Dollar-Cost Averaging in Cryptocurrency

In the early months of 2009, bitcoin had zero monetary value as it was essentially an experiment in digital currency between cypherpunks (individuals who use cryptography). Now, here we are over a decade later (the early 2020s) and there is an entire global marketplace worth trillions of dollars based on the concept of cryptocurrencies. One of the main factors that enabled this transformation was the creation & growth of cryptocurrency exchanges – which have provided consumers with a way to purchase, sell and trade cryptocurrencies. Understanding how these exchanges came into existence in the first place will help you understand what the future holds for finance.

The Birth of Cryptocurrency Trading

Prior to the creation of the first exchange, one could only acquire bitcoin by mining it or by finding someone who would agree to trade with you (i.e., sellers of their bitcoins). There were no liquid bitcoin markets and therefore there were no charts or automated matching engines. To get bitcoins back in those days, one would have to either find someone to sell them bitcoin or mine for them.

Trading Bitcoins at the Bitcointalk Forum

The original bitcoin community was formed on the Bitcointalk forum. To buy or sell bitcoins one would post a message on Bitcointalk with an expression of interest in purchasing (selling) bitcoins. Potential buyers & sellers would send private messages to one another to negotiate a price for the btc (or the amount they wanted to obtain), which involved using PayPal or Western Union to send the payment. These transactions were generally very slow, they included a high level of risk and were entirely dependent on the counterparty acting with honesty.

Bitcoinmarket.com – The First True Exchange

Bitcoinmarket.com was launched by a user named “d_thomas” on March 17, 2010, as an attempt to be a centralized marketplace for the buying and selling of bitcoins, thus creating a market for trading bitcoins. Bitcoinmarket.com was always focused on being an orderly market environment and making sure there was always a way to track the price of bitcoin in real time.

Price Discovery of Early Bitcoins was Primitive

The initial recorded exchange rate was set by New Liberty Standard, which set 1,309 BTC to $1.00 USD, calculated based on the electricity used to mine 1 BTC. This rate was set unlike today, where prices are determined via speculation.

Early Bitcoin Trading Mechanisms

The first non-trivial (major) exchanges had to overcome significant technical barriers due to the lack of an infrastructure that could support this kind of trading network, and the skepticism of traditional banking and payment processing.

PayPal as the Original Payment Method

In the beginning, the dominant method of buying coins was through PayPal. Unfortunately, there was a major issue with this form of payment because there is no way to reverse a bitcoin transaction, while it is possible to reverse a PayPal transaction. Therefore, buyers of bitcoins would purchase bitcoins from sellers and then reverse the PayPal charge. This resulted in very large financial losses to early market participants.

Bitcoin's Initial Pricing and Valuation

For most of the first year, the price of a bitcoin at an exchange was less than one dollar. The first known purchase of bitcoin occurred in May 2010, and is now referred to as Bitcoin Pizza Day, when 10,000 BTC was paid for two pizzas. At the time, this equated to approximately $41 worth of BTC, but now equates to hundreds of millions of dollars.

Challenges of First-Generation Exchange Systems

Many first-generation exchange systems were marred with problems, including relatively slow speed of transactions and the fact that trading would be halted during periods of high price volatility; also, security was an afterthought – the wallets were created on the web server, which made them easy targets for hackers. A large amount of BTC lost in the early years is responsible for creating the modern-day security policies we have in place today.

Mt. Gox Challenged the Superiority of Centralized Trading Exchanges

Mt. Gox's dominance in the market made it easy for people outside the bitcoin network to trade bitcoins at a fair value. However, the ease with which it was able to completely dominate the market resulted in people relying too heavily on it as a means for trading bitcoins. The bitcoin community came to the realization that the dangers of one exchange dominating the market could lead to an entire ecosystem's collapse. As such, the entire history of bitcoin is divided into two parts: "before and after" the collapse of Mt. Gox.

The Mt. Gox Collapse

As a result of the Mt. Gox exchange shutting down, 850,000 bitcoins were lost. The collapse of Mt. Gox has been attributed to continued and poor management of the bitcoin network and fraudulent activity resulting in risks to the entire ecosystem of bitcoin. The Mt. Gox hack, while causing the loss of nearly 850,000 bitcoins and 90% of the total trading volume of both exchanges globally, has also played a key role in causing 2014’s multi-year market collapse.

Despite the loss of nearly 850,000 bitcoins, and the subsequent underground market, bitcoin markets within 8 months experienced significant increases in volumes due in part to exchanges that have emerged with their own supply of bitcoins for trading.

