Introduction
Why must we understand banks to comprehend exchanges? Where do new opportunities lie for exchanges? What systemic risks do exchanges face? These questions frame our exploration into the monetary finance perspective of cryptocurrency exchanges.
Dr. Long Baitao, an independent monetary finance researcher and Tsinghua University computer science PhD, recently shared insights on this topic. His expertise spans cryptocurrency technology, monetary finance theory, and practical experience as a serial entrepreneur and financial systems designer.
Part 1: Foundations of Monetary Finance Theory
The Dual Roles of Banks
- Financial Intermediation
Banks aggregate short-term deposits to fund long-term loans, managing maturity transformation and risk transformation. Depositors receive IOUs, while banks pool funds into asset pools—a legal monopoly for traditional banks. Money Creation via Lending
Contrary to popular belief, loans precede deposits. Banks create money ex nihilo:- A $1M mortgage simultaneously creates a $1M deposit (liability) and $1M loan asset.
- Money is destroyed upon loan repayment.
Regulatory Constraints:
- China: Reserve requirements (e.g., 10% ratio → 10x money multiplier).
- Global: Basel III standards (capital adequacy, liquidity ratios).
Key Risks:
- Liquidity risk: Bank runs.
- Solvency risk: Insufficient assets to cover liabilities.
👉 Discover how modern exchanges mimic bank-like systems
Part 2: Exchange Business Models = Banking in Disguise
Core Parallels
| Function | Traditional Bank | Cryptocurrency Exchange |
|---|---|---|
| Liability Creation | Deposits (low-cost) | Zero-cost "deposits" via user crypto/fiat balances |
| Asset Operations | Loans, investments | Margin trading (1% daily interest, 5x leverage), self-trading |
| Money Creation | Loan issuance → New money | Ex nihilo stablecoin/asset lending |
Critical Differences:
- Banks: Backed by central banks, deposit insurance.
- Exchanges: No lender-of-last-resort → Pure systemic fragility.
Part 3: Systemic Risks of Exchanges
The Leverage Doom Loop
Hidden Leverage:
Exchanges reuse pooled assets for:- Lending (e.g., margin trading).
- Proprietary trading → Illiquid investments.
Instant Digital Bank Runs:
- Crypto withdrawals: Zero friction vs. physical cash constraints.
- A 10% reserve exchange collapses if >10% users withdraw.
Manipulation Vulnerability:
- Bad actors can trigger panic via social media ("Water armies cost less than hacking").
Current Equilibrium:
No exchange dares attack rivals—mutually assured destruction.
Part 4: Future Opportunities – Stablecoins
Necessary Infrastructure
Collateral Frameworks:
- Approved assets (BTC, ETH, fiat bonds).
- Risk-adjusted haircuts (volatility/liquidity metrics).
Full-Reserve Models:
- Libra-style (100% backing) vs. fractional reserves.
Exchange Roles:
- Minting: Reserve contribution → Share seigniorage.
- Distribution: Primary stablecoin usage = Trading/payments.
Prediction:
Only 1-2 stablecoins will survive long-term.
Part 5: Practical Considerations
Product & Operational Shifts
- Eliminate Crypto-to-Crypto Pairs:
Assets → Direct fiat convertibility via risk management. - Derivatives Professionalization:
Current offerings lack institutional-grade rigor.
Tech Debt:
No exchange meets true financial-grade stability/security standards today.
FAQs
Q1: Can exchanges avoid bank-like risks?
A: Only by eliminating leverage—but this forfeits their primary revenue model.
Q2: Why aren’t runs happening now?
A: Collusion of silence—all major players are overleveraged.
Q3: What’s the endgame for stablecoins?
A: Winners will absorb others via network effects. Exchanges must choose: mint, distribute, or perish.
Conclusion
Exchanges are shadow banks—with higher risks and fewer safeguards. The path forward demands:
- Radical transparency (e.g., proof-of-reserves).
- Community-governed models (not opaque profit schemes).