Comment: The exchange is open finance

Foreword: In the current encryption world, exchanges are the biggest catchers of value. Because of the user's demand for liquidity, the exchange has a certain degree of network effect, so it is an aggregator of capital. Based on the aggregated users and capital, it can connect with open financial protocols, provide greater liquidity, and provide more financial services to stick to users. As the centralized exchange will face supervision, when it grows to a certain extent, it will face upward pressure. The only way to resolve it is to develop in a DAO way, realizing open finance through the model of token-based and decentralized exchanges. Today's exchange is far from open finance, but if the future is due to the situation, in order to survive or to achieve greater development, the transformation of the exchange into open finance may be the only way out.

The biggest profit center in the encryption world is the exchange. On the strategic side, they often lack sufficient analysis, especially considering their systemic importance to the entire encryption field. In addition, it is also considered that the public can invest in the success of the exchange through the different tokens of each exchange.

Commentators in the field of encryption like to discuss what will lead to the fall of encrypted exchanges. But few people will ask the following questions: In order to consolidate and even gain more power, the market can reasonably expect what the exchange will do in the next few years? If the exchange has not yet reached the peak, but just just at the beginning of the rise?

Note: In the rest of this article, the term “exchange” refers to non-US exchanges, of which Binance, Bitfinex, BitMEX, CoinFLEX, Deribit, FTX, Kucoin, Huobi, and OKEx are all examples of priority. Given the US regulatory regime, it is difficult to see that US-based exchanges can implement the vision outlined below.

When capital is gathered


Exchanges are naturally affected by network effects because traders want to trade in the most liquid areas. Since the arbitrageur can set up a liquidity pool, there is a limit to the network effect of this liquidity. However, the network effect is real. That's why so many new exchanges are not attractive.

Capital is concentrated on the exchange due to the liquidity network effect. According to estimates, the top seven exchanges hold 4.73% of BTC and 8.66% of ETH.

Encrypted exchanges have been steadily expanding their reach. Most of them started from spot asset trading. Then, they gradually add more advanced trading features, such as loans, margin trading, futures, and more.

Although most of these products are in the traditional exchange business, the crypto exchange has also launched a new line of business that goes beyond the traditional exchange's business. Some examples of this:

  • Bitfinex acquired Tether in 2014 and has become an important part of the global crypto capital flow. Today, Tether is the leading stable currency in almost every respect: market capitalization, liquidity, daily trading volume and currency holding address.
  • After the supervision on September 4, 2017, the fire coin and OKEx were not closed. Although they did stop direct currency and cryptocurrency transactions, Firecoin launched an OTC trading app, similar to LocalBitcoin. The apo allows Chinese consumers to buy and sell cryptocurrencies in a truly peer-to-peer manner. They can even use WeChat Pay and Alipay to settle. Recently, the company has launched direct competition products. These OTC transactions are large and are usually not reported in any official trading statistics.
  • Last year, the company launched Binance Labs, which also acts as a venture fund and accelerator. Just as Y Combinator started with the early accelerator program and has now moved to the downstream of larger venture capital, Binance Labs has also expanded downstream, launching the IEO platform Launchpad. By underwriting the IEO, the currency security began to compete as an investment bank. In the following six months, most exchanges followed the Ian products led and launched by the currency.

Recently, we began to see the encryption of native financial services provided by the exchange:

  • Some exchanges have launched or acquired some decentralized exchanges: Coinbase acquired Paradex and Bitfinex built Ethfinex internally. A few months ago, coin security released DEX on its chain. Firecoin and OKex announced that they would launch their own chain, but have not yet released it.
  • Unmanaged wallet. Coinbase developed the Coinbase wallet, an unmanaged encryption wallet. The fire coin did the same thing and launched the fire coin wallet. Coin Security acquired Trust Wallet.
  • Earn the proceeds of cryptocurrency pricing. Poloniex began offering ATOM equity pledges approximately six months ago. Coin also launched the Earn tab, which includes staking XLM, NEO, TRX, STRAT, ONT, VET, KMD, ERD, FET, ONE and ALGO. The Earn tab of the coin also includes borrowing.

Through this positioning, it is clear that Chanan tries to help its customers use cryptocurrency as a way to earn income. Please note that this is basically the positioning that almost all unmanaged wallet aggregators (such as, Instadapp, Nuo, Argent, etc.) are adopting.

The trend is clear: cryptocurrency exchanges are building or refactoring almost every major financial service, from centuries-old lending services to encrypting native services like staking. Also, the pace at which the exchange launches new services is accelerating.

Given their position as capital aggregators and their ability to build both traditional and encrypted native financial services, the exchange is well positioned to promote the adoption of open finance.

Promote the adoption of open finance


Some of the measures highlighted below have been announced, others are speculation. Although I am not sure what each exchange will do, given the trends mentioned above, the outstanding question is: Why does the exchange not continue to expand its financial services products? The question then is not whether the exchange will support these services, but rather the relative order of operation of each exchange. (Blue Fox notes: The meaning in the text is that the exchange will obviously support these services, but the order of implementation of different exchanges is different)

  • In LEO's white paper, Bitfinex announced some future products, including regulated stock exchanges and forecasting market platform Betfinex (which may compete directly with Augur).
  • The main crypto exchanges host billions of dollars worth of assets. Some people create a payment network that connects debit cards to the assets that users store on the exchange, including USDT, USDC, BUSD, and DAI (the has already provided debit cards for these managed assets). . This is strategic for the exchange as it creates more liquidity for their stable/funded trading pairs. Further, it is conceivable that in order to promote adoption, Coin may offer discounts to customers who use BUSD to pay merchants.
  • There are billions of dollars in assets on the exchange, and it is natural for the exchange to provide interest-bearing accounts. Trading all the many ways to implement it. They can take on the assets of the user (if it is feasible, some have already started), run the internal money market, or take advantage of the open financial money market agreement.
  • Together with the lending market, it automatically accumulates interest on the customer's currency security account. For many people, the currency will feel like a checking account (especially outside the developed countries, where insurance penetration rates such as FDIC) To be much lower). In addition, with the P2P channel of legal currency and cryptocurrency, the cryptocurrency exchange provides customers with a clear path to retreat from the currency system (including technical infrastructure and monetary policy), and can choose to have unlicensed and anti-examination payments. Encrypted financial systems, as well as transparent and auditable monetary policies.

