I own tokens of some of the mentioned exchanges in this post.

Do your own research. This is just a research article to show a potential emerging sector within crypto. It doesn’t mean it’ll be successful or profitable at all. Hodling may subject your portfolio to frostbite, during Altcoinwinter. This is not investment advice.

The Emergence of Exchange based Tokens

In this post it will be explained why tokens belonging to the Exchange sector have the potential to be a solid pick for the foreseeable future. This post is based on Fundamental Analysis of this sector.

What are Exchange Tokens?

They’re tokens that represent some kind of stake in a certain cryptocurrency exchange. They often grant their holders a discount on trading fees, the right to vote and participate in the governance process of the exchange (like picking the coins listed) or a stake in the revenue generated by the exchange (like a percentage of the trading fees).

Why does this Sector have Potential?

Exponential Growth

Exchanges’ revenue comes mostly from trading fees. The bigger the volume traded, the more fees generated, the bigger the profit. We can expect the cryptocurrency ecosystem to continue to grow and attract more people. At the moment, infrastructure in the crypto ecosystem is still being built and although it has grown considerably since its inception, it’s still a long way from reaching the masses of the entire world.

The number of accounts created and volume traded on cryptocurrency exchanges doesn’t stop increasing and hitting new records every day. Just recently some exchanges had to temporarily pause new user registrations because they couldn’t keep up with demand. Binance for example, had 240,000 new registrations in a single hour. Even though there might be periods where volatility is dead, like we’ve seen during the Bitcoin lows after the end of 2013 pump, the overall trend is still up, so far. Given it’s scarcity and young age, it’s relatively safe to assume the Bitcoin price has high chances of increasing in the long term, attracting new people that then consequently discover altcoins and a whole new world. The ecosystem is still growing. New users will keep coming in during each bullish cycle until the cryptocurrency ecosystem reaches a saturation point where things might stagnate comparing to the early days. Fortunately, we’re still early in the game and many years will have to go by before we reach that point.

Exchange trading volume keeps increasing since 2013. btcchina, huobi, mtgox and okcoin excluded because of ‘fake volume’. Data from https://data.bitcoinity.org/

With this said, we’re expecting account registrations numbers and volume traded, on cryptocurrency exchanges to keep increasing during the next years.

With time, some can even be acquired by bigger players (such as Poloniex being acquired by Circle which received funding from Goldman Sachs), new ones will appear and some will eventually cease to operate for a variety of reasons (hacks, failed to keep up with competition, etc). So while this poses an interesting opportunity let’s not forget how the tide can shift very suddenly. Exchanges that were once at the top could also be left with no users because the vast majority migrated to a better one or they can simply get hacked or exit scam at anytime. Even decentralized exchanges have the potential to be hacked, as we’ve seen with EtherDelta.

Passive Income

Similarly to masternodes, just by holding/staking exchange tokens, holders can receive a constant stream of rewards (trading fees). These rewards, compounded over time, along with the growth we’ve been seeing, make tokens of this sector look like they could produce decent returns in the foreseeable future.

This year, interest in masternodes grew a lot because of their ability to provide passive income to their token holders, meaning, demand is there for coins and tokens that can provide their holders with rewards.

Good Risk Reward

The amount of ICOs during the bullrun and previous altseason was significant. After Bitcoin topped, many tokens naturally reached lower prices, with some going below ICO prices and others dumping up to 80%-90% of their value at the top of their pumps. Some of these happened to be coins of this sector. Some are still high, like BNB (Binance Coin) still sitting above $1 billion or KCS (KuCoin Shares) sitting above $250 million. There are others, however, still sitting at around $50-$20 million marketcap range, which still have lots of room to grow, comparing with the previously mentioned rivals in the space. This gives them a decent risk reward compared to other assets in the same sector. Specially if we also take volume in consideration.

