A recent study from the University of Vaasa reveals the reasons behind the failures of nearly 500 cryptocurrency exchanges and provides insights into risk mitigation.
Imagine waking up one day to find your cryptocurrency exchange platform is down, with your funds vanished and no one available to address your concerns. This nightmare has come true for thousands of traders, as nearly 500 cryptocurrency exchanges have collapsed to date.
A new study from the University of Vaasa, Finland, has delved deeply into this pressing issue. Niranjan Sapkota, an assistant professor in the School of Accounting and Finance, analyzed data from 845 cryptocurrency exchanges to unravel the reasons behind these failures and how they can be predicted and prevented.
The study, published in the Journal of International Financial Markets, Institutions & Money, identifies critical indicators that expose an exchange’s risk of failure.
Key Findings: Transparency, Centralization and Territorial Access
Though centralized exchanges in well-regulated countries like the United States and Singapore are often deemed the safest, the study reveals an unexpected fragility.
Sapkota explains that stringent regulations and high compliance costs can paradoxically create vulnerabilities that fraudsters exploit. Adding to this, U.S. customer-serving exchanges face a higher default probability than those restricting U.S. clients.
Additionally, centralized exchanges — responsible for managing wallet custody similarly to how traditional banks operate — exhibit a higher risk than decentralized platforms (DEXs), which enable users to retain self-custody of their assets.
DEXs have a 31.2% lower probability of failure due to their distributed structure that mitigates risks related to fraud, mismanagement and liquidity crises.
Warning Signs: High Fees and Limited Coin Listings
The study further indicates that high withdrawal fees often signal financial instability. Failed exchanges typically charged withdrawal fees 1.5 times higher than operational ones.
Moreover, exchanges that list a wide array of cryptocurrencies and maintain high user ratings show greater stability. Such diversity attracts larger user bases and assures steady revenue streams.
Exchanges with strong user ratings often reflect robust operational practices. Sapkota also notes that referral schemes can be a positive sign, as they align with healthier business practices.
“So, next time a friend shares a legitimate crypto exchange referral link, don’t dismiss it as mere bonus hunting,” Sapkota said in a news release.
Bridging the Knowledge Gap
This innovative research offers essential insights for creating a safer cryptocurrency trading environment. It highlights the effectiveness of combining traditional statistical methods with advanced machine learning techniques to predict cryptocurrency exchange bankruptcies.
The study achieved a prediction accuracy rate of approximately 81%, a testament to its robustness.
“Policymakers can leverage these findings to design policies that protect users and strengthen market stability. Investors and traders can learn to spot critical red flags — such as poor ratings, excessive withdrawal fees, limited coin offerings, centralized exchanges and U.S. client access — to avoid unreliable platforms and safeguard investments,” added Sapkota.
Future Implications
As the cryptocurrency market continues to evolve, this research provides invaluable tools for regulators, investors and traders. By understanding the intricate dynamics that lead to exchange failures, all stakeholders can contribute to a more secure and reliable cryptocurrency ecosystem.