Crypto exchanges are faced with hard choices today. Is going public and integrating with the established economy the way forward, or is it more productive to decentralize or even go underground? What does it mean to drive Bitcoin adoption under highly speculative market conditions where NFTs fetch millions of dollars and meme coins are all the craze? What does “regulatory clarity” even mean when assets such as Bitcoin are already regulated by a complex combination of code and a globally distributed network of nodes? Isn’t it “regulatory parity” that we’re after instead?
While answers to these questions may still prove elusive for now, some things are coming into focus, especially with regard to the role exchanges might play.
The idea is that rather than a bridge between crypto and traditional finance, exchanges function more as a portal. We’re not sure what’s on the other side, or what to bring with us from this world. But we know that once through, there is no turning back. From that perspective, we see a few key responsibilities for exchanges around education, advocacy and innovation. And in these activities, there is no neutral.
Growth in an age of contradictions
If there is anything we can say for sure about the crypto industry, it is that it compels both onlookers and participants to reconsider their assumptions and take a position. Getting into Bitcoin, for example, prompts discussions on the nature of money and the legacy system. NFTs feed into debates about art or digital ownership. Disagreements and contradictions abound, but most of us will agree that things will never be the same again.
Crypto exchanges are neither spared the contradictions nor can they stay neutral. The adoption of Bitcoin and other innovations presents a special set of challenges to exchanges, not just at the level of technology but at the level of principle and practice.
We can see the conundrum firsthand in a recent Twitter thread by Coinbase’s CEO, Brian Armstrong, where he struggles to keep a balance between appeasing the US Securities and Exchange Commission (SEC), for good relations, and taking a stand against them.
But the issue goes beyond mere regulatory sensitivities. More significant is the question of what it really means to operate a crypto exchange and what the role of the exchange may be as we chart this new digital economy.
From infrastructure to people and ideas
After Bitcoin’s topping out at $20,000 USD and the ICO-boom at the end of 2017, a new creed of exchanges emerged including AAX, ErisX, Bakkt, and FTX. Each of these, and Coinbase before them, were building towards becoming “institutional-grade”. Essentially, in anticipation of institutional investors and capital coming into the market, the infrastructure had to be upgraded.
In the case of AAX, we collaborated with LSEG Technology and branded ourselves as the first crypto exchange to deploy its flagship matching engine. More generally across the space, we saw a strong push toward data centers, co-location services, FIX connectivity, better fiat on and off-ramps, more transparency, and at least an attempt to self-regulate in the absence of regulation.
But while the institutional turn in crypto did indeed play out, as we’ve seen over the course of 2020 and 2021, the inflow of institutional capital came with more than just a demand on infrastructure.
To get a better sense of this, we have to go back to 2019 when Facebook came out with its proposal on Libra. Already then, the US Senate was somewhat shaken up and there were some central bankers who made comments on the prospect of its launch. However, with El Salvador’s recent adoption of Bitcoin as legal tender, the stakes have been raised to more serious levels with the International Monetary Fund, the World Bank, central banks, regulators, and corporate media each on high alert.
It seems, in the process, the rise of crypto is collapsing the separation between retail and institutions, at least at the level of narrative. Instead, the dividing line now runs between those who see merit in Bitcoin as an anti-inflationary reserve asset and open permissionless network for the world to embrace and those who oppose its ascent. But even these lines are fraught with contradictions.
Take banks, for instance.
- Banks are potential partners to exchanges to facilitate ease of access to crypto and liquidity. This is vital to mainstream adoption.
- Bitcoin and the infrastructure around it pose a threat to the banking system.
- Demand for Bitcoin is growing and banks could lose clients if they don’t offer access or exposure.
It’s slightly different with Ethereum, but many of its use cases likewise challenge the status quo. In fact, similar tensions exist around Bitcoin ETFs, licensing, taxation, or even in the act of providing “regulatory clarity” itself.
Crypto exchanges constitute a meeting point for such conflicting interests. They deal with banks, regulators, law enforcement agencies, media, institutions, blockchain projects, other industry partners, investors, and everyday traders – across different jurisdictions. And looking at Binance, Coinbase, or BitMex, we can see there are different ways in which exchanges work to balance these interests out. For us at AAX, it has resulted in a strong focus on people and ideas, and advocacy over “corporate neutrality”, if there is such a thing.
For example, despite the fact that compliance in certain places might not make it possible for us to offer services, at the core we do believe everyone should have equal access to Bitcoin and other digital assets – not just accredited investors.
In this spirit, AAX recently launched a unique SATS spot market in a pair against USDT, making it possible for micro-holders to trade Bitcoin with as little as $0.10 USD. Orders larger than 50,000 SATS (approx. $20-25 USD) are redirected to the regular Bitcoin market.