Fundamentally, users would prefer a token of the exchange with the most volume. So when researching tokens, we could also take into consideration the ratio between the token market cap and the exchange volume. Ideally one would prefer an exchange with a lower marketcap and more volume as this would give it the best fundamentals and risk reward. On the other hand, an exchange with a high marketcap but barely any volume would present itself with less fundamental value and worst risk reward (keep in mind we’re talking fundamentals in this article and not taking Technical Analysis into consideration here)

For example, at the moment:

  • CriptoBridge has a volume of $1,200,000 and BCO has a marketcap of $46,000,000
  • IDEX has a volume of $7,900,000 and AURA has a marketcap of $18,000,000

Obviously each token has it’s own distribution model and different percentages of available supply and circulating supply but for the sake of the example, if we just take marketcap and exchange volume as metrics, we can see IDEX has a better ratio than CryptoBridge at the moment. Fundamentally, IDEX would have more value because it has more volume and you can get it for cheaper, while CryptoBridge has 1/6 of the volume but it’s 2.5x more expensive.

What features should an Exchange have?

Exchanges should ideally possess certain features to maximize their potential of success and for their tokens to have a higher chance of appreciating in value:

Hybrid Architecture

Initially all exchanges were centralized like most services. This lead to a lot of hacks and people losing funds. With the introduction of smart contracts, decentralized exchanges started to appear. They can’t be shut down, funds can’t be stolen and are fully transparent, however they also had their own issues. Decentralized exchanges traded functionality and performance for security.

Now, it seems we might have found the best of both worlds, hybrid exchanges which combine the best aspects of both centralized and decentralized systems.

Cross-chain Trading

One of the negative aspects of an exchange with decentralization features, built around smart contracts for security and transparency, is that it’s most likely supported in a single chain (at the moment). Developers of the exchange use most frequently smart contracts on the Ethereum or NEO platforms. This causes the exchange to support Ethereum or NEO tokens only. This is why an exchange supporting cross chain transaction is important. Users want to trade in a single place. They don’t want to have 7 different accounts on 7 different exchanges working on 7 different blockchains. It’s bothersome and not practical. For the best experience, everything must be in the same place and practical.

With cross-chain transactions, an hybrid/decentralized exchange has no limits to the tokens and coins supported. Ethereum tokens could be directly exchanged for Bitcoin or other coin that supports cross-chain transactions. It would have a bigger range of products to offer. At the moment we still haven’t seen this even though some projects are working on it. The first one accomplishing this goal will have a nice first mover advantage over the other rivals.

Referral Program

While not the most important thing for the success of an exchange, it certainly helps giving it that initial kick. Users now have one more incentive to get more people on board, which might be crucial during the first initial steps of an exchange where there are not many users and liquidity is not the best.

Governance

Users can help the exchange make decisions which might be important to its success. Users with skin in the game will always go with the options they think are best for the success of the exchange. Everyone has a voice and can vote for what they want, meaning token holders are sure to be heard and their input taken into consideration. A whole community can grow around a project simply because people can participate in the decision making process of the project. This creates solid, dedicated communities that work hard for the success of the project.

Fiat Deposits and Withdrawals

This important feature means users don’t need to hop through other exchanges in order to get their money where they want. Sometimes a single extra click or step is enough to lose a customer.

They can get their money directly, in and out. It’s a great step towards lowering the entry barrier into the exchange. This means it has more chances of capturing more users from other exchanges, as they can do everything they want using a single service.

ICO Support

Many ICOs gather huge amount of money. If an ICO is exclusive to a certain exchange and everyone wants in, they’ll end up opening an account and use it. It’s a great way to bring in more customers and makes it possible for them to do multiple tasks, all in the same place. It’s pretty convenient. Not only that but when this happens, the ICO tokens often start trading on those exchanges first. If somehow an exchange starts hosting multiple ICOs and once they end, users can instantaneously start trading there, it’d have great chances of being the go to place for everyone wanting to participate in and/or flip ICOs. The first exchange reaching this status of “go to place for ICOs” would have an important advantage over others. Given the demand for ICOs, it would likely bring in a decent amount of volume.

