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As the overall cryptocurrency market enters a bearish phase, numerous institutions, especially trading platforms, are facing closures and runs. The dramatic collapse of FTX this month has once again sounded an alarm, prompting people to question whether the continuous closure of well-known trading platforms in each market cycle is an inherent flaw of cryptocurrencies or an issue with the industry as a whole.
Business Models of Trading Platforms
To answer this question, it's necessary to review the business models of traditional financial asset exchanges, which have a development history spanning hundreds of years.
The primary profit model of these traditional exchanges is quite similar. Whether it's a stock exchange like Nasdaq or the Shanghai Stock Exchange, or a commodity futures exchange like the Chicago Mercantile Exchange or the Dalian Commodity Exchange, their main revenue comes from transaction fees charged during trading.
Transaction fees can arise from both spot trading and derivative trading (perpetual contracts, futures, etc.). The more clients trading on the platform and the higher the trading frequency, the greater the exchange's revenue from transaction fees. After deducting operating costs, including personnel expenses and various fees related to asset custody, the remaining amount constitutes the exchange's profit.
Some traditional exchanges, like Nasdaq, also generate revenue from additional value-added services such as information services. In contrast, the cryptocurrency exchange Coinbase relies heavily on transaction fees, constituting over 90% of its total revenue according to data from the year 2021.
This model of asset trading platforms, whether traditional or cryptocurrency-related, is not as lucrative as people might imagine. While profits might not be hard to come by, obtaining exorbitant profits by operating an exchange is equally challenging.
Business Model of Cryptocurrency Exchanges
Cryptocurrency exchanges, on the other hand, often deviate from the basic exchange business model. Many engage in speculative or market manipulation activities, either directly or indirectly using user assets. This distinction sets them apart from traditional compliant exchanges like Nasdaq or the Hong Kong Stock Exchange.
The next question is how these cryptocurrency exchanges misappropriate client funds.
Two Forms of Misappropriation
Depending on the method used, there are two main forms of misappropriating funds by trading platforms. The first method is straightforward and literal, involving direct transfer of assets. The second method is more covert.
1. Direct Transfer:
For example, following the collapse of FTX, it was discovered that user assets supposed to be stored in cold wallets were borrowed by Alameda, also controlled by the same individual, for speculative trading or to cover losses earlier this year.
This type of misappropriation is akin to lending out assets held in custody by clients. Consequently, clients' custodied assets become Alameda's IOUs. If Alameda can continue to profit and promptly repay, things may be fine. However, if Alameda's investments fail, resulting in an inability to repay, the IOUs' value drops to zero, leaving clients' assets unrecoverable.
2. Trading with User Assets:
The second form of misappropriation is relatively more discreet. In this case, assets theoretically remain in the exchange's accounts or addresses. Often, the total value of the exchange's assets even surpasses the liabilities' value (the value of assets deposited by users). This is one of the reasons many platforms repeatedly assert their ample reserve funds.
Why, then, do we label trading with user assets as "misappropriation"?
Let's consider a simple example. Suppose a trading platform holds $10 million worth of Bitcoin deposited by users (forming a liability as users can withdraw at any time). For speculative purposes, the platform exchanges $5 million for a potentially more profitable token like Shib.
In a bull market, if the purchased Shib's price triples to $15 million and Bitcoin's price remains unchanged, the platform now possesses $15 million worth of Shib and $5 million worth of Bitcoin, totaling $20 million in assets. Meanwhile, the outstanding user liability is still $10 million worth of Bitcoin. At this point, any audit report would indicate that the platform's user assets are fully redeemable.
However, in a bear market, if Bitcoin's price drops by 50%, and Shib plummets to 1% of its peak value, the platform's assets reduce to $2.5 million ($5 million * 50% + $15 million * 1%). Yet, the user liability remains at $5 million worth of Bitcoin. At this juncture, the platform's assets are evidently insufficient to cover the outstanding user liability.
Crucially, even though the platform's assets remain in the platform's accounts and don't fit the definition of the first type of misappropriation, users still suffer losses.
This scenario illustrates why trading platforms are more prone to collapse in a bear market. The assets they hold depreciate more rapidly than the liabilities, leading to an inability to cover the outstanding debt. Notably, the platform's assets still reside within the platform's addresses, and the first type of misappropriation hasn't occurred. However, users' assets still endure losses.
This is one reason why platforms are more susceptible to collapse after a market downturn: their held assets, due to the platform's speculative trading, create a discrepancy in risk exposure compared to the assets deposited by users. Even if past audit reports indicate the platform has more than enough reserves and the first type of misappropriation isn't evident, the platform can still encounter solvency issues as market prices fluctuate.
From the FTX bankruptcy case, signs of both direct transfer and the second form of misappropriation are apparent. According to rumors, FTX's assets were significantly higher than its user liabilities earlier this year, primarily in FTX series tokens like FTT and Sol. However, as the market declined, the devaluation of its asset side outpaced the liabilities, resulting in irreparable losses.
If these rumors are true, it indicates that the FTX incident involves both direct transfer and the second form of misappropriation. This suggests that the platform has completely disregarded fundamental business logic, putting users at unpredictable risks.
Is Misappropriation of Funds a Normal Business Practice for Trading Platforms?
Some argue that using user assets to generate additional profits is a desperate move in a highly competitive market environment. The platform's only mistake is losing money in trading. If the platform can remain profitable, then none of the negative consequences would occur.
Indeed, this logic is a fair representation of the current situation in the cryptocurrency trading platform sector, given its fierce competition. However, it is essential to address whether misappropriating funds should be accepted as a normal business activity.
Even without considering regulatory issues and focusing solely on the specific business activities, both types of misappropriation are mature business models that have long existed.
The first type of misappropriation resembles the lending business of traditional financial institutions such as banks or small loan companies. The second type corresponds to asset management services such as funds and venture capital. However, when evaluating these activities purely from the perspective of basic business logic, these behaviors do not adhere to the fundamental principles of market transactions.
Comparatively, the business models of banks or fund companies are entirely different. In general, banks compensate depositors for the credit risk they bear by paying fixed interest rates. While fund investors collectively share losses, they also receive the majority of profits through dividends in profitable times.
In summary, these two models ensure that the risks and potential returns borne by clients are equitable. Clients have the right to freely choose based on their preferences, making it a fair market transaction.
On the contrary, trading platforms' misappropriation occurs in a black box. The platform not only enjoys all the profits from misappropriation but also avoids the risk of failure if investments go awry. Profits belong to the platform entirely, but in the event of losses, users bear the burden, and the platform faces little regulatory scrutiny or penalties. This asymmetric business opportunity naturally attracts participants lacking ethical standards.
Not to mention, these unfair transactions have never been accurately disclosed to users during account opening. Therefore, classifying it as fraud is not an exaggeration. |
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Post time 13-3-2024 07:20:13
