This post was last updated on November 14th, 2019 at 06:48 pm
This conversation is part of a larger series we’re doing on crypto exchanges. As part of this series, we’ve already interviewed Binance CEO Changpeng Zhao (CZ), Binance CFO Wei Zhou, Ivan Poon from Switcheo, Alex Wearn from IDEX, Sam Bankman-Fried from FTX, and John Jansen from Deribit.
If you run a top 50 crypto exchange by volume, I want to speak with you as part of this series. Please reach out to set that up.
Over the past few years, I’ve spent a considerable amount of time thinking about exchanges, exchange data, and how to combat exchange spam. Furthermore, all of the data on Nomics.com comes directly from crypto exchanges or is derived from exchange data. Because of this, we interface with exchange businesses more than any other kind of business.
Nathaniel and I are teaming up to write an article about the history of cryptocurrency exchanges.
In this two-part series, we explore the main ideas from that article and share our understanding of how cryptocurrency exchanges and the crypto exchange ecosystem have evolved over time.
My conversation with Nathaniel Whittemore is broken up into 5 chapters:
- Chapter 1: The pre-history of Bitcoin and how regulation from that era still affects us today
- Chapter 2: An exploration of the first crypto exchange that launched only a year after Bitcoin went live
- Chapter 3: The Mt. Gox story and the fallout caused by that hack
- Chapter 4: The rise of ICOs and how that led to the ascendancy of Binance
- Chapter 5: Current trends in the crypto exchange ecosystem
In episode 57, we cover chapters 1 through 3. In episode 58, we cover chapters 4 – 5.
Topics Discussed In These Episodes
- Services that crypto exchanges can provide that traditional exchanges can’t
- Why Harvard Business School will examine Binance as a case study for years to come
- How Binance has continued to innovate even at the risk of self-disruption
- How decentralization will change regulation
- The Chinese ban on crypto exchanges
- The first Bitcoin exchange ever created (it wasn’t Mt. Gox)
- What Mt. Gox was and how it got hacked
- How the news of the Mt. Gox hack broke
- Who holds the crown for the longest-standing crypto exchange
- The ICO boom
- How tokens allow you to bootstrap the value of the network
- The rise of BitMEX and derivatives trading
- Initial Exchange Offerings (IEOs)
- How custody and trading are being centralized
- Why exchanges are spamming aggregator sites like Nomics and CoinMarketCap
Links Relevant To These Episodes
- Popular Crypto Newsletter
- Clay Collins
- Nathaniel Whittemore
- Nathaniel on Twitter
- About Nathaniel Whittemore
Quotes“What makes this industry rather fascinating is that you have the unwavering belief and vision of the future requirements of traditional private startups, but they are fueled by a public market-style speculative behavior.” @nlw Click To Tweet “On a forum, the creator of the first Bitcoin exchange wrote: 'I have big plans for a Bitcoin exchange, but I still have a lot of work to do.' I feel like this is still the whole industry to this day.” @nlw Click To Tweet “When @HarvardHBS does case studies of @Binance, it will be about their willingness to play the regulatory arbitrage game in a way that hasn't been done on that scale.” @nlw Click To Tweet "At their earliest days, Web 2.0 platforms was about empowering people but they eventually became the most powerful business monopoly opportunities that have ever existed in human history. Many people saw Ethereum as a potential… Click To Tweet "The theme of crypto exchanges is constant innovation. What is the product that is going to get people excited? I would argue that the growth in derivatives and derivatives trading is one of the major shifts and trends that we're in… Click To Tweet
Part 1 Transcript
Clay: Welcome to Flippening, the first and original podcast for full time, professional, and institutional crypto investors. I’m your host, Clay Collins. Each week, we discuss the cryptocurrency economy, new investment strategies for maximizing returns, and stories from the frontlines of financial disruption. Go to flippening.com to join our newsletter for cryptocurrency investors and find out just why this podcast is called Flippening.
Clay Collins is the CEO of Nomics. All opinions expressed by Clay and podcast guests are solely their own opinion and do [00:00:30] not reflect the opinion of Nomics or any other company. This podcast is for informational and entertainment purposes only and should not be relied upon as the basis for investment decisions.
Welcome to the first installment of our two-part series on the history of crypto exchanges. I’m joined by Nathaniel Whittemore, who is a freelance crypto communications strategist and curator of Long-Reads Sundays on Twitter.
