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From here: http://www.bitcoinfuturesguide.com/bitcoin-blog/arthur-hayes-of-bitmex-chinese-exchanges-are-operating-as-shadow-banks (http://www.bitcoinfuturesguide.com/bitcoin-blog/arthur-hayes-of-bitmex-chinese-exchanges-are-operating-as-shadow-banks)



http://www.bitcoinfuturesguide.com/uploads/6/4/6/5/64656757/9578072_orig.png

Arthur Hayes, CEO of Seychelles-based bitcoin futures exchange BitMEX, has come out with an explosive speculation about Chinese spot exchanges 0% fee model. Many people have wondered how they make money with this business model, and Arthur makes a strong case for how they logically must be investing customer deposits into speculative Chinese debt instruments. Read the latest BitMEX newsletter here: http://us3.campaign-archive2.com/?u=db45c09bdf20e1866bb32123f&id=2b42af456a&e=a725d34609 (http://us3.campaign-archive2.com/?u=db45c09bdf20e1866bb32123f&id=2b42af456a&e=a725d34609)

Essentially it boils down to: these exchanges don't make money by charging 0% on trading fees, and make a pittance from withdrawal fees, so they have to be making a revenue stream somehow.

And since they are taking in loads of CNY deposits which they otherwise only credit into their own database for customers to use to trade, then OKCoin, Houbi, and BTCC are taking those customer deposits (most of them at least) and investing in 10-20% "Wealth Management Products" (WMPs).

Arthur points out that the main cause of this is the excessive demand for private credit. Because Chinese state owned enterprises have exclusive access to bank credit, small private companies have to use shady means to get financing, and institutions with excess cash take on a bank-like role, aka shadow bank.

It's a very likely scenario and it's not necessarily a bad thing. As long as the speculative debt that the Chinese exchanges are investing the customer deposits in doesn't go bad, then the deposits of customers is safe, and the traders that are using balances reflecting these deposits are robust.

However, if things get messy in China, leading to problems with debt repayments, then it may spill over and affect the bitcoin market too.

This is a fantastic theory about the 0% fee Chinese exchanges. I have long wondered  what benefit there is to running an exchange that charges no commissions, and this makes sense. If it's true, I don't see this ending well for anyone trading on those exchanges, as people chasing these WMPs and their return of 10-20% are just chasing yield to make a quick profit. Generally, people who chase yield don't weigh the risk-reward carefully, and things with yields that high are generally quite risky. China as a whole isn't a place I'd want to invest in the first place because the government is actively pumping the stock market, then add on top of that pump that these guys are investing in the most risky class of assets there, and this ends badly.

Alas, this is speculation, as Arthur admits he has nothing to substantiate his theory. Interesting nonetheless.

Nothing stops these exchanges from earning a return on these deposits. I just hope they do it from relatively safe venues like bank deposits. You don't need to make 10% returns per month when there is a risk that your customers might try to withdraw funds at any point in time.
It would help if these exchanges come out with a statement on where their funds are stored.