The Three Worst Things About Crypto Exchanges

#1. Trust and Variance

Cryptocurrency is often touted as a trustless system, and between two individual people there’s a strong case to support that claim. However, when you’re on an exchange you are interacting with an institution, rather than an individual person and this institution has certain responsibilities to people within it that affect the exchange experience and thus alters the feeling of trust for the individual.

Every exchange has its own unique technical infrastructure which runs the service. Over the years, legal standards for operating in the world of cryptocurrency are beginning to emerge, but exchanges still aren’t regulated in the same way that banks are. For example, within the collapse of FTX, if it were an American bank, the (American) users deposits would have been protected (up to $250k per user) under the FDIC. While non-regulation might be a strong appeal for some cryptocurrency fans, for other investors this presents risks of instability, uncertainty, and concerns about the security and integrity of the exchange.

When an event like the FTX collapse, or the Mt.Gox hack, or the Quadriga scandal happens, it taints the reputation of the entire cryptocurrency space. Regulators and law enforcement look upon all other cryptocurrency exchanges with a much higher level of scrutiny. The public watching these events unfold often have their skepticism of crypto vindicated and trust eroded.

This is one reason why the reputation of an exchange is paramount for the operators. In the absence of a formal regulatory process, exchanges must prove to its customers and regulators that they are operating legitimately. Despite best efforts, exchanges can find themselves in the crosshairs of regulators. Even Coinbase, one of the most reputable exchanges known in cryptocurrency and an industry leader in trust-creating certifications, finds itself under investigation from the SEC this year. This just goes to show that no crypto exchange is too big, too reputable, or trustworthy to avoid scrutiny.

#2. The Staking Question

Speaking of the SEC lawsuit against Coinbase, the crux of the lawsuit is about the legality of staking cryptocurrency. Staking has become a topic of debate in the field of cryptocurrency for a couple of years now. The SEC claims that Coinbase was selling crypto asset securities without a license for 13 assets. Coinbase claims that the SEC is harming their economic competitiveness by categorizing the 13 assets in question as crypto asset securities. As previously mentioned, the lack of a legal precedent in the field of cryptocurrency is responsible for feelings of uncertainty from would-be startups to break into the market to become compliant with a fair categorization. So long as the legality of staking is mystified and without a clear framework, there will be volatility in using an exchange for the purposes of staking.

While exchanges are a popular place for crypto users to stake their proof-of-stake (PoS) tokens, staking can be done with a number of PoS tokens without having to go through an exchange. Depending on the outcome of potential precedent-setting lawsuits, exchanges may be forced to separate their staking services from their exchange services entirely. Regardless of what may come of the ongoing lawsuits, staking on exchanges comes with these risks until clear legal precedent has been established, and that has a negative effect on the exchange experience.