The Crypto Exchange Business (Intro)

The Crypto Exchange Business (Intro)

Some of the most wildly successfully products throughout history were completely unintended; an accidental success. Crypto exchanges arguably fall under this category since Bitcoin was originally marketed as the first truly peer to peer currency that eliminated the need for any middlemen (including exchanges). Initial adopters of Bitcoin, however, eventually discovered the need for fiat exchangeability which led to the founding of the Bitcoin Market, the first crypto exchange that offered a fiat on ramp using Paypal. The exchange found immediate success but also its share of scams and illicit activity, resulting in Paypal to cut its ties with Bitcoin Market.

Bitcoin Market became the first exchange casualty with a number of newly established exchanges fighting to take over as the market leader. The infamous Mt.Gox exchange launched in 2010 and by 2013 was handling roughly 80% of all BTC trading volume. Its 2014 loss of 850,000 BTC and subsequent collapse was thought to be the beginning of the end for crypto, but this was only the beginning of the golden age of crypto and the crypto exchange business.

The current market leader, Binance, didn’t launch until 2017 and didn’t even have a fiat-on ramp. They decided instead to focus on offering as many coins as possible, which proved to be a wild success as they rode the 2017 ICO wave. Fast forward to 2020 and the exchange business continues to grow with spot trading volumes reaching roughly $6.6 trillion in the first quarter of 2020 alone. Even after deducting the fake trading volumes, the numbers are staggering considering its humble beginnings only 10 years ago.

There are a few giant cryptocurrency exchanges (ie: Binance) that have transformed into crypto-financial supercenters that the big banks could only dream of becoming. They not only offer a large diversified line of trading related products and services but also are vertically integrated in most of their business lines while operating with limited/no regulatory oversight. Business is a booming as they say.

Crypto Compare’s cryptocurrency exchange report found that the top tier exchanges only account for roughly 30% of all daily spot trading volume. Even though the Binance, Houbi, OKEx handle a significant amount of volume, the market is still very much fragmented and immature. The growth story the last two years has been in the crypto derivatives market, led by the BTC perpetual swaps inventor, Bitmex. Other exchanges have rushed in with their own swaps, futures, and options with the crypto derivatives market hitting $2 trillion in Q1 2020 alone.

The reality is that many of these smaller exchanges will cease to exist in the near future with the average life of an exchange currently around 3 years. Even with the prospects of this lucrative business looking increasingly dim, there are still new exchanges that continue to launch. Which begs the question, why? What exactly do these exchanges do to make so much money? While on the surface, exchanges appear to generate revenues from matching sellers and buyers and charging a fee, their business models in reality are much more complicated.

Crypto exchanges differ from traditional exchanges because they are involved in the entire vertical of trading; from customer acquisition to fund custody to trade matching and settlement. Traditional financial market exchanges handle only the customer acquisition and the trade matching. As we found out through the increased media coverage on Robinhood, just one of these verticals can be incredibly profitable with Robinhood estimated to have generated roughly $400MM in revenue through selling trading flow in Q1 alone. While the financial results of the crypto exchanges are not public info, Binance alone is estimated to have netted $550 Million USD in 2019 across their myriad of different businesses.

In the following posts, we will take a closer look at the different business lines of the exchanges and understand more about their respective models through research and through conversations with exchange business insiders. By having a deeper level understanding of the different business lines, we will then understand why this is such a lucrative business. The early beginnings of the BTC exchange business exemplified that a business as simple as offering traders a venue to exchange a crypto token for fiat can grow into a billion-dollar international operation in just a few short years.


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