Why do Exchanges Charge Base Currency Fees?

February 15, 2020    Trading Market structure

Some prominent cryptocurrency exchanges charge fees in each market’s base currency, rather than the counter (quote) currency, and I’ve never quite gotten a satisfactory answer as to why. More confusingly, they only do so on one side of the book (when buying).

My problem with this is twofold: one, there’s a slightly different transaction cost for buying, which is not significant in magnitude but is conceptually perturbing; and two, why not charge fees denominated in the asset that you’re already using as both a unit of account and a medium of exchange on the market itself?

E.g. the price to buy qty units of “ABC” on an ABC/USD market is (qty / (1 - fee)) * price in this scheme, compared to qty * price * (1 + fee) in a “normal” fee structure.

I asked a friend formerly employed by one such exchange, and he framed the decision in terms of common sense (“shouldn’t the fee be taken out of the thing that the user receives?”) and user experience (“if you have just enough money to buy some quantity, wouldn’t it be confusing if you needed slightly more to account for the fee?”).

As a writer of trading algorithms, I find it a significantly worse user experience than one using a normal fee structure, but I see where he’s coming from! Plus I guess I do appreciate it in terms of like, gamesmanship. It’s slightly harder to develop abstractions to insulate pricing logic from the details of a more complex fee structure — which affects both the price and quantity, so they have to be considered together — and therefore those who do so might have a slight advantage compared to those who overlook it. (Okay, this is probably insignificant, but part of being an engineer is, after all, the insatiable desire to solve utterly useless problems that are just difficult enough to be fun.)

Still, I want to know why. Somebody is in charge of thinking about markets (and fees, the main revenue source!) at these exchanges.

I’ve heard tax evasion (that notorious impetus of human ingenuity) offered as one speculative explanation (tax treatment of digital things that are not strictly money is still not totally clear), but it doesn’t feel realistic that cryptocurrency exchanges could just not declare half of their fee revenue.

It also occurs to me that this practice could be ideologically motivated. Maybe there’s correlation between being the type of person that starts a cryptocurrency exchange and being the type of person who thinks cryptocurrencies are sounder monetary instruments than fiat currencies — probably exhibiting a higher r^2 than a correlation with being fascinated by market structure as an algorithm for human cooperation — in which case using cryptocurrencies to denominate fee payments would make perfect sense. In fact that would be an excellent explanation, if and only if, they charged base currency fees on both sides of the trade!

I’ve also heard it framed as a speculative bet. Maybe these exchanges want to build up exposure to each of their listed assets, but also be sure to collect some revenue in the same money they use to pay rent and salaries. If this were the case, wouldn’t it make more sense for them to employ a normal fee structure, and then systematically exchange some percentage of their collected fees on the open market? It would even boost their volume a little bit.

The most sinister explanation I can think of is that it could be a way to take advantage of the adverse selection faced by those offering liquidity, systematically and transparently front running their most informed users. The best way to front run a gargantuan buy order is of course to have already bought at the very same price as that order, not to trade later against the post-execution order book. This is the only situation I can think of where it does makes sense that the fee currency would change with the side of the order.

But this also seems wildly unlikely — why would exchanges look for that type of edge, which might be probabilistically significant but would nevertheless be negligible given the quantities at which they could execute? And, more fundamentally, the correct way to do this would be to vary the fee currency with the aggression of the order in addition to its side. To take maximum advantage of the maker’s adverse selection risk, you’d want to always charge both the maker and the taker fee denominated in the asset that the taker is receiving.

There’s no other market I can think of where this happens — commodities markets, even those that settle in the underlying, don’t take in-kind commissions, and for obvious reasons bookies, art galleries, and auction houses don’t operate in that manner either. If anybody out there can shed light on this mystery, please email me!