A-book / B-book
Cryptocurrency trading briefly known as crypto trading can simply be defined as the market for trade in cryptocurrencies which use blockchain technology. It is a decentralized market over which the major cryptocurrencies of the world are traded.
Not only is it a highly liquid market but it can an average daily volumes of trade in excess of hundreds of billions USD, it also is one of the top 10 largest markets in the world by trading volume right now. The most standalone aspect of this market that makes it so big is the absence of a physical location or central market place making trading to be done electronically between traders all over the world.
One of the major participants in crypto trading is the Exchange. This is an individual or firm who executes buy and sell orders for investors in exchange for a fee. In the crypto market, Exchanges are firms used by traders to access the market as they provide traders with a platform for buying and selling cryptocurrencies. There exist two types of Exchanges – A-Book and B-Book.
An A-Book Exchange is an individual or firm which passes the trades of its clients through to the market. This means that when a trader wants to place an order, he/she contacts the Exchange who places the order with the liquidity provider – who fills the order. This makes A-Book Exchanges facilitators as they simply bring the two parties involved in the trade together and earn a commission without actually buying or selling anything. This is the traditional role of the Exchange.
Here, the Exchange works for the client and as such, there is no conflict of interest as the Exchange is guaranteed the same profit/commission irrespective of the profitability of the trade. Most STP/ECN Exchanges operate using A-Book transactions, as they place all customer orders with a liquidity provider or find other traders willing to take opposing positions in the trade.
B-Book Exchanges on the other hand actually buy and own the cryptocurrency before selling to traders. Here, when a client places a trade, the B-Book Exchanges uses their balance sheet to fill the trade instead of passing it through a liquidity provider. By internally filling the trade, they take up all the risk of the trade, betting against the client.
So, when the client wins, they lose and when the client loses, they make a profit. Thus, the total profit of a B-Book Exchanges may equal the total amount of losses recorded by traders who placed orders with them. This makes them in direct conflict with the clients. However, they use risk management and mitigation techniques to manage the inherent risk of doing B-Book transactions such as spread variation and internal hedging among others.
When one factors in the fact that many crypto traders lose money, one discovers that B-Book Exchanging is a lot more profitable than A-Book Exchanging, for the Exchange itself. Some examples of B-Book traders are those who use large amounts of leverage, those who don’t place stop losses on their accounts and those who trade in small accounts.
Conflicts Of Interest
Due to the conflict of interest, traders are very skeptical of B-Book Exchanges as they fear Exchanges can compromise trader profitability in order to make profits. This explains why most brokerages have adopted the Hybrid Exchange Model. The hybrid model if used properly can be very profitable, reason why it is used by a good number of Exchange firms.
It enables Exchanges to make profits by using the client classification tool where some traders are placed in the A-Book while others are placed in the B-Book. Generally, clients with larger trading accounts are placed in the A-Books to avoid large losses while small accounts are placed in the B-books. Risk management software exist which help Exchanges to rank clients.
Conclusively, most Exchanges are a hybrid of both A-Book and B-Book types but there are still some Exchanges who belong just to a single type. However, if traders trade profitably, it doesn’t matter whether their trades are performed by A or B-book brokers.
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