The Gatekeepers to the New Financial System
by Marvin Ordonez
It seems that the only things in the crypto market that haven’t suffered from the downturn at the start of the year are ICOs and cryptocurrency exchanges. ICOs in the first quarter of 2018 raised over $5.7 billion USD which is more than what they raised in all of 2017. Exchanges came out big as well. Binance, for example, made an estimated $200 million USD in the first quarter of 2018 which is more than the $146 million that the Deutsche Bank of Germany reported to have earned in the same quarter. Since they’re so profitable, exchanges are popping up almost as fast as ICOs. In January South Korea had sixty cryptocurrency exchanges. Five months later and they’re pushing over a hundred. As we gear up and head into the next bull run I want to take some time and do a write up on the most prominent cryptocurrency exchanges in the industry.
OkEx recently became the largest exchange by daily trading volume. Shortly after accomplishing this monumental feat, the CEO of this Hong Kong based exchange resigned in order to take sometime for himself and his family. After OkEx comes the fastest growing exchange we have ever seen. Binance launched in July of 2017 and saw $7.5 million USD in revenue the last quarter of 2017. As mentioned previously, they saw $200 million USD in revenue the first quarter of 2018. A very impressive feat since the cryptocurrency demand caused them, and other exchanges, to temporarily halt new user registration in January. What separated Binance from the other exchanges that closed their doors was the speed in which they were able to improve their system. Because of this their popularity continued to grow and for a couple of months in 2018 they were the largest exchange by volume.
Next on the list is Huobi. The Singapore headquartered exchange has their fingers in all realms of cryptocurrency. Their Huobi Labs is a blockchain incubator and they have recently partnered with Tianya Community to launch a billion dollar blockchain fund. They are also working closely with the Chinese government on regulatory blockchain issues in order to keep China at the forefront of blockchain technology. After Huobi comes South Koreas largest exchange UPbit. On Friday May 11th UPbit was raided by South Koreas financial regulatory enforcement on rumors of fraud. On May 15th Upbit’s CEO announced that internal audits proved that all of their funds were legitimate and that no fraud was apparent. Exchange fraud and solvency issues have been enormous in the crypto space. Clients of exchanges tend to leave their crypto assets on exchanges instead of taking care of the funds themselves. This leaves the exchanges responsible for billions of dollars in client funds. As an example, Bithumb, South Koreas second largest exchange, released audits in December 2017 that showed they were holding $6 billion USD in client funds on their exchange.
Speaking of exchanges losing client funds, Bitfinex is the largest exchange to still be operating after having been hacked not once, but twice. The first time was in 2015 and the second was in 2016. After the second hack they repaid their customers with BFX tokens which were made to represent $1 USD. In April 2017 they announced that they had bought all of these tokens back and in essence had returned the stolen funds back to their clients. Bitfinex has received a lot of scrutiny for not being transparent about their hacks. They have also received criticism for their affiliation with Tether — the stable coin that may or may not be backed by the USD reserves that it claims to have.
This rounds off the list of the exchanges that are most often in the global top six. Now I am going to focus on exchanges that I believe are of noteworthy mention. Starting with Coinbase — the New York exchange that was the fiat gateway for cryptocurrencies in the United States. They are one of the most respected crypto companies in the world and many of their alumni are prominent crypto influencers. Charlie Lee, creator of Litecoin, and Olaf Carlson-Wee, founder of Polychain Capital, are just two examples. However, Coinbase currently offers a very small selection of cryptocurrencies. Americans who wanted cryptocurrencies other than Bitcoin, Bitcoin Cash, Litecoin, and Ethereum had to purchase one of the aforementioned coins and then send it to an exchange like Bittrex or Poloniex. Once the funds were on one of these the user had several altcoins they could choose from. Recently, Poloniex was acquired by Circle, a Goldman Sachs backed company, for $400 million USD.
Bitmex gets a notable mention because they are estimated to have the most volume out of any cryptocurrency exchange. However, Bitmex offers derivative trading and not the underlying crypto assets. They were one of the first to offer futures contracts on bitcoin and ethereum and they also come up with some of the best research in the industry which they post on their blog. Speaking of futures, in December two legacy financial institutions began offering futures contracts for investors who wanted to get involved in trading bitcoin on a regulated and secure platform. The CBOE and CME are now rumored to be adding Ethereum future contracts to their exchanges next. Interestingly, the Federal Reserve recently published a paper which showed evidence that the futures contracts being offered by these two exchanges was part of the reason for the downturn in the market at the beginning of the year.
Rumors about other traditional financial institutions gearing up to enter the crypto market have also been flying around. These should be taken seriously since the rumor of Goldman Sachs opening a crypto trading desk turned out to be true. Shortly after they announced they were opening a trading desk focused on crypto assets, new rumors began circulating that JP Morgan and Barclays would be doing the same. Traditional stock exchanges are also jumping into the fray. The NYSE owner wants to let customers buy bitcoins and the NASDAQ CEO says that they are open to becoming a crypto asset exchange once everything becomes clearly regulated.
It is interesting to see all the traditional financial players throwing their hats into the ring. The demand for them to enter is apparent, but the timing is also right since they are coming into this after learning from all the mistakes that the vanguard of crypto exchanges have made. The most important area to learn from is the hacks that have plagued the crypto world like the infamous Mt Gox hack back in early 2014. The aftermath of that hack still haunts the market to this day. In the recovery efforts after the hack, Mt Gox was able to recuperate 200,000 bitcoins. They put a trustee in charge of holding onto these coins and gave him full discretion over when to sell them. Recently, the Mt Gox trustee revealed that he had liquidated 35,000 BTC and 34,000 BCH from December to February and received an approximate $400 million USD in order to pay back those affected by the Mt Gox loss of funds in 2014. Some analysts have linked Mt Gox as the reason for starting both bear markets in bitcoin.
Another large exchange that was hacked is Coincheck. In February they lost an approximate $500 million USD in NEM tokens that were stored in their hot wallets. They claimed that a lack of engineers was the reason as to why the coins weren’t in cold storage. Coincheck has repaid their affected customers but these two Japanese exchanges are the largest crypto hacks that have occurred and this has put the Japanese government in a peculiar situation. On the one hand they are looking to increase adoption within the country and have over 260,000 merchants accepting cryptocurrencies. On the other hand they need to impose stricter regulations without stifling innovation so that citizens don’t continue to unnecessarily lose money in an already volatile and highly speculative market.
One solution to all of these hacks is the development of strong custodial services for clients who wish to keep their crypto assets in the care of trusted and regulated actors. Another solution is that of decentralized exchanges like 0x and Ether Delta. Decentralized exchanges leverage blockchain technology to create a trading platform where the clients funds are always under the clients control. This way if a hack occurs it would only affect a small number of users instead of the entire exchange.
The old adage of selling shovels and picks in a gold rush holds true even in the digital age. This is exemplified by GPU and ASIC manufacturers and how well they did during the bull run last year. Exchanges can be compared to the land owners on which the gold sits. They are the gatekeepers to our new financial system and they have enormous power like being able to decide what crypto assets are readily available to the public. Rumors say that Binance charges a seven million dollar fee to have a coin listed on their exchange. Other exchanges charge something similar. However, the highly competitive nature of this market and the introduction of traditional financial players plus decentralized exchanges will force the current leaders to continue innovating and improving. I am excited to see what the future hodls.