The History of Exchange Token and Its Significance
Block Crafters Research Division
- Heetae Yoon
- Michael Park
Introduction
2018 has been a rough year so far for the crypto-industry. Most coins and tokens are showing trough of sorrow, value dropping and transaction traffic hitting rock bottom. Despite all the drama and elongating bear market, new exchanges were able to grab traders’ interest and expand its market presence through issuance of exchange tokens. Exchange tokens are very significant in the fact that compared to most blockchains thus far, exchange tokens were developed with a clear purpose of use and has exhibited high public usage. However, it also showed signs of weakness in sustainability in contrast to its merits. Understanding the history of exchanges tokens and its significance will help the crypto community to grow the blockchain industry towards the right direction. In this session, we will discuss the definition and history of exchange tokens along with their main purpose and limitations in detail.
Definition of exchange tokens
“Exchange tokens” are referred to tokens issued by the exchange for the benefit of the exchange itself. The exchange tokens have a strong ICO like nature and their main purpose is to provide various benefits to the exchange users and to secure funds for the exchange. Customers who hold more than a certain amount of exchange tokens can receive benefits such as commission discounts, voting rights, and dividend payments from the exchange. The latest type of exchange tokens currently trending are “mining tokens,” which is a combination of commission reimbursement and dividend payment. Up to now, more than 60% of the exchange tokens that are issued are used for exchange users’ benefit and less than 40% have are for funding exchanges.
Background of exchange tokens
The main issue that led to the debut of exchange token is red-oceanization of blockchain exchanges. As the price of Bitcoin and the majority of alternative coins skyrocket in 2017, the number of blockchain exchanges has also increased rapidly. As a result, the survival struggle between the old and the new exchanges became fierce to the point people calling it “The War of Exchanges,”, dramatically changing the exchange market.
From 2016 to early 2017, the Poloniex exchange dominated the crypto-exchange market with strict altcoin management and margin trading. After a major server breakdown in May 2017, Poloniex was pushed to second place behind Bittrex exchange. Since then, various new China based exchanges with more than hundred listed altcoins appeared. However, due to the low reliability of the exchange itself, the wave of new exchanges could not build a sustainable user base and was unable to become a top influential exchange.
Then, the exchange tokens were introduced to overcome these limitations. On July 25th, 2017 the first exchange token BNB (Binance Coin), which provided customer benefits through commission discounts was introduced by Binance. BNB received massive responses from the crypto community, resolving user complaints regarding “high commission fee.” By issuing BNB, Binance was not only able to acquire new users, but was able to use the fund to upgrade the UI/UX and stability of the exchange, raising the overall reliability of the exchange. As a result, various exchanges followed Binance’s footsteps and issued exchange tokens. These exchanges are now recognized as global top tier exchange, making issue of exchange tokens a prerequisite for the new exchanges that are entering the market.
Types of exchange tokens
The exchange tokens can be categorized into four generations, depending the issued date and purpose of use. (Figure 1)
A. 0-Generation Exchange Token
Although BNB is known as the “first” exchange token, by definition, ‘Tether’ coin issue by Tether Limited can be considered as the “real first” exchange token. The Tether (USDT) is a coin issued to minimize the legal and economic constraints imposed by the use of fiat currencies on the blockchain exchange and to allow users to trade crypto currencies smoothly. The value of 1 USDT is equal to 1 USD. Tether Limited maintains the value of the Tether coin by claiming that it has the same amount of dollars as the amount of issued Tether coin, which is actually quite controversial and raises suspicion due to the fact that billions of USDT was issued in a very short period of time with uncertain source of USD.
Tether may be debatable as to whether it can be categorized as an ‘exchange token’ given that it was not issued directly by an exchange. However, it is a well-known fact that the owner of Tether Limited and Bitfinex Exchange is the same person, and because Tether was made for the benefit of Bitfinex Exchange, it can be classified as an ‘exchange token’ by definition.
B. 1st Generation Exchange Token
The first-generation exchange tokens are the early exchange tokens that were officially issued by the exchanges. The first-generation exchange tokens can be used to receive commission discounts by using the corresponding coins. The right to vote on decisions is also given to the token holders. The first-generation exchange tokens were significant in terms of increasing the number of exchange users and securing funds for the development and operation of the exchange.
C. 2nd Generation Exchange Tokens
The second-generation exchange tokens focused on attracting users with unique features; dividend and recommendation. With the dividend system, users holding second-generation tokens receive a portion of the exchange’s profit daily in proportion to their holdings. In other words, the exchange provides greater profits to the users through increment of number of tokens in exchanges, profit of the exchange itself, or the volume of transactions within the exchange. The dividend system alone can increase the number of exchange token holders, but it cannot lead to a significant increase in overall transaction volume of the exchange. These limitations were resolved by increasing the number of exchange users through a recommendation system. Each user is given a unique recommendation code from the exchange. If a new user enters a recommendation code of an existing user when joining the exchange, both new user and the recommended user receive a recommendation fee from the exchange. Also, a new user joining with a recommendation code has a higher dividend rate than a new user without a recommendation code. Therefore as the number of referrals increases, the recommendation commission also increases, naturally encourages every existing user to recruit new users for their maximum profit.
