Trading Strategies: How Exchanges Determine The Way You Trade

I hope that this post is helpful for some cryptomaniacs out there who are determined to stack those sats by means of an aggressive trading strategy.

If that sounds like you, then you may find this interesting. If that is NOT you, then please do not let me be the one who encourages you to start day trading. It is tough, will surely cause sleepless nights, and if you are a passive HODLer or completely satisfied with the long term crypto earning effort, do not stray from what you know and what fits your personal comfort zone best. Having said that, for those crazy enough to think you can guess your way to the top, come join me, because I too am slightly insane, and I've been doing this for several years now.

You probably don't realize it, but we are influenced by the world around us in so many ways, that often times we accept the rules, boundaries, and pre-determined options as if they were our own choices.

Sometimes they aren't.

Some of this comes from marketing, where every choice is presented as a feature; as a plus. Other times, we simply accept that things 'have' to be done a certain way, because that's the way they're done.

Let's walk through an extremely simplified version of how the Cryptocurrency Exchange business strategy works. First, it does take a large investment and the exchange platform does have to have its own crypto funds on the platform and also preferably locked up in cold storage as well. When customers load their crypto on the exchange, security is part of the platform's expected burden, but it is the beginning of their profit model in almost every case. Every time someone buys or sells crypto on an exchange, there is a fee. Usually, they will follow a maker/taker model, where the user is rewards to some small degree for maker orders that rest on the order books, providing liquidity to others who are looking to buy or sell that bid or ask. The taker fees are typically higher, because a person is simply looking to grab the current market value of the coin immediately, which removes liquidity from the order book, causing a deepened gap between the highest buyer's offer and the lowest seller's offer, hence the spread. They also earn from withdrawal fees, which are designed to encourage people to either load larger amounts on the platform when they trade, or to encourage people to withdraw often, so the fees can add up.

Another factor that is usually considered is a reward or bonus for the user's volume of trades, which is typically measured in a 30 day cycle. If a user trades often enough, they may be able to reduce their trading fees, hence keeping more of their profits. This is usually designed in a tiered model, where the more you trade, the lower the fees may be.

It becomes apparent that even the largest exchanges value customers who are able to trade $10 Million and upwards. The premise is clear, that the exchange earns the most by providing liquidity, so that more trades can get processed. It is better for them to have customers who are able to provide massive amounts of volume, than it is for the highest level whales to actually pay a fee. There is always someone who is willing to pay a small fee to grab the current spike of an upward rising value, and there is always someone desperate to get out of a falling hand regardless of what the market is doing. The main issue an exchange can face, is not having an order book with enough depth in either direction. In fact, that is their greatest fear, perhaps second only to a hack.

One other aspect that factors in, is a minimum trade size, and how small the units are calculated on an order book. These may be hard for you to contemplate, and truly you may not even realize how this has affected you until now.

First, the minimum trade size determines not only the value that has to be placed at every position in the order book, but in truth is determines the flow of volume in both directions. If you can make extremely small trades, you can also make more trades more often with the same investment. That may not interest you at all, but for some it could be the difference in whether they try to get involved in the market at all, or whether they have to sit some things out. Even more important, perhaps, is whether the exchange takes advantage of those eight digits after the decimal in Bitcoin, for instance, but also with USDT Tether. Even if there is a minimum order size of, let's say for argument, $20, it doesn't necessarily mean that you couldn't, with crypto, have a bid of $20.00001 for instance, if you want to barely outbid someone without losing a limit-order position. In addition, there are two splinters of importance that can come from an engine designed only to go a few decimals deep. One of them is the creation of dust, which we all hate, and the other is simply rounding down your value in a trade.

With the latter, it is very possible that a trade worth, lets say $20.22003222 is rounded to $20.22, commonly where we have only the units representing pennies on the dollar. Often, exchange engines will round down the sell value, or up the buy value. You may not care about a fraction of a penny, at least not for now, but it is possible, and legitimately so, that an exchange can bring in tens of millions of dollars in fractions of pennies that no one is even aware is being skimmed from their orders.

Then, there are those who are keenly aware of the shorting in math taking place, in the form of the dreaded "dust". Dust is an accumulation of math that's off by fractions of pennies. Technically, Bitcoin was designed so that dust would never ever ever have to exist. It is 100% a choice of the platform to reduce the units that can be traded, which if confirmed in the balance, but not the order book, will always lead to tiny discrepancies in value that cannot be traded away. Once again, subconsciously, this encourages the gambler... whoops I mean the trader to become more active with the hopes that the dust will rise to a value that eventually can be traded, even if that value is mere pennies.

How does this all tie-in?

Let me ask you this: as a trader, how would you choose to trade if there were no limitations in fees? Better yet, how would you choose to trade if there was endless volume and liquidity, with an order book a mile thick and every single unit could be factored in? Would you hold out for 10% profit every time? Would you try to ride the actual movement of the market, and maybe grab a few tiny dips that weren't an option before? What if you could do some grid trading by setting a trading bot to make hundreds of really small trades downwards, while immediately switching to hundreds of sell orders just before the price starts to go back up? Perhaps you would try to guarantee that you didn't guess wrong, by using a fraction of a price change to squeeze in closer trades on the order book? Would you try to scalp pennies on the dollar while waiting for a coin to stop trading sideways?

There's a good chance that your trading strategy is exactly what you wish for it to be, but for many, they may be either sitting out on a ton of activity they wish made sense to their trading style, and for others they may be forced to take larger profits because they simply don't have the funds to keep placing smaller orders.

Let me simplify an easy example for traders at all difficulty levels. Let's say that the minimum trade size is $10, and the order book only sees to the $0.01 unit at its smallest, and the maker fee for low volume is 0.2%. One thing that I can guarantee, is that you will not make any money if your plan was to make a lot of small trades at 0.15% profit. Due to the best fee at your bracket, this strategy would lose you 0.05% every time you guessed correctly. But, how much do you want to earn? Let's say 1% profit per trade. Make that 1.4%, because you need to deduct the value of the trade fee, and that fee comes when you buy, and also when you sell. You may do some research similar to what I have done, and find that curiously most of the market movement happens a minimum of almost exactly what the average exchange fees represent. What I am saying, is that the amount that a coin rises and drops in value over minutes and hours, is usually barely over the lowest average fees. You can almost tell how many wealthy whales have bots set up to skim tiny fractions of profits off of the market hundreds and hundreds of times over. You will see waves of activity that move by 0.2%, 0.3%, 0.4% and then dive, and upwards in the same manner. This is not a coincidence. No one who has the funds to move markets is missing the fact that they would lose funds if they sat right at the fee valuation. Similarly, exchanges almost universally invite people to join their market maker programs which allow extremely high volume traders to act as a mechanism to close the spread or gap in the order book. In this case, it also actually benefits them to allow small fractions of values on the books.

I could give literally hundreds of examples that explain how the rules and boundaries arbitrarily chosen by exchanges have a massive effect on the movement of the market, which in turn affects the ways you are allowed to earn a profit. You may not feel this matters at all, but my hope is that just one person (okay, let's face it I hope to influence millions!) reads this and seriously examines how much more they might be able to earn by adjusting their strategy to take advantage of the best exchange platform for their trading personality. In the next article, I'm going to raise the similar point to help with this, by outlining the importance of the 3 intertwined determinations for how you can trade effectively. These are the volume, the liquidity, and the trading fee.

I will let you ponder on this, and for now, Crypto Gordon Freeman out.