How to Evaluate Cryptocurrency Exchanges' Reputations

The most important thing in making money is not to lose money. A large loss from a bad exchange can wipe out the profit from many good trades. More importantly, you don't have that money to reinvest. Over time, this opportunity loss is more significant than any one trade.

Most exchanges are good, or they couldn't stay in business. You can usually avoid the few bad ones. Here's how.

Exchanges are your partners in trade, your counterparties. The biggest risk in arbitrage is counterparty risk. You can expect to spend most of your time evaluating exchanges, especially when you are starting. Monitoring them is an ongoing process. Ownership, management, and practices change

Do the research

As with any investment, you should do your own research. A great learning resource is Counterparty Credit Risk by Jon Gregory.

The first step is to check the exchange's reputation. Find customer experiences. Read as much news about them as you can. Search online for the exchange name and red flags like "scam", "fraud", and "dishonest". Of course it's rare for any business to have no unhappy customers. Compare the number of bad reports between exchanges. Be careful about these reports, both good and bad. Sources are often biased.

The most important thing you are looking for is whether they perform as agreed. Obviously taking people's money without delivering is as bad as it gets. The euphemism for this is "withdrawal delays".

Excuses don't matter much

KYC and AML are the favorite excuses from bad exchanges for taking your money and not delivering. If an exchange processes all required KYC/AML up front, that's a good sign. Waiting until you want your money isn't.

One secret of finance is that AML and KYC are very profitable for some financial businesses. If they can find an excuse to freeze your account, they often keep your money. This is a clear conflict of interest.

Delays and high fees can kill profits

Any delays by the exchange mean your trading frequency — and therefore profit — will be lower. Look at the currency pairs the exchange supports. Moving fiat currencies on and off exchanges usually takes days. Avoiding fiat can mean much faster and more profitable trades.

High fees are not necessarily a reason to avoid an exchange. Always make sure your gross margin in each arbitrage leaves you a profit after all expenses, including trading costs. If the spread is wide enough, the fees may be acceptable.

Watch carefully for "errors"

If errors are almost always in one side's favor, they probably aren't errors. For a real life example, if the exchange magically turns stop loss orders into stop profit orders, don't use that exchange.

Pay close attention to slippage. Notice how often delays and price changes benefit the exchange, and how often they benefit you. Some slippage is normal.

If you have the skills, look for signs of malware. For example, if the site's ico file includes javascript, you should wonder why.

Possible signs for caution

Find out how the exchange makes their money. Is it from lending you money, trade commissions, withdrawal charges, reinvesting your deposits? Income sources strongly bias exchanges. Many businesses sell your private information. When money is involved, privacy is priceless.

Compare currency prices to other exchanges. Usually a great price is just a whale in a hurry. This is an opportunity, not a worry. But the further the price is from other exchanges, the more careful you should be. Alternatively, if multiple exchanges have almost exactly the same price, this can be explained by HST arbitrage, or by price rigging. It's another sign for caution.

Why accept the errors that come with using multiple platforms when you don't have to? It's easier and safer to learn just one app for almost all exchanges with TopArb Trader. But if you can't, ask the exchange if you can try their app without risking money. This is often called a sandbox, or paper trading. Pay careful attention to how clear the app is. Will you make mistakes if you are in a hurry? Does the app try to excite you into trading? Many businesses carefully test what makes you click fastest. This practice reduces thinking and encourages errors.

If the sell side of your trade doesn't work out, it's not a very serious signal for the exchange. Markets move. Because this is arbitrage, you bought near the low end of the market. There are usually many good alternative exchanges where you can sell at a profit.

Learn more about risks.