The $72 Billion That Never Existed
Amidst Fraudsters, Can Legitimate Crypto Exchanges Survive?
Lack of regulation, money laundering, listings of questionable cryptocurrencies — with this laundry list of problems, the crypto exchange business is not for the fainthearted, and neither is trading on it.
Exchanges are at the heart of the cryptocurrency market and the focus of much negative press on the industry. With 2019 not even halfway over, trading platforms have seen no less than $365 million lost to hackers.
Meanwhile, inside threats pose a problem of their own. Canadian exchange QuadrigaCX customers, in a highly publicized scandal, lost a total of $190 million to mismanagement and fraud at the close of 2018. And bitcoin exchanges more generally have earned themselves a reputation for faking trading volumes, which could account for up to 90% of reported market turnaround, by some accounts.
But for all the horror stories, both established platforms and upstarts are making significant profits. Last year, top exchanges took in hundreds of millions in profits, with Coinbase earning an astounding $1 billion. With the chance to gain these kinds of profits, entrepreneurs and established companies alike have an eye on the business.
Yahoo’s Crypto Aspirations
Starbucks, Samsung, and JP Banks made headlines this spring by announcing the launch of crypto projects ranging from blockchain tracking systems to developing branded cryptocurrencies. Now Yahoo is joining the party, too, launching its own trading platform in Japan, Taotao.
Taotao is jointly owned by Yahoo, which holds 40% of shares, and CMD Lab, with the rest. Licensed by the Japanese Financial Services Industry, Taotao is a bitcoin exchange offering bitcoin, ethereum, ripple, litecoin, and bitcoin cash. While these options may be limited in comparison to other platforms, professional traders can take advantage of margin trading in the same currencies. Taotao says they have plans to add additional currencies to their offerings in the future.
In Taotao, the crypto industry has an example of how the market is open even to new players from the traditional sphere. And while Taotao may have a leg up on the competition, as a subsidiary of two multi-billion dollar companies, the vast majority of crypto businesses are much smaller. Given the profitability of crypto and the relative openness of the sphere, it is likely that this trend will continue.
Enormous Earning Potential
Because cryptocurrency exchanges are not required to publish their financial records, tracking their real income and expenditures is difficult. Looking at the self-reported income of industry leaders, however, gives us a rough idea of the upper earning potential of crypto exchanges.
Coinbase, one of the first trading services, set the bar high in 2017 with reported earnings of $1 billion. By January 2018, the global reported trading volume was up to $68 billion. Most of this volume was distributed over many smaller exchanges, with industry giant Binance accounting for just $446 million, according to the Block.
While that is good news for startups, there is bad news, as well. Trading volumes and profits in 2019 so far have fallen vastly short of expectations. Last year’s $68 billion markets had decreased by 17.6% to $12 billion by the beginning of 2019.
This decrease in trading volume led, in turn, to decreased profits for exchanges, which earn the majority of their money from commission on trades. Reuters reports that Coinbase, which had in 2017 projected profits of $1.3 for 2018, in fact, earned just $520 million.
Investors and crypto entrepreneurs who may be scared off by this would do well to remember that that BTC crashed in 2018. After peaking at nearly $18,000 a coin in 2018, the coin was down to just $3,700 by January 2019, a dramatic 79% decrease. Other coins dipped by as much as 99% of their previous value.
Nonetheless, after a weak start to 2019, crypto appears to be back on the rise. Binance has already earned 66% more this quarter than in the previous, promising to outstrip its 2018 earnings significantly. Meanwhile, the most popular coins have been at the least holding steady since the crash, with several increasing.
Fraudsters, Scammers, And Fake Coins
The high earnings of top exchanges cover up another story of the crypto business: the prevalence of hackers and scammers. In an industry in which regulation is only beginning to develop, the soil is fertile for black business to proliferate.
In May, the crypto community woke up to headlines that Binance had been hacked. The platform, which has daily trading volumes of over $1 billion, lost $40 million to hackers overnight. The company was quick to patch the breach and get back up and running, but the hackers are still at large.
Other times, it is the exchanges themselves that are the villains. Canadian cryptocurrency exchange QuadrigaCX is one of the most recent examples of this. After the unexpected death of CEO Gerald Cotten in December 2018, the exchange claimed that only he had access to the company’s cold wallets. Without having his credentials, said leadership, all investor funds (which amounted to $190 million) were irrecoverable.
An independent investigation by Ernst & Young, however, revealed a more sinister story. Quadriga’s wallets had been emptied before Cotton’s death, and the funds that were in them vanished, seemingly, without a trace. Investors are unlikely to see their money again.
Fraud, however, is more likely to occur on a smaller scale than those that appear from time to time in the headlines. Because exchanges charge listing fees from crypto projects, cash-strapped startups are often willing to turn a blind eye to possible scam coins, as long as the project touting it pays the fees. One advantage of trading on a large, established platform is that these exchanges generally exercise more oversight over the coins they are willing to list.
Fake Trading Volumes
At the same time, fake trading volumes are another issue that plagues the industry. It is not uncommon for small exchanges to fake their numbers in order to draw in new traders, building the image of being a high-traffic platform without the customers.
Bitwise published in March a report claiming that up to 95% of all reported BTC trading volumes are fake. At the time of the report, the daily trading volume of BTC was reported at $6 billion, according to Coinbase. Bitwise findings put the actual number at just $273 million, a fraction of what exchanges claimed.
Even more surprising is that of that $273, the vast majority came from just 10 exchanges — Coinbase, Bitfinex, Gemini, and Binance.
While one report could be discounted, the findings of three investigations are less easily thrown aside. That is exactly the case we have here: The Tie and Crypto Integrity both reported similar findings, claiming, respectively, that fake trading volumes account for 87% and 88% of the market total. Even according to the lowest of these three estimates, $70.4 billion of the reported $81 billion trading volume supposedly does not exist.
Exchanges are not responding to these allegations, but popular market tracker Coinmarketcap is promising to improve its current methodology for assessing trading volumes in order to give more accurate estimates.
Top 10 Exchanges For Daily Trading Volume In 2019
At the beginning of June 2019, the combined daily trading volume of the top ten exchanges (making up the bulk of genuine trading volumes) was over $17 billion — 20% of the global industry turnover.
Cryptocurrency exchange OKEx brings in the highest daily trading volumes, with $2.4 billion. Binance comes in second.
It is worth mentioning that this list looked quite different a year earlier, in June 2018. Only four exchanges from the current list were included on that one: Binance, OKEx, Huobi, and Bit-z. The combined daily trading volume of all four was just $6.2 billion, nearly three times less than in 2019.
Market Reality
The cryptocurrency exchange market may be open for all, but that does not mean that all can make it. Achieving success is possible — just look at Binance, which went from fledgling exchange to industry giant in just two years.
Even so, the Binance of the world is far fewer than the pop-up exchanges fueling industry problems like false reporting, fake currencies, and scams. The industry potential is there. What is still needed is the integrity to be open about the problems in order to address them. Only then will the crypto market truly thrive.
