Why Bitcoin Exchanges Are Building Their Own Blockchain
2020.04.29 Academy
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Bitcoin exchanges are building their own blockchain networks to build moat and grow market share. (Photo by Chesnot/Getty Images)GETTY IMAGES
On April 17, cryptocurrency exchange operator Binance released a white paper describing the inner workings of a new smart contract blockchain, a year after the initial launch of its native blockchain Binance Chain (BC). The new blockchain, dubbed the Binance Smart Chain (BSC), will work as a smart contract layer parallel to the existing chain, the company said.
“This innovative solution brings the interoperability and programmability of the Ethereum Virtual Machine (EVM) to Binance Chain. Both Binance Chain and Binance Smart Chain will allow transfers and other communication thanks to the native support of interoperability,” the exchange wrote in a blog post.
Despite the exchange insisting that the BSC isn’t designed to compete with Ethereum, which is presently the largest smart contract platform, Binance’s new smart contract platform should have superior performance to Ethereum in certain areas, including faster and cheaper transactions, the white paper shows.
The latest Binance white paper in the area of blockchain development is only the latest of similar announcements from bitcoin exchanges.
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Since Binance launched its native blockchain in April 2019, at least three other leading centralized digital asset exchanges have announced that they are developing a blockchain network.
In February, OKEx that its own blockchain OKChain was proceeding to test mode. The Malta-based crypto exchange first disclosed that it is developing a blockchain, along with a decentralized exchange (DEX) built on top, in March 2020.
“OKChain is a commercial public chain developed by OKEx independently, and it is already 100% open-source to provide an efficient, free and boundless value-added ecosystem for all of our ecological partners,” said Jay Hao, CEO of OKEx. “The cross-chain and ‘OpenDEX’ technology enable us to push forward our vision of ‘Commercial Chain Alliance’ to facilitate the substantial development of the blockchain industry. “
In March, Huobi also announced that its blockchain was entering test mode, nearly two years since the Singapore-based bitcoin exchange first plans to develop a native blockchain. Bithumb, based in South Korea, is also developing on its own blockchain, according to an announcement in November 2019.
Some crypto industry participants see the emerging trend as a threat to decentralization, which is a linchpin feature of public blockchain networks.
Moving to Build Moat and Market Share
Exchanges are among the biggest winners of the growing popularity of cryptocurrencies. They play an important role as the gateway to the crypto world, and many of them have built multimillion-dollar businesses off it.
United States-based exchange Coinbase had a revenue projection of nearly $1.3 billion in 2018. Elsewhere, crypto news website The Block, that Binance had reached $1 billion in cumulative profit, as of Sept 30, 2019. The news website arrived at that figure based on the company’s token buyback structure.
At its core, the emerging trend of exchange-built blockchain platforms is a move by exchanges to consolidate their positions as industry leaders and, in some way, build a moat around their respective businesses. That’s the consensus view of cryptocurrency and blockchain commentators.
By developing their own blockchain, crypto exchanges will be able to grow their market share and operate more efficiently, according to Ken Misuma, CMO of Quras, a smart contract platform that claims to give consumers and enterprises the freedom to set the privacy level of their transactions.
“Digital asset exchanges try to attract as many traders as they can in order to increase their user base, which is a core driver of their profits,” Misuma said. “Developing a blockchain allows an exchange to have more flexibility from a usability and trading offering perspective without the need of a centralized operator.”
Hugo Renaudin, CEO LGO, an institutional crypto exchange based in Europe touched on how having a blockchain could help exchanges become more efficient.
“Operationally, it's a significant cost-cutter as a lot of operations and fund movements — deposit, withdrawals or settlements — can be automated through smart contracts,” he said. “And because an exchange blockchain lowers the overall listing costs for a cryptocurrency issued the chain, one might argue that it allows exchanges to list more and more assets at a lower cost.”
As the blockchain and cryptocurrency space continues to evolve, an increasing number of digital assets will be issued. The resultant effect of more crypto assets is that the business of running an exchange will enjoy higher demands.
Prior to when exchanges started building their own blockchain, new projects issue digital assets via a public blockchain such as Ethereum. These projects then seek to list their respective digital assets or tokens on different exchanges. Token holders and traders have the flexibility of trading these tokens across different exchanges where they are listed. This flexibility, however, means that the exchanges face a constant risk of losing their user base to competitors, which could lead to dwindling revenues.
In addition to the competition from other centralized exchanges, the emergence decentralized trading is a growing threat.
By developing a native blockchain, to which it invites projects to issue digital assets, an exchange is more likely to retain trading volumes — a critical determinant of their top line.
Still, the principles upon which crypto exchanges are building their exchanges differ and potentially indicate the areas of the industry that each of them wants to be most relevant.