This move was prompted in part by El Salvador’s recent adoption of Bitcoin as legal tender and the realization that regular spot markets for Bitcoin where minimum order sizes are usually around $20USD may be out of reach for a large portion of the world’s population. Lightning wallets do of course already facilitate transactions in SATS, allowing for small order sizes, but everyone should also have access to spot markets, charts, indicators, and other such tools to engage the market if they wish to trade.
Another reason to switch to SATS was that too many new tokens are deceivingly presented as the “next Bitcoin”, but then “cheaper”. SATS-denominated markets for Bitcoin counter these sly marketing tactics head-on.
That brings us to another topic, which is once again fraught with contradictions.
The Arbitrage On The Trend
Lightning app Strike’s CEO, Jack Mallers, spoke powerfully when he called out Brian Armstrong on his business model being essentially a long position on altcoins, which in Mallers’ view are just an arbitrage on the trend. The trend being the rise of Bitcoin with the arbitrage found in the mispricing of blockchain projects that thrive on misinformation, ignorance or hype.
Mallers’ position has merit, and might turn out to make sense on a broader timescale, especially when we take the adoption of Bitcoin as legal tender and its non-sovereign nature into account. And to Mallers’ point, there is a need for more focus, if the community wants to win against legacy.
However, there are scenarios where alternative tokens can and do flourish. Games that enable players to earn tokens, build status and a social following make sense in the context of a micro-economy. Even when we play Monopoly, there is a joy in accumulating play money. Being able to withdraw and exchange those game tokens for sound money at a later stage is attractive. Tokenized equity, stablecoins, collectibles – there is plenty of reason to see continued interest and growth in the altcoin space.
A counter-argument could be that if value does converge on Bitcoin, and as more functionality comes to the network in additional layers, that many of these micro-economies would likely switch to Bitcoin.
But the world is unpredictable and while Bitcoin has a clear trajectory and there is a strong case to be made for a Bitcoin Standard, this is not where we are right now, and there is no telling what the future of other tokens are. The free market will determine the outcome and exchanges provide the battleground.
Unlike Mt. Gox that had the privilege of serving a single idea and community, crypto exchanges today need to speak to a multitude of tribes, and while Bitcoin is generally respected across the board, there seems to be an insatiable demand for altcoins and NFTs.
As an exchange, we are focused on the adoption of Bitcoin, encourage HODLing and even self-custody. These are the common ethics. Exchanges also play a vital role in onboarding more people into the space from all walks of life with different views and levels of experience. There is a fine line then, between providing guidance and enabling the free market to run its natural course.
At AAX, we publicly advocate for Bitcoin, list and provide education around all types of tokens, actively support high-quality projects, and take part in public discourse. From on-chain analytics, technical analysis and macro-economics to discussions on the fundamentals, we provide a range of perspectives and users can take these insights where they please.
But at times, exchanges need to be able to make a stand such as when AAX delisted Bitcoin SV due to its poor performance and security – or because for too long the coin has been branded as the real Bitcoin, which is not true.
Over the last few months, AAX has operated $0-fee spot markets for all 80+ tokens that the exchange currently lists. From top ranking coins to niche projects and yes, meme coins: in a bull market exchange listings drive growth and attention to the space; the bear market is there to concentrate that value in the right places.
Low volume, low interest coins eventually face delisting, while high-profile projects continue to be supported. The role of the exchange here is not to decide for the market, but to closely trace the trend while looking for those deeper social transformations to try and get ahead of the curve.
Where some users actively trade the markets, diversifying across different crypto sectors and using futures to hedge, others are led to focus on a single asset or resort to a majority allocation to Bitcoin with a small percentage in low-cap tokens. Some users only come to the exchange to buy and withdraw funds into their cold wallet.
It is the role of the exchange to cater to all these users, optimize the experience and provide useful content for users to also progress in their thinking.
Crypto Exchanges At a Crossroads
Crypto exchanges tread a narrow path. In an effort to both grow the industry and drive the adoption of Bitcoin, there is a range of contradictions exchanges need to navigate.
We believe the best way is to act as an educator, but with guidance tempered by the understanding that markets need to run their natural course. It also means acting as explorer, or innovator; the goal shouldn’t be to recreate the stock market in the digital world. Rather, it’s about contributing to the development of an entirely new ecosystem.
In that sense, a crypto exchange is able to act as a portal where users undergo a transformation both financially and at the level of culture. Where that transformation leads to no one knows exactly, but to get there we need to keep revisiting the question of what it means to be an exchange.
About the Author
Ben Caselin is Head of Research and Strategy at AAX, the first crypto exchange to be powered by London Stock Exchange Group’s LSEG Technology and the first exchange to switch to a Satoshi Standard to drive the adoption of Bitcoin.