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Cryptocurrency exchanges are maturing through team professionalization and business strategy optimization, but they will eventually face the Thucydides trap, inevitably contending with traditional banks and technology giants.
Written by: Huyette Spring and the Coin Metrics team
Compiler: Perry Wang
The main points
- Cryptocurrency exchanges grew out of nothing and have rapidly grown into a relatively mature industry.
- The growth of exchanges has made them become ” super predators ” in the crypto field. They have participated in many mergers and acquisitions and have become the entrance for other companies to enter the public market.
- The latest trends in exchanges include professionalization through recruitment and regulatory positioning, and optimization of their respective strategies through the appropriate addition and removal of product lines.
- However, cryptocurrency exchanges still face some major and unresolved issues, even if they are mature, this is not enough to ensure that they can get rid of the influence of traditional financial technology companies.
The article “Network Status” mainly focuses on the network and market data of the cryptocurrency industry. In this discussion, we will enlarge our horizons and discuss the business trends and strategies of transactions built on various decentralized protocols.
Cryptocurrency exchange originated in October 2008, and the industry has matured at an alarming rate. However, this maturity does not guarantee that cryptocurrency exchanges will remain independent forever.
Below we will discuss how cryptocurrency exchanges have matured over the years.
From Satoshi Nakamoto to 2017
The first challenge facing cryptocurrency exchanges is how to gain attention in a market that basically does not exist. Simply put, can they build a product that early adopters of cryptocurrency are really willing to use?
In the early days of the crypto industry, when centralized exchanges began to appear, the “cyberpunk” who believed in the concept of decentralization was frightened. Trust is a luxury of choice, and no matter what function, there were few other options that could compete with this type of exchange. These conditions have contributed to a paradox: MtGox exchange can occupy 70% of the Bitcoin market, while at the same time, the objects trusted by its users are completely out of control. Not surprisingly, the inevitable hack of MtGox has become a major event in the history of the development of crypto exchanges and threatens the future of the industry.
On February 25, 2014, the MtGox exchange suddenly went offline. The figure above is the average transaction volume of the 7 days before this point in time
However, the price increase in 2017 allowed the cryptocurrency market to achieve explosive growth and brought more users, practitioners, business models and competition. So users of cryptocurrency exchanges get the Prometheus Tinder of the industry: choice, and the expectations that come with it. These expectations mean that exchanges need to not only launch a product that early adopters are willing to use, they also need to create a product that people are willing to trust.
2017 to 2020
The challenge of trust is that it is expensive and accumulates mainly on the brand, not on the product. Therefore, the focus of the exchange has shifted from the product to the company: Can you build something that keeps people’s attention; for example, a business with good financial performance?
Today, there are two very different but interconnected trends that are taking place. They represent the exchange’s efforts to capture the changing minds of customers (ie, trust): specialization and strategic optimization.
The first trend is to win the minds of customers through specialization. Now, no matter which market segment, customers want the services of crypto exchanges to look like experienced and battle-tested.
The quickest way is to recruit veterans . In the past, visionaries started the encryption business in vain, but the current theme seems to be “Professional business needs professional managers.” Although the first principle of reimagining the social contract of currency is often to attract top talents, the current situation is that top talents are then introduced into professional talents from leading institutions, who have experience in the “traditional world”. To name just a few recent examples: Coinbase hired executives from Barclays, Google, and Lyft; BlockFi hired executives from American Express and Credit Suisse; and Gemini hired a former Goldman Sachs executive to lead its Asian operations. expansion.
The second method of specialization is to accept supervision . Yes, this is indeed driven by the strong push of regulators, especially in the United States, but on the other hand, many people in the industry have, in one form or another, turned it into a competitive advantage that builds customer trust.
Supervision, and accompanying evidence such as SOC audits, seems to have become a positive rather than negative marketing tool. Despite the well-documented problems, the number of BitLicense licenses issued by the New York State Department of Financial Services is accelerating. International companies like Binance.US and FTX.US have cleared the regulatory barriers to entering the US market. The most typical approach is to register as an MSB. Bitstamp, headquartered in Luxembourg, went one step further and obtained a complete BitLicense. BitMEX announced the “User Verification” (aka KYC) plan. Unlike many other crypto “exchanges” (in fact, they are not qualified to be exchanges), ErisX sought and obtained the Derivatives Clearing Organization (DCO) and Designated Contract Market (DCM) licenses from the US Commodity Futures Trading Commission (CFTC). Enable it to realize a business model for the institutional market.
Another key component of the supervision of crypto exchanges is market supervision to reduce market manipulation. Coinbase, Gemini, Bitstamp, Bitfinex, etc. all adopt some form of market surveillance. However, market surveillance alone is not enough—at least for the US Securities and Exchange Commission (SEC). The SEC requires cross-exchange market surveillance to share multiple agreements before they approve an ETF. As for how this type of sharing agreement will develop in the future, it needs continuous attention.
The number of BitLicenses issued each year, source: The Block-The number of BitLicenses granted by NYDFS is increasing every year, and there are already 8 this year
If specialization has won the customer’s brain, then strategic optimization is how to win the customer’s heart . The large number of talents brought under the theme of specialization should and have been focused on defining the most attractive value proposition in the most effective cost way; at the same time, they also invest resources in key revenue-generating areas that make customers happy and reduce Investment in areas where customers are dissatisfied.
