The World Federation of Exchanges (WFE) has studied the relationship between exchanges and wider crypto market developments, in particular the ways in which regulated exchanges are looking to capitalise on the opportunities posed by these nascent technologies.
The WFE research paper outlines how demand for crypto-related products and services is changing and, crucially, how crypto-trading platforms have operated without the standards required from established public financial markets and with very little regulatory oversight.
The WFE Research paper, ‘A review of crypto-trading infrastructure’, studies how this offers a greater opportunity for illegal financial activities and the consequences for market integrity, and for investor protection.
Neil Thomas, chief commercial officer of AsiaNext, told BEST EXECUTION: “While retail investors have largely driven the crypto market until now, this report clearly shows institutional investors are seeking greater exposure to digital assets.
“We are beginning to see evidence that institutional demand will largely drive the crypto market, and the majority of institutions will only work with exchanges that adhere to regulatory compliance and good governance.”
Nandini Sukumar, CEO of the WFE, said: “Crypto is at the forefront of all of our members’ minds and we are in constant dialogue with them about how to capitalise on the new opportunities in the area.
“As this industry and market matures, coming into the mainstream of financial markets, the exchange-traded model which places investor trust, transparency, accountability and investor protection at the heart of the platform, will gain further momentum.”
The paper outlines how the risks that unregulated crypto-trading platforms bring are compounded by the fact that they frequently carry out further activities that would not be permitted, or would be closely regulated, in mainstream public markets.
The WFE paper also teases out the differences in model design between decentralised platforms (DEX) and centralised platforms (CEX) and what effect each has on liquidity provision, price discovery and the custody of assets.
The centralised platforms (CEXs), which are owned and operated by a central entity (or
consortium of entities) intermediating access to the blockchain (or distributed ledger) where the crypto-assets exist. They typically rely on an off-chain CLOB to display and match the buy and sell orders and execute trades and they utilise the blockchain to store, over its user nodes, the order and transaction data as well as settlement records.
Centralised crypto-trading platforms (CEX) typically rely on an electronic CLOB to match and execute user orders. The CLOB is separated from the blockchain, where the crypto-assets sit, and is operated and maintained on a computing system or server owned by the central entity acting as the platform administrator or provider.
In a CLOB, liquidity is generated by the continuous interaction between buyers and sellers. Traders submit their buy and sell orders using different order types, including market orders and limit orders.
The CLOB system matches these orders on a ‘price time priority’ basis and aggregates the unmatched orders in the limit order book. Such a matching system distinguishes liquidity demand from liquidity supply according to incoming orders. More specifically, market orders or marketable limit orders are matched against the prevailing limit order book and executed immediately; therefore, they demand liquidity. At the same time, non-marketable limit orders are not matched nor executed but instead added to the limit order book, therefore supplying liquidity. Liquidity suppliers, such as market makers, profit from the bid-ask spread, after compensating for their market-making costs, by completing round-trip trades.
Decentralised, permissionless platforms (DEXs), where there is no central entity
operating the platform, participants directly control their assets in the blockchain, and trading and execution happens in the blockchain (in addition to settlement and record keeping), usually using the automated market maker (AMM) protocols.
Pedro Gurrola-Perez, head of research at the WFE, said: “There is a growing demand for crypto products and services. Crypto-related innovations are seen as an opportunity to advance technology development and increase investor choice, however, the lack of minimum governance and investor protection standards of unregulated crypto platforms, as well as the high volatility observed in these markets, and the risk of cybersecurity threats, is a concerning mix.”
©Markets Media Europe 2023
