From Mt. Gox to Ungox
This week, former Bitcoin star and founder of the Mt. Gox cryptocurrency exchange Mark Karpelès made an appearance at the Foreign Correspondents’ Club of Japan to talk about his new venture, Ungox, a rating agency for crypto exchanges.
Having been given a suspended sentence in Japan for falsifying information, the path chosen by Karpelès immediately reminded us of Frank Abagnale, enshrined in the 2002 Steven Spielberg movie “Catch me if you can”, depicting his cons worth millions of dollars by posing as a Pan American World Airways pilot, a Georgia doctor, and a Louisiana parish prosecutor. Abagnale later founded a consultancy to advise companies on secure documents, and in 2015, was named the AARP Fraud Watch Ambassador, where he helps “to provide online programs and community forums to educate consumers about ways to protect themselves from identity theft and cybercrime.” So Mr. Karpelès has a role model in his path to atonement.
But we digress. We were delighted by the invitation to comment for articles that appeared in the German business daily Handelsblatt and the Swiss Neue Zürcher Zeitung. Given the brief nature of these comments, we wanted to take the opportunity to provide a more comprehensive argument in this Medium article.
In our quotes, we have expressed skepticism that Karpelès’ Ungox venture will be successful. For the most part, we base this skepticism on his timing, and both the regulatory and market developments that have taken place since an earlier, more opportune time for such an idea. That does not mean he will not be able to make a living from it, given that his fame (notoriety?) will always provide some sort of platform. However, Ungox will hardly become a unicorn, for that he is coming to market a few years too late.
Karpelès is certainly right when he says that there are more than 1,000 cryptocurrency exchanges, but separating the chaff from the wheat has become much, much easier. Regulation has helped, for once, in narrowing the field.
As the first country globally, Japan introduced regulation for cryptocurrency exchanges in April 2017. Since then, there were two notable hacks. First, in early 2018, Coincheck got compromised, leading to its acquisition by Monex Group, which now intends to list it through a SPAC transaction. In August 2021, Liquid was the victim of another attack, leading initially to an emergency loan by powerhouse FTX, and in 2022 to Liquid’s acquisition by the same.
Regardless, there are only 31 licensed exchanges in Japan, which are all strictly supervised through the Japan Virtual and Crypo asset Exchange Association (JVCEA) as the Self-Regulatory Organization (SRO) under the FSA’s oversight. Similarly, when the Korea Financial Intelligence Unit (KoFIU) announced licenses in December 2021, 29 cryptocurrency exchanges got approved, out of an initial field much larger than 100. So in both cases, the regulators have already separated the wheat from the chaff.
Alongside these regulatory developments, market forces have clearly had an impact as well. First, the crypto market overall has become much more institutional (rather than retail). For example, Coinbase, which is listed on Nasdaq and hence makes various disclosures, generates two thirds of its revenue from institutional clients. In turn, these institutional market participants are required either by their own governance or their fiduciary duty to evaluate the exchanges they are doing business with. They simply would not be able to take their order flow to the 120th-ranked exchange — and they would not find the required market depth there either. This very effectively tilts the playing field to a limited number of well-run, well-governed and technologically solid (e.g., trading APIs) exchanges.
On a related note, such institutional due diligence extends beyond exchanges to market mechanisms such as stablecoins. Investment manager Wave Financial, for example, composed an evaluation of nine stablecoins, focusing on those with high usage in DeFi, and the regulatory framework surrounding them.
For those who are not required or unwilling to perform their own due diligence, there are already services available that attempt to rate & rank various cryptocurrency exchanges, sometimes including DeFi protocols as well. Coingecko, one of the first to attempt such a quality seal, has currently listed 14 services with their highest “trust score” of 10.
Coingecko started publishing its trust score in May 2019, and the current iteration, updated in November 2020, is its fourth. It also includes a cybersecurity evaluation.
Similarly, just as we had finished providing our commentary, CryptoCompare published their latest exchange rankings, with four (Coinbase, Gemini, Bitstamp, and Binance) achieving the top “AA” rating, and another eleven listed as “A”.
Obviously, the fact that such rankings already exist does not mean they cannot be improved, or another service cannot take market share. After all, Google was not the first search engine either. As we said in our commentary, “If Mark Karpelès believes he has a sustainable business model, we certainly wish him well.”
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