Practicality

Like it was mentioned above, exchanges need to be practical and simple to use. Some, however, due to their hybrid or decentralized nature, require users to take a few extra steps before they can start trading. They must install browser extensions or download an app to their computers. This is that one extra necessary step that can turn people off. Users just want to trade, they don’t want to lose time installing stuff so they can start trading. On top of all, every single piece of software installed and running on their machines is one more potential attack vector that can make them lose all their money. A phone app on the other hand might be useful so users can access their account anywhere at anytime. Know plenty of new people that came in 2017 all using Coinbase’s mobile app.

Rewards

The type of rewards offered to token holders can also be an important deciding factor when picking the token/exchange they want to use. Some might only offer discounts on fees while others share profits, making them more attractive and also a source of passive income. Some exchanges might burn their own token using profits, reducing available supply, others pay dividends directly to their token holders’ addresses.

What exchanges follow this token model?

Mothership (MSP)

Mothership is centralized, but allows users to participate in the governance process. Supports ICOs on their Genesis platform and plans on supporting fiat deposits and withdrawals as well as a mobile app. The team is working on getting certified by the EU as a financial institution. Part of the trading fees will be used to burn tokens.

Legolas/LGO (LGO)

Legolas (now rebranded to LGO) is an hybrid-centralized exchange. Allows users to participate in the government process. Will support ICOs as well as fiat deposits and withdrawals. Will allow large fiat transactions and is also aimed at Institutional Investors. It has partnered with global brokerage Makor Capital which will provide their customers with custody of their deposits at major banks, and access to many financial institutions already on boarded. Part of the trading fees will be used to burn tokens.

IDEX (AURA)

IDEX is an hybrid-decentralized exchange planing on going full decentralized. Fees are paid to stakers. It has surpassed 100,000 users. It only supports Ethereum tokens but it’s the most used smart contract on the whole Ethereum network at the moment. It has been in the top most used contracts for a while now. You can check that here: https://ethgasstation.info/gasguzzlers.php

Switcheo (SWH)

Switcheo is a decentralized exchange built on the NEO blockchain. Plans on supporting multiple other blockchain tokens (Ethereum, Qtum) via cross-chain trading initially and then add support to the top 5 traded coins later on. First mover advantage on NEO because it’s the first DEX that immediately allows ICO tokens to be traded as soon as they’re distributed. Tokens are burned when used to pay for fees

Others

There are many other exchanges which follow a token model with advantages to their users. Some of those are: Eidoo, Kucoin, CryptoBridge, Bibox, BigONE, COSS and more.

Conclusion

We can expect more users and more volume traded on cryptocurrency exchanges for a long while as long as the trend continues. This means that until then, current exchanges will keep growing and expanding. This could be the beginning of a new trend in the cryptocurrency ecosystem with a sector that many still haven’t paid much attention to. The opportunity to receive part of the profits from these exchanges — when they’re at their very beginning, their volume and number of new registration keeps increasing every day and many of their tokens still have a low valuation — looks quite interesting at the moment.

Some of these tokens have also a decent risk reward, having a low valuation compared with others in the same sector. The high valuation of those other tokens like BNB shows there’s demand for this type of token.

Basically we have:

  • A sector that has the potential to grow significantly even compared with the whole cryptocurrency ecosystem, since it has shown no signs of slowing down.
  • New exchanges that can perform as good as any other existing and already established centralized exchanges. Only their users can benefit from this token model.
  • Tokens that produce rewards, either by burning supply or paying dividends to token holders.
  • Tokens that have a decent risk reward, compared with other established tokens in the space and in the same sector.
  • Apparent demand for this type of tokens.

Hope this article was useful.

You can follow me on twitter @akadosang