If we think about the future, once the exchange offers interest-bearing accounts, they will start to see themselves as banks. Moreover, if they see themselves as banks, they will begin to provide credit. Although there are many forms of credit, they are likely to start with microfinance and take the form of a secured credit card, which will eventually evolve into unsecured credit and large credit.

I can continue, but I think the point is clear: the exchanges have gathered capital, and they can strongly influence the flow of capital. In addition, since most exchanges have native tokens to motivate users to stay in their respective ecosystems, exchanges and users have incentives to build and stay in their respective ecosystems.

Let us now revisit the money market and consider the forks in the open system.

Fork or not fork


Instead of running a money market internally, it is better to use an open financial agreement, which is more in the best interest of the exchange because they can gather external liquidity to provide better interest rates for their customers.

However, it is unclear whether the exchange will provide liquidity for existing agreements such as Compound, or whether they will fork Compound themselves and use their own liquidity pool to lead a competitive network.

Considering that exchanges are much larger than separate liquidity pools (such as Compound), I suspect that exchanges will fork Compound and create their own pools so they can achieve more control and also for their respective Token holders create more value (for example, to capture profits from the money market for the exchange's respective token holders, rather than to provide profits to third parties such as Compound holders)

To make this clearer, let's assume that the currency has been released, and it has released the core of its open financial strategy: the currency chain. Above the base chain, you can see the focus of the rest of the strategy: Coin Security will use Trust Wallet as the preferred (though not the only) way to interact with the currency chain. They may want to implement seamless key management with a key management system like Torus.

They will either fork Compound and Maker, or motivate others to do so through Binance X to bring these agreements into the coin-chain ecosystem, thereby capturing the natural profits of these agreements to BNB holders. This in turn motivates more people to hold BNBs and trade on binances, adding liquidity to ecosystem participants and creating more value for BNB holders in a virtuous circle.

Please note: The effective rebuttal to this view is that Ethereum is more trustworthy than Binance Chain. It requires: 1) requiring a trusted gateway to bridge non-native assets, and 2) still having a consensus that requires relative licensing. However, both of these points have a very clear solution, which can take advantage of Cosmos's IBC (Inter-Chain Communication) protocol and the Tendermint consensus without a license.

Expect other exchanges not to launch their own ecosystem chains to fork agreements like Compound, but to fork at Ethereum, retaining the same trust minimization feature while leveraging their existing liquidity Lead the network effect.

Many aspects described above sound less feasible. How can a single company provide all of these services? In the traditional financial system, each of these markets contains dozens of different companies.

Broadly speaking, there are two reasons why the encryption world is different.

First of all, it is the field of encryption. When all forms of value transfer (currency, commodities, bonds, stocks, etc.) are supported by APIs that do not require licensing and anti-censorship (these APIs are on open ledgers with generic, reusable, combinable smart contracts) It is at least ten times easier to build financial services than before. This is the main reason why coin security is faster than traditional financial services companies.

Second, a company is unlikely to build all of these services. The exchange will push development to the community and encourage developers to build in their respective ecosystems and be supported by their own ecosystem tokens (as mentioned above, this can be a separate chain or a neutral chain). on). In addition, since the network effects of all of these systems are capital, not code, they aggressively fork other people's open source code (such as Compound and Maker).

This will happen faster than people expected: now Coin Security provides grants for developers to port open financial agreements to the currency chain. This happens everywhere in the world of encryption: Open Libra forks Libra, Solana implements Libra's Move VM, Tezos implements Cosmos's Tendermint consensus, Tezos implements Zcash's SNARK circuits, Solana uses Filecoin's PoReps… and many more. The main beneficiaries of this heavy component fork will be entities and ecosystems with existing network effects.

From company to DAO


For believers in open finance, everything described above seems to be the opposite of open finance. Indeed, the first time I reasoned about all of these situations, I felt a similar discomfort: if the centralized exchange gathered all of this capital and did not decentralize it? (Blue Fox Note: Go back to the title of this article and say that the exchange is open finance. From the current point of view, it is definitely far-fetched, but it refers to the future evolution direction, due to the financial attributes of the exchange, the ability of the capital aggregator, There are objective reasons for supervision, and it is likely to gradually evolve toward open finance through integration with open finance.

However, due to regulatory restrictions, it is increasingly found that centralized exchanges are unlikely to aggregate all capital and financial services within an economy. As exchanges become more powerful, they will increasingly be subject to a series of conflicting regulations. Politicians will tear them apart. Look at Libra and you will know.

In the long run, the best way out for an exchange is to decentralize itself. Tokens are the only way to de-center the architecture and governance needed to achieve maximum toughness. Tokens can achieve this by unifying the parties that distrust each other with shared economic consistency.

Today, the exchange is a centralized company. But they are gradually developing to DAO. (Blue Fox notes: DAO refers to decentralized autonomous organizations)

Decentralization is not one or the other, it has a scope. Therefore, decentralization does not happen at some point in the future, but is a process. Today, exchanges have become the best entity to bring billions of users into the world of encryption. Early participants in their ecosystems are likely to be rewarded when they become DAOs.

Author of Kyle Samani

Translation: Blue Fox Notes – SIEN