When bitcoin trading was taking off in 2013 there were only a handful of primary exchanges, with the now infamous Mt. Gox handling over 70% of the world’s Bitcoin transactions. Fast forward to present day and we have over 500 different cryptocurrency exchanges around the world with more seemingly launching every day.

During this rapid evolution, the primary exchanges that have come to dominate the landscape are considered ‘centralized exchanges’ – i.e. Binance, Coinbase Pro, Bittrex, Bitfinex, etc. However, less known but recently emerging with a vengeance are decentralized exchanges, or DEX’s. A few popular DEX protocols that have gained steam recently include IDEX, Waves, and 0x.

While still early, we’ve already begun seeing the debate about the future of exchanges escalate. As a potential indicator of what’s to come, even the head of centralized exchange Binance, Changpeng Zhao, recently agreed with avid DEX proponent and Ethereum founder, Vitalik Buterin, that decentralized exchanges should lead the way moving forward. On the day of this writing, Zhao even released a brief demo of Binace's upcoming DEX chain as they press on in that direction.

Driven by this fierce competition, a new trend has developed among both approaches: commission-free exchanges and trading platforms. In the US, one of the more popular platforms to successfully attract investors by touting no fees is Robinhood – helping them reach a $5B+ valuation as they expanded their ‘zero fee’ stock trading mantra into the crypto space.

But before you flock to a ‘fee-free' exchange, it’s important to note how they're actually making money. And in order to better understand that, we’ll first take a quick look at how centralized and decentralized exchanges function and generate revenue.

Centralized vs. DEX: Differences & Fees

Centralized exchanges are defined simply as an online platform where people can buy and sell cryptocurrencies. It’s called a centralized exchange because it acts as a trusted middleman that handles your assets and directly facilitates buy and sell orders within the exchange. The downside to using these exchanges for some investors include the lack of anonymity, vulnerability to hacks, and centralized influence of selecting asset listings. However, they are usually straightforward with their trading fees as a % of transactions – with Coinbase Pro for example taking transaction fees of 0.1-0.3%, and Binance at 0.1%. And as a trusted middleman, there’s also typically a route to recover your wallet access and funds if you’re locked out of your account.

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On the other hand, a decentralized cryptocurrency exchange (DEX) creates a highly intelligent “trustless environment” that eliminates the need for a middle man. Peer-to-peer deals are all made through the use of smart contracts and atomic swaps, never passing through the hands of an escrow service. While these exchanges are not immune to being hacked (i.e. EtherDelta, Bancor), this environment definitely makes them far less vulnerable. While proponents embrace the security, anonymity, and often lower trading fees – lost wallet access, or worse funds being stolen, would likely be far more difficult to recover.

Despite still being in the very nascent days of DEX’s, they’ve seen noticeable progress in 2018, typically touting lower fees as an additional key advantage. IDEX is one of the more popular, who coincidentally also boasts a ‘no transaction fee’ model, actually institutes 0.1% maker fees, 0.2% taker fees, along with additional gas fees.

So if both centralized and decentralized exchanges charge trading fees as a key source of revenue, how exactly do ‘commission-free’ exchanges make money?

“Commission-Free” Exchange Revenue Model Explained

Turns out, these exchanges may not be completely transparent with how they’re able to offer zero transaction fees - simply by hiding them elsewhere. Robinhood, who we mentioned earlier, touts ‘commission free’ trading for Bitcoin and a handful of other cryptocurrencies. But dig a layer deeper and you will discover they have a pretty profitable way of recuperating these fees: charging interest on user account funds, charging for premium access, and perhaps most striking, adding percentages of up to 5% to the actual price of coins and profiting off the spread. Which, in the end, could lead to even HIGHER costs to the end user than a more transparent fee-based exchange.

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Institution-focused platform Circle Invest is another example of how these exchanges earn revenue through adding percentage fees to the value of cryptocurrencies. The investor essentially pays a ‘premium’ when buying crypto with the exchange, who collects that extra markup you pay. In short, buying $10,000 of Bitcoin with ‘no fee’ could result in owning less than $10,000 worth of Bitcoin at real-time market prices across exchanges.

Another recent entrant, ABCC, also advertises itself as the “true zero-fee” exchange, but the reality is a bit murky. ABCC’s only ‘fee-free’ feature is that they don’t have a deposit fee. Instead, they charge a 0.1% fee for every transaction and also charge fees for each withdrawal.

In attempt to beat Robinhood at their own game, earlier entrant Cobinhood is ironically one of the few exchanges that actually doesn’t charge trading fees at all. It profits primarily from its underwriting service, which allows it to collect five percent of the funds raised during an ICO, and additional underwriting service fees for large ICO projects like Kyber and Filecoin.

Decisions, Decisions…

So with all this in mind, you may ask: how do I choose the right exchanges and get the best bang for my crypto? Obviously, each trader will have varying priorities when it comes to anonymity or preferred digital asset listings. However, all should realize the importance of transparency, security, and liquidity over "free commissions":

  • Transparency: As an investor, you should know exactly how much and what you're paying for. While ‘fee-free’ exchanges sound nice, most of them end up hiding their fees behind an opaque revenue model.
  • Security: Don’t turn to exchanges with lower to no fees if they aren’t reputable - fees cease to matter if you're at higher risk of losing funds from hacks.
  • Liquidity: Any sound investor knows that you should always prioritize liquidity to avoid having your funds stuck somehwere and losing out on other opportunities.

These often conflicting elements of the trading experience are just a few of the many reasons we developed the Quadency platform to begin with. Exchanges will continue to keep innovating and evolving with no end in sight. But Quadency will be there every step of the way to make sure you’re trading smarter.

Pre-registrations are closing soon so be sure to sign-up today to get early beta access!

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Special thanks to Quadency’s summer intern, Dan Lu, for his research support on this article.