Meltdown of the Mt. Gox exchange

The meltdown of the Gox exchange vastly changed cryptocurrency. Proof of reserves became an accepted idea in cryptocurrency. Bitcoin users started storing their coins, using private wallets instead of keeping them on exchanges. The Gox meltdown also was the first time a government agency took a closer look at bitcoin and other cryptocurrencies, resulting in increased regulation.

Reinvented Exchanges

As a result of the Gox exchange collapsing in 2013, a new era in bitcoin began. Anchorage, Coinbase, and Bitstamp came onto the market with banking regulated standards and compliance. They created first-rate infrastructure for trading and moved away from the "wild west" mentality.

Compliance and Regulation Changes

Newly established exchanges had to implement stringent KYC procedures and AML post-Gox. This changed the way that bitcoin and other cryptocurrencies were being viewed, resulting in bitcoin exchange-traded funds (ETFs) and bitcoin futures.

New Trading and Services Creations

With time exchanges matured from simply trading BTC to USD to offering thousands of commercial cryptocurrency pairs. New digital coins (Bitcoin Cash, Ethereum, stablecoins, etc.), along with complex financial products (listings or derivatives and ETPs) became available.

Binance: The Next Generation Exchange

Binance launched in 2017 and became the largest cryptocurrency exchange by volume in just a few short years. Binance offers a full range of tokens and operates with a lower fee structure than most other exchanges.

How Trust is Built By Customer-centric Policies

Centralized exchanges like Binance have created insurance funds (the "SAFU" fund) as a result of being proactive about protecting their users against security breaches. This was an incredible opportunity for Binance to dominate in cryptocurrency.

Global Regulatory Landscape

As Bitcoin matures, Binance (and others) have faced increasing pressure from different government regulatory agencies around the world. This has led to a much more globalized bitcoin standard where all exchanges need to have a license to operate in certain jurisdictions (for example, the U.S. or the EU.)

How Exchange Platforms Look Today

Exchange platforms could be divided into centralized exchanges (CEX's) and decentralized exchanges (DEX's) such as Uniswap. Selling bitcoin and other digital assets has improved dramatically.

• Centralized Exchange Platforms: Speed, liquidity, and fiat onramps.
• Decentralized Exchange Platforms: No intermediaries, very private, but offer limited support for novice bitcoin users.

Conclusion

In conclusion, the evolution of bitcoin from a single thread on a forum - to the worldwide bitcoin economy has marked a huge financial revolution. In the early days, trading exchanges like bitcoinmarket were weak platforms but were the cornerstones for the exchanges we know now, which are stable, organized and highly liquid markets that can accommodate the growing number of bitcoin holders looking to invest. The trajectory of Bitcoin's price continues to provide opportunities for investors and will continue to position exchanges as critical infrastructure to support the growth of digital finance worldwide.

Frequently Asked Questions

How did early Price Discovery occur before Exchanges existed?
Prior to the creation of exchanges in 2010, price discovery was conducted through individual negotiation in forums or based upon the price of the electricity used to mine each coin. Prices were based upon the availability of coins and there was not yet an orderly book or global pricing structure for bitcoins.

What Security Enhancements Are Available on Exchanges Today That Were Not On Earlier Platforms like Bitcoinmarket and Mt. Gox?
Currently, the most utilized security practices on modern exchanges include cold storage of clients' assets, multi-signature wallets, two-factor authentication for client accounts and independent third-party audits of exchanges. To protect the billions of dollars worth of coins maintained on their platforms from hacking, many exchanges maintain insurance funds, like Binance's SAFU.

How Have Cryptocurrency Exchange Business Models Changed Since First Establishing Trading Platforms?
Transacting on exchanges in the beginning was a limited function that only served as a hub for transactions, whereas now, exchanges are full-fledged financial ecosystems with the ability to provide a diverse range of services including bitcoin futures contracts, staking, lending, ETFs, and even providing development support for core bitcoin developers.

What Regulatory Changes Have the Most Affected the Operation of Cryptocurrency Exchanges?
The most influential regulation on cryptocurrency exchanges is the implementation of KYC/AML (Know Your Customer, Anti-Money Laundering) regulations. This resulted in an evolution of the exchange from an anonymous to a regulated financial institution, and it has resulted in the splitting of bitcoin's value into an area of mainstream adoption and an area where institutions purchase bitcoin.

How Has Mt. Gox Affected the Evolution of Security Practices in Crypto?
The collapse of Mt. Gox was a watershed event in the crypto industry. In response to this event, many industry participants adopted "Proof of Reserves" and began working on a model for decentralized trading in which users maintained control of their private keys.