In the wave of seeking sharper and clearer value propositions, relevant organizations have expanded their product range to meet the needs of customers and potential customers, while eliminating unnecessary product lines when necessary. How active an experiment is, and correspondingly, to what extent these experiments will become part of the strategic framework, rather than random supplements.
Coinbase closed its index/basket of products, and not long after that it acquired Tagomi and Xapo Institutional, and then launched an institution-oriented product.
Driven by optimization strategies, there is no need to reinvent the wheel. Many companies have imitated the strategies of established Wall Street institutions. Many participants are vying to provide prime brokerage services. Like the business model of traditional financial industry counterparts, cryptocurrency custodians have also been increasing lending services.
More importantly, these refined value propositions create professional institutions in market segments, which allows exchanges to outsource necessary but not differentiated components of their products to complementary institutions (sales and leaseback transactions). The Block and Vision Hill counted high-quality industry layout maps for these market segments, covering miners, exchanges, wallets, infrastructure, data, investors, etc. In the past, such market segments could not exist.
A typical example is third-party custody (for example, Bitstamp outsources custody to BitGo), while the latest example is node infrastructure. In the past, crypto companies located somewhere in the value stack generally needed to operate their own nodes. This is costly and troublesome, and once it exceeds a certain point, there is no differentiation. The development of specialized institutions (HOVA and other projects) for crypto node infrastructure has made this critical function available for outsourcing. For example, Coinbase is outsourcing this link to Bison Trails.
Finally, give another example of strategic optimization: Several large traditional financial technology companies have cooperated with various crypto exchanges to provide users with an entrance to invest in the category of encrypted assets. This is called ” crypto -as-a- service ” (Crypto-as-a- Service). PayPal and Revolut have such cooperation with Paxos. Just think about it, and you can discover the meaning of this new product and related transactions: PayPal and Revolut can help existing fixed customer groups efficiently enter a new market, while Paxos can get an order flow. These transactions are good examples of value proposition refinement and complementary participation within and across industries.
More importantly, these transactions have greatly expanded the crypto community and exposed millions of people to crypto concepts for the first time. We will definitely see more similar cases in the future. But in the medium term, this partnership also raises some key issues for the encryption business. For example, what are the advantages of Paxos compared to Citadel? Is Paxos the best solution to meet PayPal’s needs or is it the only solution currently available? What is a super competitive advantage: to be the best liquidity provider or to have the most knowledge of encryption? We will explore these issues further in the section “Future Issues” below.
Survival of the fittest
It is foreseeable that this strategic optimization theme has and will move towards mergers and acquisitions . We are currently at the beginning of the process of mergers and acquisitions and elimination. In each encryption sub-category, there will eventually be only two to three high-quality survivors left.
The most capable exchanges have used their economic advantages to expand their organizations into more mature areas. Strong cash flow enables the transaction to have the ability to (i) attract capable and expensive employees; (ii) comply with expensive regulatory requirements; (iii) explore and enter new markets; (iv) become a major strategic acquisition in the industry By.
Number of M&A transactions in the digital asset industry, source: Mapping out M&A acquisitions within the digital asset industry
The survival of the fittest in the industry brought about by mergers and acquisitions has just begun. As a “top predator”, many practitioners in the crypto industry will need to refine and strengthen their business models to form a symbiotic relationship with exchanges, or at least consider this point, otherwise they will face the fate of being eliminated.
Source: Coin Metrics Market Data Feed
As baseball star Yogi Berra said, predictions are difficult, especially regarding the future. The madness of the encryption industry has not made this easy. But crypto exchanges have matured and evolved to a point: there are certain known unknowns.
For example: Does a retail crypto exchange want to be a brokerage or an exchange? Maybe more like a bank? For example, will ErisX become the “Nasdaq in the encryption field”, or will ErisX only become the encryption branch of Nasdaq?
If retail customers want to buy Bitcoin and Tesla stock at the same time (which they really do), what strategy should Gemini adopt to obtain the appropriate license?
Similarly, if various macro hedge funds want to trade Bitcoin and other asset classes, does it make sense to have an institutional broker that is limited to cryptocurrency business?
As the PayPal-Paxos transaction mentioned above shows: Is the exchange an add-on product to existing financial technology companies, or does it have an independent value proposition?
These questions are textbook examples of Thucydides’ traps, and this is not the first time that emerging commercial forces have contended with existing ones. Just as various cryptocurrency businesses must be developed around exchanges, when traditional currency banks and technology giants fully enter the industry, cryptocurrency exchanges themselves may need to make similar adjustments. How cryptocurrency exchanges survive this almost inevitable Thucydides trap may become a decisive trend in the industry.
to sum up
Cryptocurrencies are an initial attempt to reimagine the basic concept of “currency”. They are decentralized, have no single point of control, and protocol changes are designed to be slow and incremental.
Nevertheless, in less than ten years, the problems faced by the cryptocurrency industry, especially exchanges, have changed from the viability of basic products to “Compared with Google, JPMorgan Chase and even the Federal Reserve, the entire industry has What kind of competitive advantage”.
The real, unresolved issues and major challenges are still ahead, but so far, the development of the industry can be called extraordinary from any angle.
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