bitfinex admitted half their reserves were used in mtgox in 2013, which should not happen, no exchange should be background trading with peoples funds behind their back.
This is a serious problem if exchanges are doing this on a large scale.. The exchanges are not investment funds or "banks" and they offer nothing in return for using the customers funds (in a bank you gain interest in order for the bank to give away your money in loans etc).
Exchanges should always have 100% of customer funds in reservers, no matter what. If they want to speculate they can use the money they get from the trading fees, which are still quite substantial..
Makes me wonder if this behaviour is causing the trading volumes that we are seeing on some alts.
1. banks do not give customers interest in order for the bank to give away customers money in loans.
imagine it this way
banks show their reserves and are allowed to create 900% new cash due to holdings. its this 900% new holdings that get handed out as loans not the customers funds.
(EG $1000 reserves= $9000 new money creation...... total bank now has is $10k. but doesnt touch the customers $1k and only hands out the new $9k)
and the interest of 5% on the 9000= 45% of the customers holdings..
($9000 new money creation = $450 interest)
to legally generate this new cash, bank made a deal that they have to give some of the 'profits' to the customers because it was the customer funds that was being used as collateral.
(EG customer gets $50 banks keeps $400)
remember the banks never touched the $1000..
however if a bank loses the $9k then there is a risk of banks needing either a bailout or the banks just go bankrupt and uses the $1k customer reserve to pay off debts.
in bitcoin, exchanges CANNOT do fractional reserve in the sense of banks. but they do loans. EG they lock funds into a mutual reserve (multisig) where both exchanges need to sign.
and then while funds are locked in the multisig they can credit each others (mysql database) balance with a set amount.
and then when trading, win or lose to decide who owes who what. and when the winning exchange calls in the debt of the losing exchange and signs off on the multisig.. its time for the losing exchange to shout "hack" because customers funds are now in the pockets of the winning exchange.
2. you can see its happening because everyone knows it takes hours(mainly bitcoin, some fiat)/days(fiat) to deposit into an exchange for customers to arbitrage.. yet the exchanges 'sheep follow' each other within minutes..
its even possible to work out which exchange is sharing reserves (to allow instant arbitraging) just by looking at the price charts history of exchanges and see when a price moves first and then which exchange is first to sheep follow.. if there is a pattern that a certain exchange sheeps follows another certain exchange first. then they obviously have a combined reserve.
3. i agree that exchanges should only use the profits of their trading fee's to take arbitrage oppertunities, but you have to realise that the owners of exchanges are not 'wall street guys', all they see is money sat doing nothing where they feel greedy to put it to use behind closed doors.
im not saying exchanges need 'regulations' to solve this. because regulations wont.. but i do think that exchanges need 'consumer protection' rules to be written up to protect customers funds being mis-used. (if you understand the difference between the purpose of a regulation and a consumer protection, you would understand why we should never push for regulation. and only push for consumer protection)
