The hidden costs of cryptocurrency trading

Ads for cryptocurrency seem to be everywhere these days. Previously unknown names like FTX, crypto.com, and Coinbase burst onto the scene, bombarding our morning commutes as well as cultural touchstones like the Super Bowl and the Oscars. We are bombarded daily with heated advertisements featuring A-list stars like Matt Damon and Larry David, insisting that we would be fools to miss out on the great opportunities that crypto presents.

That may be the case, but it’s important to keep in mind that digital assets don’t advertise themselves. As financial rewards for participating in verifying transactions on a decentralized ledger, cryptocurrencies cannot act on their own. Instead, it was real companies, those that make money when investors trade crypto, that shelled out the cash.

These companies have compelling incentives to expand their reach. Cryptocurrency markets lack the traditional barriers between broker, custodian, and exchange, allowing companies to charge big commissions and cut off investors at multiple points during a transaction. Because the lines between services are blurred, several types of companies have entered the fray, including:

  • Centralized exchanges that exclusively or primarily trade cryptocurrencies, such as Coinbase and crypto.com;
  • Incumbent retail brokerage platforms like Robinhood;
  • Payment apps like Paypal and Square.

Types of Crypto Exchanges

Recently, a new type of exchanges has entered the mix: decentralized exchanges, which take the concept of decentralization one step further by completely removing central intermediaries. In the plumbing of a decentralized exchange, a series of pre-programmed smart contracts on a blockchain algorithmically connect buyers and sellers, using lines of code to set prices for people who choose to trade.

Centralized counterparties (including exchanges, payment apps, and retail brokers) work differently from decentralized exchanges, and both have their flaws. Investors who use centralized counterparties cede control of their assets to the counterparty, since the counterparty holds the private keys to the investor’s crypto wallet. So, if the exchange is hacked, the user loses all the assets he owns on the exchange. Decentralized exchanges, on the other hand, require an investor to link their cryptocurrency wallet, so even before a user sets up a transaction on a decentralized exchange, they must exchange the fiat currency for a cryptocurrency. another way and create a wallet by itself.

Despite their differences, cryptocurrency trading platforms all have one thing in common: high transaction fees. Unlike stocks or exchange-traded funds, which most brokerages will allow customers to buy and sell for free, cryptocurrencies are still expensive to trade. This is partly a consequence of design: each time a cryptocurrency changes hands, its blockchain must be updated to reflect the transaction, which can require a significant amount of energy. It also takes time and effort for these exchanges to research potential coin listings, and the exchanges are held accountable for every coin they list. For this reason, Robinhood, the only provider that offers commission-free cryptocurrency trading, lists only seven cryptocurrencies available for trading.

Finally, while the cryptocurrency market has grown by leaps and bounds in the past 15 years since its invention, its market capitalization of US$1.4 trillion is still a drop in the bucket compared to the global market capitalization. of US$116.9 trillion in June 2021.[1] Smaller markets transact less frequently, resulting in higher transaction costs and larger discrepancies between the market value of a cryptocurrency and the price paid by investors.

All of these factors put enormous pressure on the price structure of cryptocurrency transactions. In a recent study we conducted for our Cryptocurrency Landscape 2022, we have found that fees per transaction can range from free to over 6% depending on the conditions surrounding the transaction. Below, we have compiled a list of common exchange types, prominent members within these groups, the variety of coins available for trading, and the costs of execution. For this illustration, we used an example of buying $500 of ether, executed in US dollars or USDT, a popular stablecoin that tracks the value of the dollar. (Unlike other cryptocurrency exchanges, decentralized exchanges cannot denominate transactions in fiat currencies — instead, all participants must buy and sell cryptocurrency.)

Transaction cost on different exchanges

This shows that for investors accustomed to frictionless stock and ETF trading, there are no good choices. Of all these options, Binance has proven to be the most palatable to investors, despite increasing regulatory pressure, as it charges relatively low fees to buy and sell cryptocurrencies and offers a wide variety of cryptocurrencies available for trading. trade. Binance facilitated 41% of total spot trades and 52% of derivative trades executed in January 2022.[2]

Retail brokers may have fewer coins available to investors, but they charge 0.5% on average compared to the average crypto-native exchange fee of 0.85%. These lower prices may have a catch, however: Robinhood, for example, does not allow users to migrate their cryptocurrency purchases into a wallet at press time. Payment companies, which often hire a third party to process cryptocurrency transactions, have the most unfavorable pricing structure relative to the amount of choice they offer.

Yet even these fees are dwarfed by the widely varying “gas fees” Ethereum network users pay to use decentralized exchanges like Uniswap. Gas fees pass on the costs of mining a cryptocurrency to platform users by adding a fee to each transaction. As platforms like Uniswap proliferate, developers are increasingly focused on creating scaling solutions to reduce gas fees charged to users, and Ethereum plans to solve some of the headaches by moving to a Proof-of-Stake blockchain in 2022. It’s still unclear how much of an impact the change will have on gas fees, but scalability issues will continue to escalate as digital assets take of importance.

[1] Source: Statistics. Data as of June 30, 2021.

[2] Cryptocompare. 2022. “CryptoCompare Exchange Review, January 2022.” https://www.cryptocompare.com/media/39501098/cryptocompare_exchange_review_2022_01-1.pdf

Abdul J. Gaspar