Simon Moser


Where the multi-billion dollar cryptocurrency exchange industry is headed

This year is the year of cryptocurrency exchanges. Visionaries, like Binance CEO Changpeng Zhao (“CZ”) and Coinbase founder Brian Armstrong, made tens of millions of dollars through their digital currency exchange platforms.

With an estimated daily profit north of $3 million by the top ten exchanges, they are undoubtedly some of the most profitable businesses in the cryptocurrency space, only trumped by the imperious mining industry. Furthermore, major exchanges are dreaded influencers within the space and appear to have an enormous impact on the prices of the “chosen” cryptocurrencies, as recent reports suggest.

Recent news like the announcement of Bakkt, a Bitcoin futures exchange launched by the operator of the NYSE, are pointing towards growing institutional interest in the cryptocurrency exchange industry. The ball is rolling and it’s rolling fast. The question is: where is it heading and how far can it go?

The perfect storm

The outlook for cryptocurrency exchanges wasn’t always as bright as it currently is. Most early cryptocurrency investors probably stumbled across the notorious hack of the Mt. Gox exchange in February 2014, which resulted in the loss of tens of thousands of Bitcoins belonging to private investors and triggered a downtrend that lasted nearly 2 years. This event stands for one of the biggest setbacks in Bitcoin’s history.

Unfortunately, the story doesn’t end with the Mt. Gox fiasco. Despite being the former most downloaded app on Apple’s U.S. App Store, the controversial monetary gateway Coinbase is presently suffering from unflattering user ratings. At the same time, several other cryptocurrency exchanges are being accused of charging obscene fees for the listing of initial coin offerings (ICOs), some supposedly as high as one million dollars. Another persistent allegation, that the trading volume on numerous exchanges is artificially inflated, has already been proven and could lead to erroneous rankings, as well as trust issues from the customer side.

Understandably, such events attracted the attention of international regulatory entities, who already demonstrated their willingness to shut down fraudulent trading platforms. Some regulators even doubt the legitimacy of most coins and tokens exchanges in general. As SEC representative Brett Redfearn mentioned in an interview with CNBC: ”There are a number of exchanges that are trading ICOs that I would think that we would see more registrations.”

A piece of the pie

In spite of all these worrying incidents, the companies behind those platforms are continuously recording breathtaking revenues, even outpacing some of the biggest banks in Europe in certain cases. Blockchain magnate CZ, who appeared in many headlines for becoming a billionaire in less than six months through his exchange Binance and its utility token, even made it to the Forbes cover. News of this caliber are starting to move large established organizations to explore this new market further.

Earlier this year, Goldman Sachs subsidiary Circle spent about $400 million on acquiring the U.S. based cryptocurrency exchange Poloniex. Moreover, stock market heavyweight NASDAQ disclosed the intention to become a cryptocurrency exchange itself a few months ago. A similar trend can be discovered on the European continent, where Switzerland’s main stock exchange SIX plans to support Bitcoin and other altcoins in the next months. The cherry on top are the news about ICE, parent of the world’s biggest stock exchange NYSE, which recently announced a crypto trading platform scheduled to go live in November 2018.

Tokenizing Wall Street

While the big players of the traditional stock market are trying to catch up, established blockchain companies, like Coinbase and Poloniex, have bigger fish to fry. The tokenization of financial assets, such as stocks and other securities, represents a promising business field — global securities market valued around $15 trillion — with the potential to disrupt the entire stock market itself. This is leading to a highly competitive race to build the first operational security token exchange.

Nevertheless, choosing the right jurisdiction for a security token exchange seems to be one of the main challenges when considering to open such a platform. After an alleged regulatory approval for a Coinbase security token exchange in the United States, the company was forced to pull back only a few days later. Others, like the China based OKEx, are trying their luck with smaller oversea jurisdictions. Potential destinations could be the Mediterranean islands Malta and Gibraltar, as well as the central European banking hub Switzerland.

Very recently, the crypto startup Open Finance announced that it just launched the first regulated security token exchange in the US. This development is an interesting step towards a wide adoption, but there are still many critic voices in the space. Andy Singleton, CEO of security token platform Aboveboard, mentioned in an interview that “exchanges are only being approved with significant restrictions on private market trading”.

Andy Singleton is known for his campaign to create a market for professional investors and quality securities. He points out that the industry is currently not selling quality tokenized securities to professional investors and that many of the offerings we are seeing right now are bad deals. Andy claims that while security token exchanges are a very promising industry, the first step is to create high-quality tokenized assets.

Fragmentation is key

Tokenizing assets is certainly a revolutionary idea, but the beneficiaries of this upgrade would be mainly high net-worth individuals, respectively accredited investors. In contrast to that, decentralized exchanges feature an architecture that is indeed designed for the lion’s share of all traders.

With this concept, all users hold their crypto assets on a personal wallet. Furthermore, every trade on the platform occurs peer to peer and will be executed by a smart contract. If run with high-security standards, this approach would forever make large-scale hacks, like the Mt. Gox disaster, a story of the past.

Binance has recently announced its plans to launch a decentralized exchange. This has come as a surprise to many since Binance is the largest centralized exchange in the space, earning hundreds of millions per quarter from their core business. In the words of “CZ”, CEO of Binance: “I believe that decentralized exchanges are the future”.

Although there are already several fully operable decentralized exchanges, most of which are running on the Ethereum blockchain, they have also been heavily criticized for reliability issues and suboptimal user experience. In order to provide both secure and satisfying user experiences, decentralized exchanges might be in need of more mature blockchain constructions, that come along with the capacity to handle high-frequency trading.

The prospects of cryptocurrency exchanges are many. As the field continues to evolve at a very fast pace, and more large players enter it to get their piece of the pie, it will be truly fascinating to observe which direction it will end up taking.

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