[Analysis] Exchanges creating public chains have little decentralization purpose: Maintaining competitiveness and boosting valuation

In recent years, many globally renowned exchanges have announced the development of their own blockchain systems. What are the purposes of these exchanges in doing so? What benefits can establishing their own blockchain systems bring to them?

Exchange Development of Blockchain Becoming a Trend

Cryptocurrency exchange Binance released a whitepaper on April 17th describing the workings of its new smart contract blockchain, Binance Smart Chain. The new blockchain will coexist with the existing Binance Chain and operate as a smart contract layer for Binance Chain. In a press release, Binance stated:

"This innovative solution brings Ethereum Virtual Machine (EVM) interoperability and programmability to Binance Chain. Thanks to native interoperability, both Binance Chain and Binance Smart Chain will be able to transfer and execute other communications."

In fact, exchange development of blockchains is not a new phenomenon. Since Binance introduced Binance Chain in April 2019, at least three other exchanges have revealed that they are developing their own blockchain systems. In February of this year, OKEx announced that its blockchain OKChain had entered the testing phase. Jay Hao, CEO of OKEx, stated in the press release:

"OKChain is a commercially public chain independently developed by OKEx. The source code is currently 100% open, providing an efficient, free, and infinitely valuable ecosystem for all our ecological partners. Cross-chain and 'OpenDEX technology' enable us to realize the vision of commercial chain alliances and promote the substantial development of the blockchain industry."

On the other hand, Huobi exchange also announced in March of this year that its blockchain entered the testing phase, and the South Korean exchange Bithumb revealed blockchain development plans in November 2019.

Building Moats and Retaining Market Share

As gateways to the world of cryptocurrencies, exchanges play the most crucial and profitable role in the cryptocurrency industry.According to reports, the U.S.-based exchange Coinbase had an estimated revenue of around $1.3 billion in 2018. Based on data from BNB burns, as of September 30, 2019, Binance's cumulative profits may have reached $1 billion.

Cryptocurrency and blockchain commentators generally believe that exchanges are building their own blockchain systems to consolidate their position as industry leaders and to some extent create moats around their businesses.Ken Misuma, Chief Marketing Officer of smart contract platform Quras, stated that by developing their own blockchain, cryptocurrency exchanges will be able to increase their market share and operate more efficiently. Misuma said:

"Digital asset exchanges try to attract as many traders as possible to increase their user base, which is the main driver of their profits. Developing a blockchain without the need for a centralized operator can make the exchange's availability and trading products more flexible."

Hugo Renaudin, CEO of European-based institutional cryptocurrency exchange LGO, pointed out how having their own blockchain helps exchanges become more efficient:

"Operationally, this is a significant cost reduction measure, as many operations and fund flows (deposits, withdrawals, or settlements) can be automated through smart contracts. Additionally, the exchange's blockchain can reduce the overall listing costs for issuers, allowing the exchange to list more assets at a lower cost."

With the continuous development of blockchain and cryptocurrency markets, the number of issued digital assets will increase, raising the barrier to entry for running an exchange business, which will help establish barriers to entry in the industry.

On the other hand, before exchanges begin building their own blockchain, new projects typically need to issue digital assets on public blockchains like Ethereum. These assets are then listed on various exchanges. Token holders or traders can freely choose which exchange they prefer to trade these tokens. However, this freedom means that exchanges face the risk of constantly losing their user base to competitors. In addition to competition from other centralized exchanges, decentralized exchanges may also become a threat in the future.

By developing a native blockchain and inviting projects to issue digital assets on their chain, exchanges can create inherent barriers against other competitors, allowing them to retain the maximum market trading volume of those assets.

Bringing Growth to Its Valuation

In the past, platform tokens were mainly used for fee discounts, paying listing fees, or enhancing user levels. Developing their own blockchain can upgrade an exchange's platform token to the native token of the blockchain ecosystem, directly raising it by a level. This not only widens the token's usability but also increases its potential value.

Jack O'Holleran, CEO of SKALE Labs, even believes that this can increase the valuation of companies behind each blockchain network.

"The valuation multiples of exchange equities are significantly lower than the valuation multiples of cryptocurrency assets because compared to equities, cryptocurrency assets are non-dilutive. As a simple example, if an exchange earns $100 million in fees annually, their valuation may be in the range of 5 to 7 times, meaning from an equity perspective, their value is $500 to $700 million. If they issue tokens to pay fees, then from a completely diluted perspective, with the same income, the token may be worth billions of dollars."

The above content only touches on a few basic reasons for exchanges developing blockchains. As exchanges have different long-term development directions, the purposes of developing blockchains may also vary. The only certainty is that the blockchain systems developed by exchanges are generally based on commercial purposes, so one should not have high expectations for the decentralization of these blockchain systems.

Related Reading

• BOH Competition Heats Up: Why Are the Three Giants of Exchanges Building Public Chains?
• For Real? Huobi Has Burned 150 Million HT, Launching Testnet for Open Finance on Public Chain
• Binance Launches "Binance Smart Chain" Testnet, Supporting Smart Contracts and Ethereum Compatibility
• OKEx Announces Launch of OKChain, DEX Testnet, OKB Surges Over 40% in a Day

Join Telegram now for the most complete information on financial technology, blockchain news, and industry examples!