Centralized Crypto Exchanges

Centralized crypto exchanges have much of the same problems, but in many ways the liquidity fragmentation is much worse. There are dozens of exchanges offering markets for crypto assets such as Bitcoin and Ether, and latency arbitrage is rampant between them.

Making matters worse, there are also many markets (pairs) for the same underlying assets, such as Bitcoin markets with differing stablecoins, and also different types of futures that vary according to expiration (fixed-date vs perpetuals) and margin (coin-margined vs stablecoin margined).

This splits volume and liquidity among hundreds of different markets for a single underlying asset. The number of possible arbitrage pairs increase quadratically with the number of such markets, and the costs for market makers to provide liquidity also increase as a result.

Latency arbitrage happens in a very similar way compared to in traditional exchanges (fast links between exchanges are important). However, arbitrage bots also compete in other ways that are not common in traditional, regulated exchanges, such as paying for or otherwise getting privileged information feeds, or negotiating with exchanges for access to privileged low-latency endpoints for sending orders. Such negotiations are rarely transparent or equitable.

Centralized cryptocurrency exchanges also act as custodians of user funds, and have a very poor track record at keeping users safe. From the old Mt. Gox hack to the recent colossal fraud at FTX, end users with money on crypto exchanges have often paid the cost for security lapses (often resulting from negligence), as well as blatant criminal behavior from exchange owners.