Bitcoin exchanges want to protect their profitable businesses by building native blockchain … [+] 2018 CHESNOT
Binance Chain Is a Bet on the Future of Crypto Exchanges
While the development of a dedicated smart contract blockchain presents an opportunity for it to compete with Ethereum, Binance seems focused on growing its market share of the crypto exchange market.
The BSC whitepaper reiterates that the company’s DEX is the “primary focus” of its native blockchain, an indication that the development of a smart contract platform is rather to augment the DEX than anything else.
“The concentration on providing a convenient digital asset issuing and trading venue also brings limitations. Binance Chain's most requested feature is the programmable extendibility, or simply the smart contract and virtual machine functions. Digital asset issuers and owners struggle to add new decentralized features for their assets or introduce any sort of community governance and activities,” the BSC white paper reads.
Another indication that Binance is betting on the future of exchanges is the February launch of Binance Cloud — an exchange-specific cloud solution. Through it, the company is offering anyone the ability to launch a crypto exchange that leverages the company’s already-established exchange infrastructure. CEO Changpeng Zhao, known in the crypto space as CZ, that the cloud services will become the company’s source of revenue in five years. Liquidity is one of the promises of the cloud solution, a promise possibly insured by the volume-retention benefit of owning a blockchain.
OKChain Is a Bet on Decentralized Finance
Following the footsteps of Binance to move operations to crypto-friendly island Malta, OKEx has seemingly been playing doppelgänger to Binance. However, OKEx insists that its own blockchain endeavors aren’t an imitation.
“OKChain is not replicating Binance,” an OKEx spokesperson said. “Our blockchain has totally different visions and positioning than Binance Chain and we are actually working on different products.”
The vision with OKChain is to drive the growth of decentralized commercial applications, particularly toward financial inclusion.
“We believe decentralized finance is the key to financial inclusion and financial freedom for all. That’s why we have longed for unleashing the power of DeFi.” Hao said in a blog post announcing the testnet launch. “OKChain is a huge milestone for us, meaning that we are now able to provide an open, low-cost, and autonomous ecosystem for everyone to enjoy the benefits blockchain and decentralization brings.”
Just how the exchange plans to use its blockchain network to play in the DeFi space remains unclear.
For now, OKEx continues to take its exchange business seriously, having said a DEX will be the first application to lunch on OKChain. Compared to Binance, which “is building [its own] chain and creating the DEX application, we are building a financial infrastructure and the OKEx DEX is only one of the applications on OKChain,” the OKEx spokesperson added.
OKEx says it will allow users to create and customize their own DEX on OKChain.
In addition, OKChain supports the deployment of smart contracts out of the box, compared to Binance, which has only just announced the development of a separate chain for smart contracts.
Huobi Wants to Capture Traditional Financial Institutions
While other cryptocurrency exchanges were avoiding regulators, Huobi decided to build a relationship with China’s government. Last December, Huobi that it was joining a government-led blockchain alliance. The exchange is looking to deepen its relationships with regulators, and subsequently financial enterprises, by making compliance central to its native blockchain development.
"DeFi has become one of the most promising applications of blockchain technology but its future requires both sides — regulators and enterprises — to work together to establish the standards and guidelines of the new decentralized economy," said Ciara Sun, VP of Global Business at Huobi Group. "With Huobi Chain, we want to provide the decentralized framework that facilitates industry-wide collaboration, which is critical to the widespread adoption of DeFi."
Huobi Chain will allow regulators to take part in the network as validators through a regulatory node feature. This might look familiar to followers of blockchain-related regulatory updates in the U.S. Last year, the Federal Reserve Bank of Boston released a white paper in which it detailed concepts for a “supervisory node” for on-chain regulatory surveillance.
A Common Denominator: Native Token Value
While exchanges blockchains are being set up to address different parts of the blockchain space, they all stand to benefit from a rise in their native token value if their bets pay off.
For one, exchange tokens, which were originally used to pay trading and listing fees, are now transitioning into coins that power an entire blockchain. That widens usability, and potentially, value for these tokens.
In fact, it could give the companies behind each blockchain network a valuation boost, SKALE Labs CEO Jack O’Holleran believes.
“Valuation multiples for exchanges on fees are significantly lower than multipliers on crypto assets, which are non-dilutive compared to equity,” said O’Holleran, whose startup is building a scalability solution for Ethereum. “As a simple example, if an exchange is making $100 million a year in fees, they may get a 5-7x multiplier on their value, meaning they are worth $500-$700 million from an equity perspective.
“If they release a token that is utilized to pay for fees, that token may be worth multiple billions from a fully diluted perspective with the same amount of revenue.”
Decentralization Alarm Bell
It’s unclear how much power exchanges exert over their native blockchain networks and that raises questions about just how decentralized these networks are. “One major disadvantage is that exchange-built blockchains are typically not truly decentralized, and decentralization is one of the most valuable aspects of blockchain technology, said Misuma.