D. 3rd Generation Exchange Tokens
Third-generation exchange tokens are collectively referred to as ‘Transaction-fee mining tokens.’ ‘Transaction-fee mining’ is a combination of commission refund and dividend payment. Specifically, the user receives certain amount of exchange token from every transaction made on the exchange that is equivalent to the transaction-fee of each transaction. (The exchanges describe the tokens as being ‘mined’ through the transaction, but in fact these tokens are evaluated to be the same as an ICO because the user is ‘buying’ the token as a commission.) In addition, the exchange will distribute a portion of the exchange revenues to the holders of the mining token in proportion to their holdings. In other words, the users of the exchange profit only by doing the transaction and larger transaction volume yielding in greater profit generated. When 3rd generation exchange tokens were introduced, the reaction from the market was explosive. The new exchanges that adopted mining tokens such as FCoin, Bit-Z and CoinBene sprang up at the top of the trading volume ranking in an extremally shortest period.
The evolution of the exchange tokens will continue
It is obvious that the success of exchange business depends on how to expand the user base and maintain liquidity. As competition becomes fiercer, exchanges will try to attract users by providing differentiated benefits.
Even before the exchange tokens appeared, exchanges offered commission discounts to users as a marketing tool. Bithumb based in South Korea sold discount coupons that allowed users to get a discount on transaction fees for a limited period. The first-generation exchange like Binance generated the utility token for discounting transaction fee. They attracted users with the expectation of increasing token price in the future.
The second-generation exchange like Kucoin attracted users with its unique referral and dividend system. Despite succeeding to increase the users base, the dividend system itself was not enough to convince new users to initiate their trades.
The transaction-fee mining model stepped into the market by resolving the activation problem faced by the 2nd generation exchange tokens. The 3rd generation exchange tokens succeeded to increase the user base and maintain its liquidity for a short period. However, as the early investors started to liquidate their profit, it failed to maintain transaction volume for liquidity.
What would the next generation exchange look like? The attraction model of exchanges has been evolving from the discount coupon model to the transaction mining model. Currently, variations of the transaction-fee mining model are the mainstream. However, it is clear that the exchange resolving the liquidity problem of the current generation would be the winner of the next generation.
Conclusion
Exchange tokens are significant in that they can receive ‘intuitive’ and ‘substantial’ benefits ‘immediately’ and ‘continuously’. Considering that the actual use cases of the currently developed blockchains are very rare, the exchange tokens are evaluated as the most practical blockchain since they have a clear use case. In other words, if most existing blockchains are an investment for the ‘future,’ the exchange tokens are an investment for the ‘present.’ The track record of exchange tokens from the very beginning reflects this anticipation of the crypto community. Immediately after issuance, the BNB exchange token not only replaced the world top exchange to Binance, but also brought various new exchanges such as FCoin, Bit-Z and Coinbene to the top of the ranking within a week. Exchange token is now recognized as an ‘opportunity for asset growth’ beyond the strategy of securing the competitiveness of the exchanges, and expectations for the emergence of more innovative exchange tokens among investors are steadily rising.
However, excessive trust and investment in exchange tokens does possess potential risk as well. The biggest downside of exchange token is regulatory news around the world. Governments around the world, including United States, South Korea, and Japan, are committed to eradicating tax evasion using blockchain and taxing blockchain transactions. In particular, the ICO regulations have been intensified to the extent that they are illegal in many countries. In recent years, it seems that issuance of exchange tokens is also being regulated since they are virtually the same as ICOs. It could be impatient to proceed in a negative direction in the absence of specific regulatory measures, but none the less investors should be cautious and be aware of the risks as well as the potential opportunities.
Reference
- Tether whithpaper : https://tether.to/wp-content/uploads/2016/06/TetherWhitePaper.pdf
- Binance whitepaper : https://www.binance.com/resources/ico/Binance_WhitePaper_en.pdf
- https://www.huobi.com/ko-kr/ht/
- Bibox whitepaper : https://www.bibox365.com/static/pdf/Bibox_Whitepaper_en.pdf
- KuCoin whitepaper : https://assets.kucoin.com/kucoin_whitepaper_en.pdf
- Fcoin whitepaper : https://www.fcoin.com/static/ft-en.pdf
- https://www.coinex.com/token
- https://big.one/one
- https://www.coinbene.com/#/coni
- https://www.bit-z.com/
