Executive Summary: Centralized crypto exchanges (CEXs) have grown incredibly fast, because they make crypto easy to use.
Their user-friendliness makes them the on-ramp for most investors, so CEXs today control most of the trading volume in cryptocurrencies. Monthly user numbers are now in the tens of millions, and quarterly revenues at the largest CEXs have topped $1 billion, with long-term growth continuing to rise. CEXs also enjoy massive institutional investment, seeing over $3 billion in inflows last year.
In this piece, we’ll look at the CEX space from a bird’s eye view, outline our investment thesis, and learn the top opportunities in the space for crypto investors.
While many advanced crypto investors use decentralized exchanges (DEXs), it’s centralized exchanges that are bringing crypto to the masses. It’s why big names like Binance, Coinbase, and OKX are many investors’ first choice for buying, selling, and storing crypto.
Unlike DEXs, centralized exchanges have focused on building user-friendly products to attract and retain users. Since most CEXs generate income by charging fees on transactions, a growing user base means increased trading volume and revenue.
Though DEXs have gained market share over the past few years, most crypto transactions are processed by centralized exchanges. According to The Block, DEXs do around 8% of the trading volume of CEXs (click to read our Sector Report on DEXs).
DEXs still have a long way to go before they catch up to CEXs. Plus, in the past few years, some CEXs have been ramping up their marketing efforts with lavish ad campaigns and major sponsorships. They are building brand moats that DEXs, with their meager marketing budgets, will find it difficult to overcome.
There are different ways to invest in centralized exchanges. For publicly-traded companies like Coinbase (COIN), investors can buy traditional shares. Non-traded CEXs have launched their own exchange tokens, which we believe is like a proxy for owning company stock.
It’s now a norm in the industry for exchanges to release their own tokens that allow users to enjoy certain perks, such as discounts on fees. On top of these perks, some investors choose to buy and hold the tokens, hoping the price will increase as the exchange gains market share.
While a successful exchange would most likely mean a growing stock or token price, the reverse is also true. Exchanges can get hacked; regulators can shut them down. Investing in CEXs is high risk, high reward.
As always, the risk can be mitigated by building our Blockchain Believers Portfolio, and keeping exchange tokens as no more than 1-2% of your overall portfolio.
Who’s Investing: Institutional Backing
According to a recent report from Messari, over $30 billion of capital was raised across the industry last year. $10 billion of this was raised toward Centralized Finance (CeFi), which includes centralized exchanges. In fact, over $3 billion of this capital was geared toward centralized exchanges alone.
CEXs have benefited from these institutional investments. For instance,
Binance, the biggest exchange in the world by trading volume, has reportedly raised over $3 billion across 4 funds. Coinbase has raised $573 million over 17 rounds, with the latest one coming late last year.
This influx of institutional capital is essential as it fuels the growth of the industry. It also signals that institutional investors are betting on the potential of exchanges — and, by extension, the crypto industry. Institutional investments also help build industry credibility, and drive mass adoption of crypto.
Top CEXs by Trading Volume
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Binance was launched in 2017, nearly five years after Coinbase, but it didn’t take long to rise in popularity. The crypto exchange reported over 13 million users just a year later and became the world’s largest crypto exchange by trading volume in the process.
In 2019, Binance took some big steps to grow the company. First, they launched their own USD-backed stablecoin, BUSD. They migrated BNB from the Ethereum blockchain to their own Binance Chain. And they launched a US version of the Binance exchange, in an attempt to comply with US regulations.
Like Coinbase, most of Binance’s income comes from transaction fees. In an interview with TechCrunch late last year, Binance CEO Changpeng Zhao revealed that transaction fees account for 90% of the company’s earnings. These transaction fees include purchase fees (which vary depending on the method of payment), trading fees, and withdrawal fees.
Binance’s revenue properly took off toward the end of 2020, and generated over $20 billion in 2021, registering a 260%+ year-over-year increase.
Despite the market downturn in 2022, Binance’s annual revenue topped $12 billion, according to on-chain provider Cryptoquant, growing ten times over the past two years. We believe the exchange is poised to grow even bigger due to its position as the current market leader, though regulators could slow it down.
Coinbase (COIN: NASDAQ)
Coinbase was launched in 2012, just a few years after the inception of bitcoin, with a clear and simple goal: “Anyone, anywhere, should be able to easily and securely send and receive bitcoin.”
Over a decade later, Coinbase has launched multiple crypto products to cater to individuals, businesses, and even developers, which has greatly expanded reach and revenues.
Coinbase’s revenue can be grouped into two main categories. The first and largest is transaction revenue, generated by processing transactions for retail or institutional investors.
Because trading volume follows the ebbs and flows of the crypto market, CEXs make less money in bear markets, and more money in bull markets. (Just watch the price of bitcoin for a predictor on how much money CEXs are making.)
For this reason, CEX investors cannot expect transaction revenue to grow linearly over time. In the Coinbase financial statement below, Q3 2022 transaction revenues are only a third of Q3 2021 revenues — but the year-over-year price of bitcoin had dropped by half.
The good news is that Coinbase has offset this reliance on transaction revenue with a second category: subscription and services revenue, which comprises custodial fees, interest income, and subscription services offered on the platform.
This category has grown steadily, and is an anchor to offset the choppy waves of crypto transactions. It may also be a hedge: according to Coinbase, “The biggest contributor within subscription and services – interest income – benefited from the rising interest rate environment.”
While the bear market dealt a blow to these numbers, Coinbase was still able to record an average of 9 million monthly transacting users throughout the year and surpassed the 100 million verified users mark and as one of the most regulatory-compliant exchanges. In our view, Coinbase is the gold standard of U.S. crypto exchanges.
OKX is a centralized cryptocurrency exchange that offers not only exchange services, but also a range of other crypto-related services such as trading bots, copy trading, and a variety of derivatives. The exchange is based in Seychelles and offers its services to a worldwide client base, but is not available to U.S. residents. The exchange attracts users primarily on its low trading fees.
At the start of 2022, OKX was the second largest centralized exchange by volume, eclipsed only by Binance. However, it has since been overtaken by Coinbase and slipped into third position. Even so, in mid-2022 the company committed to continue growing, promising to increase its staff levels by 30%, even as other exchanges were considering cutting back on staff.
According to an OKX blog post from June 2022: “We have a careful and deliberate hiring plan in place to ensure sustainable growth during this period. We are accelerating our recruitment with a plan to increase our global workforce by 30% and reach a total of 5,000 people within the next 12 months.”
OKX announced in February 2023 that they are developing on OKBChain, which is planned to help foster the development of a larger OKB ecosystem. The new OKBChain is meant to complement the existing OKXChain, with the former focused on enterprise business solutions, while the latter will remain focused on the creation and deployment of decentralized applications.
For a space that is barely over a decade old, the revenue and user growth of CEXs is impressive. They are certainly one of the proven use cases of blockchain, because people need “bitcoin banks” to custody their crypto.
We think the future growth potential for CEXs is still huge, evidenced by large capital investments flowing into the space.
With that said, it’s important to mention that the sector’s ability to grow is heavily dependent on the future of regulation, especially within the U.S. If they really are banks, they will need to act like banks.
The careful crypto investor will look for CEXs that are acting like banks, staying fully licensed and compliant, and working within the existing regulatory framework. The companies that do this, we believe, will become the next financial superpowers.
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