Online forums are filled with disgruntled users sharing their bad trading experiences on various high profile exchanges. A lot of these are related to cryptocurrency exchanges operators displaying undesirable trading behaviour or turning a blind eye to users who do it.
For us to understand these issues, let’s begin with learning how orders are executed in exchanges.
How orders are executed in exchanges
An exchange is a platform where buyers and sellers meet to conduct trades under a fixed set of rules enforced by the exchange operator.
All trades happens via an order book, where market makers place orders – either buy or sell – and market takers can enter the market at a price they deem fair.
AAX leverages on the proven technology of LSEG to line up orders following a price-time priority. Orders are arranged by price, i.e. the order that has the best price is placed first. When there are multiple orders carrying the same price, the earliest one has the highest priority to be executed.
This raises a question about how a larger order with a less competitive price will be able to be executed ahead of orders with more competitive prices? The answer is it won’t. A larger order is executed after orders with higher prices because the price-time priority does not take trade volume into account. This is a significant point in creating a fair market which we will discuss later.
How traders abuse gaps in pricing
On exchanges with high price precision in their order books, traders are able to hop in front of orders at a slightly better price.
Let’s say the current market price is at $4,001.00. A trader places an order to buy one bitcoin at $4,000.00 and another trader instantaneously places an order ahead of the user at $4,000.01. The trader places a new order at $4000.02 and again was out run at $4,000.03 and it goes on until one side gives up.
This situation often leaves traders frustrated and unable to execute a deal. Even if the trader does manage to trade, he or she may have to pay more than expected due to this undesirable market situation.
Exchanges trading against their users
The media has revealed cases of exchanges trading against users on their own exchange. In many occasions, the operator of the exchange gains an unfair advantage by having access to information that is not available to other traders.
One common scenario is where an exchange operator takes advantage of a buy or sell order before other customers can. Let’s say an exchange operator receives a market order (an order to buy or sell assets at the best available price in the current market) from a user to buy 100 BTC, and the current market price for BTC is $4000.
Since the exchange operator is able to get a hold of this piece of information ahead of the other users, it is able to step in front of the user to acquire 100 BTC at $4001 and then executes the client’s market order at $4002. By doing so, the exchange is guaranteed a profit, buying BTC at $4001 and selling at $4002, and the client ended up paying more than the actual market price.
This is one of the many ways exchanges take advantage of information exclusive to them. Information such as the degree of leverage of each position or the price at which it will run out of margin to profit off traders is only available to the exchange, giving them an unfair advantage over other users.
It has also been reported in the media some exchanges offer some kind of secret gateway to a selected group of users allowing them to gain an unfair advantage over the others. In case of a system overload, most users cannot access their account but the orderbook is still functioning. This leads to speculation that an exclusive group of traders are operating whilst others are forced out of the game.
At AAX, we believe fair-play as the only dominant strategy and holds an impartial position towards trading activities on the exchange.
In the next post, we will share how AAX designs mechanisms to discourage undesirable trading behaviour.
To find out more about AAX or to pre-register please visit www.aax.com.