked. Yes, definitely hacked.”

The past two years brought a spate of CEX hacks to the crypto industry, with Binance’s loss of $40M — 7,000 BTC — representing the third-largest source of funds going down the rabbit hole in 2019.

Image credit: Chainalysis

But you don't have to take my word for it. Let’s get a POV from someone currently in the trenches. As Strategic Advisor to Komodo Platform and CEO of RedFOX Labs, Ben Fairbank is no stranger to conducting business with CEXs.

Any particular exchanges spring to mind when you think, "they hacked themselves?"

Takeaways

While your favorite exchange may or may not have hacked itself, selling customer data and deeming it “leaked” in the process, the exchange is only one piece of a giant puzzle. You see, last year’s Binance hack was but one of a dozen high-profile breaches spanning 12 months.

Two significant lessons arise from these exchange heists. First of all, feature-rich, user-friendly, trading pair heavy, decentralized exchanges are sorely missing in the crypto industry. Multiple DEXs are now operational, but none have broken the barrier of widespread adoption.

And perhaps the most important message here is to minimize personal funds held on CEXs. Because CEXs own the private keys for all account holders’ funds, every user, at all times, is at risk of succumbing to breaches — contrived or not.

Bottom line, if you must use a specific exchange for trading, get your funds in, make the swap, and get your crypto the hell out of there as quickly as possible.

Call them hacks or exit scams but no matter your label, the next multi-million dollar heist is coming soon to a CEX near you.

How do you feel about exchange coins? Totally legit or just one big con? Share your thoughts in the comments below!

Peace and love,

~BlockchainAuthor