A cryptocurrency exchange is a service that allows you to exchange one type of cryptocurrency for another (for example, ETH for XRP) or for fiat money (for example, ETH for USD, or vice versa).
Most trading operations with Bitcoin, Ethereum, and other altcoins are conducted on cryptocurrency exchanges. The daily trading volume of Poloniex, Kraken, Bitfinex, and other top sites amounts to hundreds of millions of dollars. At the same time, there are more and more crypto exchanges — which, according to advertising, allow you to buy and sell cryptocurrency faster, more easily, and more conveniently. But how do they make money? Why are they so popular among investors?
Ihor Bauman, the business analyst at Applicature, answers these and other interesting questions regarding crypto exchanges.
How big is the cryptocurrency market trading volume right now? Is it going to grow further?
According to the latest research, the current market trading volume is at a high level and demonstrates permanent growth. Crypto trading volume is set to overtake U.S. corporate debt trading volume this year and is on track to equal approximately 10% of U.S. equity trading volume. This growth is estimated at $8 CAGR by 2028. Furthermore, we see that trading volume could easily grow by at least 40% by the end of 2019.
How do crypto exchanges make money?
This is a very sensitive question because it refers to something we all love – money! Exchanges make money in a variety of ways. The first and the most efficient way is the spread created between buy orders and sell orders. This is where exchanges take and actively utilize user deposits stored in cold wallets. This is also one of the reasons decentralized exchanges (DEXs) are not so popular: they have no access to user funds, as they are stored in private wallets. On centralized exchanges, users store their funds in wallets created by the exchange itself. This is one of the ways in which an exchange can supply liquidity. The higher the liquidity, the bigger the cash flow and the higher the profit.
Other common ways to make money include commissions for transactions, entrance/withdrawal fees, and deposits. In addition, some exchanges make big money via OTC deals, crypto listings, and broker listings/support. The trade market is like a deep ocean that contains numerous possibilities for becoming rich, and even more ways to lose everything. It’s a big game for the best players!
What makes the crypto trading market one of the most attractive areas for investment?
I think that the answer is simple: flexibility! It allows you to have one of the highest ROI (return on investment) levels in the financial industry. You may be able to get back all you’ve invested in an exchange in three to five months. In the worst case, the reimbursement period may take a year or more. Also, flexibility means you are welcome to concentrate your business model on classical trading or OTC, or just create an additional operational layer and use the exchange as an instrument by providing some unique possibilities to your users.
What is the biggest threat to crypto exchanges?
As I have already mentioned, if you are looking for big money, please be ready to face big risks. Let’s mention the case of Mt.Gox, a crypto training newcomer established in 2013. It was the world’s largest Bitcoin intermediary, handling 70% of the world’s Bitcoin exchanges. There are many reasons why it was hacked, such as a lack of VCS (version control software), lack of a testing policy, lack of proper management, etc. Mt.Gox suffered a loss of $473 million in user funds. The biggest robber, unfortunately, was the government. This market is full of money, and the government is always interested in new ways to get a sweet piece of cake, if not the whole cake. Regulation, taxes, limitations, mandatory KYC/AML procedures — all of these are real challenges. Only a well-prepared and experienced team can deal with them.
What do you think are the unique exchange features that make Binance different from others?
A platform called Binance, which targets the Chinese crypto community, raised $15 million during their ICO in 2016. Despite difficulties with the ban on ICOs in China and strong competition on the crypto exchange market, Binance has managed to become a leader.
This not only about technology. This crypto exchange has the ability to handle 1.4 million orders per second, combined with its ability to host 20 million users with multilingual support. In addition, it has huge operational capacity when it comes to handling more users without slowing down or reloading the system. Another great feature is that Binance has one of the lowest transaction fees. If you are not using BNB (Binance Coin) to pay your trading fees, each trade will carry a standard fee of 0.1%.
The BNB transaction fee applies a discount to your trading fee. If you hold BNB in your wallet, your trading fees will automatically be subtracted from your BNB balance. As you can see, Binance could also provide a great lesson to numerous ICOs that use utility tokens. The Binance token economics strategy is one of the reasons for the almost constant growth of the BNB coin’s price.
Nowadays, Binance actively works in cooperation with its home jurisdiction, Malta, creating regulations for the right to list security tokens. From a technical point of view, this will also affect utility-token regulation. However, security tokens could represent common shares with equity as a backup. So it’s a totally different ball game, in which Binance wants to take a leading role.
Is the future of crypto exchanges decentralized or centralized?
This is a challenging question! Blockchain is about decentralization and distributed technologies. Providing full transparency to the order execution process by making it publicly auditable is for sure a great idea. Currently, the number of decentralized exchanges is constantly growing. There is the BitShares DEX, established by Dan Larimer (also known as the co-founder of EOS), Idex, WavesDex, and many others. The thing is, some modules, such as KYC/AML modules (databases), just can’t work in a decentralized manner.
Liquidity is an additional issue. Yes, you can provide it by sharing a standard API and creating a network effect around liquidity that compounds as more relayers are online. But this is just an effect, and as I mentioned above, it doesn’t provide real access to wallets. You can’t utilize user funds for creating additional cash flow on spreads. I think we will be seeing more cases similar to EOSFINEX and ETHFINEX. Bitfinex itself is one of the leading centralized crypto exchanges. Its goal is to effectuate a smooth transition by combining the benefits of centralized and decentralized environments. Let’s see how they will survive!
What is the main drawback of modern crypto exchanges?
For now, there are more than 500 crypto exchanges on the market. The thing is, only 30 of them (that’s 6%!) can provide enough liquidity for day-to-day operations, and this is a really sad story. Another issue is security. For the last four years, almost $2 billion have been stolen from various crypto exchanges by hackers.
There are a lot of reputable opinions with regard to security. Nowadays, third-party auditors are providing penetration tests (e.g., Netwrix), which have become more and more popular. It’s better to spend money today than lose business tomorrow with a long list of penalties.
This is another indicator that this market is becoming more regulated. Regulation is a great idea, but the government should work together with business, not separately. Only then will it be possible to gain a positive outcome.
The future should be secure and transparent, as cryptocurrency was developed for these very reasons.