Concerns in Cryptocurrencies: Buyer Beware

Concerns within the digital asset industry need to be addressed. This article will examine sellers in the cryptocurrency market, unregulated crypto exchanges and the use of the phrase ‘security’ tokens.

Many traders speculating on cryptocurrencies are doing it virtually. They do not receive a blockchain receipt of origin. Most speculators are trading with market makers who charge excessive spreads and quantify digital asset values via their own platform technology with aggregated prices taken from data suppliers. The dominant theme among these exchanges is they are unregulated and do not answer to government authorities. Market makers literally can create their own marketplace without having to exchange real assets, what they offer is asset data values and the ability to trade them. Market makers are more similar to casinos because they are betting against you.

The ability to sell a stock before you own it, going short, with ‘physical’ corporate shares is done by borrowing securities from a brokerage firm’s clearing house which is allocated as a selling position. When a cryptocurrency trader is selling short, there is no actual cryptocurrency being sold, unless a third party is legitimately lending the digital asset to an exchange so it can be held as a selling position – and this is extremely rare. In most cases the exchange is hoping values rise against your short position, so you lose your money and they can profit.

Digital assets fall in price as demand drops and traders lower their ‘asking’ price. If a large amount of traders win big sums and the exchange runs out of money, the exchange has distasteful choices to make. They can pay the winners, crushing their bottom line and putting their enterprises at risk. They can choose to go out of business and disappear. Or the exchanges find excuses to tell clients they are not going to be given the money they have made legitimately.

Exchanges sometimes restrict the amount of withdrawals and impose fees on winning positions. The OKEx exchange located in Hong Kong this past summer was forced to make tough decisions. A trader took a large buying position of Bitcoin and the coin promptly lost considerable value, other traders who went short against him won a considerable amount of money. However, the Hong Kong exchange only paid out a percentage of the winnings, taking advantage of terms and conditions within the accounts trading contracts which stipulated the exchange was allowed to restrict the amount of winnings if the business was faced with catastrophic risk.

Ask your exchange for a blockchain receipt. Ask if you can hold your cryptocurrency within your own hot or cold wallet instead of the exchange. You will likely be told this is impossible for a variety of odd reasons, but in reality it is because you have likely not been issued legitimate cryptocurrency. Selling can intensify in the marketplace when large holders of coins, namely crypto mining companies are liquidating positions. Rumors abounded this summer regarding Ethereum based utility tokens being sold by companies which were created by ICOs, Initial Coin Offerings, as they sold their ‘unique’ coins to fund their ventures or cash out.

In Chicago via the CME you can buy and sell cryptocurrency options, but you are not using the physical asset. The futures contracts in Chicago are quantified per the values of Bitcoin or Ethereum, but no cryptocurrencies are exchanged via a blockchain at expiration. Thus, even one of the most respected and regulated exchanges do not trade ‘physical’ cryptocurrencies and are merely allowing speculators to wager.

The reporting of trading volumes is suspect and is an additional concern with unregulated exchanges. Volumes can be grossly inflated without hash tags for blockchain certification, making actual proof of cryptocurrency trading difficult. Questions about liquidity and real market size shadows traders and fuels the belief we are witnessing dangerous market hype instead of genuine value.

The originators of cryptocurrencies clearly stated in their doctrines known as ‘white papers’ a fundamental reason for cryptos to exist was to confront and circumnavigate what they claimed was the printing of money with no real value by ‘bad’ central banks. However unregulated exchanges are much less accountable than most central banks.

The majority of Bitcoin is now owned by four major miners in China and because of this the cryptocurrency world needs to answer a serious philosophical question. Early enthusiasts’ portrayed cryptocurrencies as a mechanism to decentralize the power of money. If four major miners really control the largest supply of Bitcoin and other digital assets, what is the difference in risks between Bitcoin and fiat currencies which are controlled by central banks and government treasuries?

Tokens which are off shoots of other cryptocurrency blockchains, like Ethereum, are a growing concern too. Utility tokens in theory can gain value from transactions for services, besides speculative forces on exchanges. However, some enthusiasts have begun to use the phrase ‘security token’. This is not a small coincidence because the preference for ‘security token’ comes while the Securities Exchange Commission in the U.S is being asked consistently to approve cryptocurrency ETFs which have failed thus far.

Security tokens are only another way of saying utility tokens. Marketing hype is a big part of the cryptocurrency world. Enthusiasts like to say a token is a security because it derives value from the worth of its company. This is problematic at its core because the holder of a ‘security token’ owns no corporate shares of the company which conducted an ICO, unless a company allocates value to a token holder via a legally mandated offering. Worse, companies which issue tokens can theoretically conduct an Initial Public Offering of corporate shares.