Moving Money - Crypto Exchanges

So far in this series we have focused on the various ways in which fiat currency (i.e. money directly or indirectly issued and backed by sovereign government) can be moved or transferred. In this article I'm going to dip my toe into the complex world of cryptocurrency to explore how funds can be exchanged outside the realm of traditional currencies.

As we have seen in previous articles the process of electronically moving fiat money is the process of transferring debt through a centralised chain of intermediaries. Obligations transfer via a series of swaps: you agree that your bank will owe you a little bit less, they in turn agree to adjust their balance held with the next participant and so on until finally the funds recipient is owed a bit more. The logical debt moves just as the gap moves on a sliding puzzle; no actual artefact (such as a bank note) physically moves or changes ownership. 

In contrast crypto transactions can be conducted more directly between participants and without the need for middlemen. At least that's the dream anyway. As we'll see the practical reality for most users is somewhat different.

The process of moving money via cryptocurrency starts with the process of acquiring the currency in the first place. How do I 'get' crypto? For most people this is achieved through a crypto exchange (e.g. Binance, Coinbase, Crypto.com), an online broker who offers to buy/sell cryptocurrencies in return for fiat currency, minus a fee of course. 

So here is the first swap: upon signing up with a crypto exchange you will be offered conventional fiat payment details for the exchange's bank in your chosen currency. You make a payment to that account and the funds shows up as your balance with the exchange. You have a claim on the exchange, to the value of your deposit, and they (or more accurately their bank) has your money! At this point you can buy/sell any crypto coin or token the exchange supports, swapping the exchange's fiat debt to you to a debt in whichever crypto currency you wish to 'hold'. The exchange owes you less fiat, say USD, and some more crypto, say ETH (Ethereum) or BTC (Bitcoin). You can then trade to your hearts content buying/selling (some would say betting on) different virtual assets, and then 'cash out' back to fiat at the prevailing exchange rate at the time. You can also transfer cryptocurrency directly to another participant on the same exchange (typically identified by their email address), often free of charge. All this activity takes places entirely on the exchange's ledger and never touches the blockchain associated with the coins or tokens you purchase.

If however you want to transfer your cryptocurrency to another person who holds their crypto on a different exchange, or perhaps a self-hosted wallet, then we need to step onto the blockchain. Without going too deep at this stage the blockchain can be thought of as an openly shared and mutually owned (or decentralized) bank ledger. Its a freely accessible record of who owns what assets and how, when and logically from whom, they acquired them. To transfer crypto to another external participant, your crypto exchange will debit your profile (i.e. they will owe you a bit less) and will then publish a transaction instruction onto the blockchain to reassign some of the cryptocurrency they control to your designated beneficiary. 

The crypto will originate from a shared address belonging to your exchange, so it won't be obvious on the blockchain record that it came from you. Similarly if you want to receive crypto into your exchange wallet, then the crypto exchange will typically provide you with a one-time address to which your counterparty can send to. Again, this address will belong to the exchange and not to you. Indeed that address will only hold the cryptocurrency for a short period of time until the coins or tokens are swept (transferred via another blockchain transaction) into the exchange's central wallets. Once the blockchain transaction completes, the exchange will credit your wallet (i.e. it will owe you a bit more or whatever has been sent).

There are some important consequences that flow from this transfer method. Firstly because the transaction is finalised on the blockchain before the exchange is notified, it cannot be rejected, suspended or reversed like a conventional fiat transaction; making policing who can send funds to whom somewhat difficult. Secondly a blockchain transaction is by default anonymous and does not identify the participants involved. This violates the FATF 'travel rule' that financial institutions, including virtual asset service providers (VASPs) like exchanges, must share certain information about the originators and beneficiaries of transfers over a threshold (usually USD 1,000–3,000). Whilst some VASPS have created off-chain peer-to-peer messaging platforms (e.g. Travel Rule Information Sharing Alliance) to exchange these details in parallel with the transactions, these are neither universal adopted nor easily interoperable, making it challenging to 'Identify the owner' even if you can 'Follow The Money'. 

This explains why so much attention is paid to the means on acquiring and disposing of crypto - known as on and off ramps - where the identity of the transactors and their intended business purpose can be established via strong KYC (Know Your Customer) controls.

In the next part of this series I will look at how self-hosted wallets and privacy coins add further dark magic to the art of moving money, without identifying on whose behalf, or to what extent, a transfer happened at all!