This conversation is part of a larger series we’re doing on crypto [00:01:00] exchanges. As part of this series, we’ve already interviewed Binance CEO Changpeng Zhao also known as CZ, Binance CFO Wei Zhou, Ivan Poon from Switcheo, Alex Wearn from IDEX, Sam Bankman-Fried from FTX (creators of the FTT token), and John Jansen from Deribit.
Upcoming interviews that are part of the series include an interview with the CEO of Liquid and the founders of 0x. As a side note, if you run a top 50 exchange [00:01:30] by volume, I want to speak with you as part of this series. Please reach out to set that up if you’re interested.
Now for a bit of background on this episode and this content. For the past few years, I’ve done a lot of thinking about exchanges, exchange data, and how to combat exchange spam. On top of this, all the data from nomics.com comes directly from crypto exchanges or is derived from exchange data. Because of this, we interface with exchange businesses [00:02:00] more than just about any other kind of business.
Nathaniel and I are teaming up to write an article about the history of crypto exchanges and this conversation reveals some of the things we’ve learned while writing this article. In this two-part series, we explore the main ideas from this article that we’re writing and we share our understanding of how cryptocurrency exchanges and the crypto exchange ecosystem has evolved over time.
This conversation is broken up into five chapters. In Chapter 1, we discuss [00:02:30] the pre-history of Bitcoin and how regulation from that era still affects us today. In Chapter 2, we explore the first crypto exchange that launched only a year after Bitcoin went live. In Chapter 3, we dive into the Mt GOX story and the fallout caused by that hack. In Chapter 4, we discuss the rise of ICOs and how this led into the ascendancy of Binance. Finally, in Chapter 5, we close our conversation by exploring current trends [00:03:00] in the crypto exchange ecosystem.
In this episode, which you’re listening to right now, we’ll cover chapters one through three. In the following episode which comes out next week, we cover chapters four through five. We’ll get right to the content in just a second, but before we get started, I’d like to pause for a moment to tell you that this episode is brought to you by the good folks at Nexo. Here’s a word from them.
Nexo is the only lender offering instant crypto credit lines, which let you use digital assets as collateral to get cash in 45 fiat currencies and stablecoins. [00:03:30] Nexo is also a strategic partner of exchanges, OTC desks, and crypto funds through its portfolio of structured financial products. Institutional counterparties can earn up to 8% annually on their idle stablecoins, enter into asset swap agreements, or directly borrow crypto. Individuals can also park their cash and stablecoins in a Nexo interest-earning account and get an annual return of 8%. What’s more, interest is paid out daily and you can add or withdraw funds at any time. [00:04:00] So if you are looking to borrow, lend, or swap digital assets, Nexo is your go-to partner. Definitely explore nexo.io or if you’re an institution, you can reach out to them at email@example.com
This episode is also brought to you by the Nomics API and CSV Data Export Service. If you need an enterprise-grade crypto market data API for your fund, smart contract, or app, or if you need historical CSV dumps of trading data or crypto market cap data from top exchanges or even obscure ones, [00:04:30] then consider trying out the Nomics API or our historical data export service. Our cryptocurrency API enables programmatic access to clean, normalized, and gapless primary source trade data across a number of cryptocurrency exchanges. Instead of having to integrate with multiple exchange APIs of varying quality, you can get everything through one screaming fast fire hose. And if you’d like to order historical cryptocurrency market data as CSV exports from top exchanges, email us at firstname.lastname@example.org.
Okay, back to our [00:05:00] regularly scheduled program. Here’s part 1 of my conversation with Nathaniel Whittemore. Enjoy.
It strikes me that when talking to investors, often in the space, they’ll describe some kind of thesis around decentralization or whatever their thesis is. Sometimes they’re fairly [00:05:30] sophisticated. At the end of the day, people are really just investing in tokens or exchanges. Those are really the two businesses or two investment types is they’re going to acquire some percentage of the tokens from a token project or they’re going to own part of an exchange and hopefully that’ll be profitable. I mean, there doesn’t seem to be a whole lot of investable business types, that work at scale where you can generate VC-type [00:06:00] returns. Exchanges seem to be the most prominent one. Every other day I’m hearing about an investment in another exchange. What are your thoughts on exchanges? Before we started this historical deep dive, what was your relationship to exchanges other than perhaps a user?
Nathaniel: If you look across the crypto industry, there are really two categories of iconic brands. One is the tokens themselves and the second is exchanges. What makes this market fascinating, what makes this industry rather fascinating is that [00:06:30] you have the unbelievable belief and vision of the future requirements of traditional private startups, but they are fueled by a public market-style speculative behavior. So you have this weird mixture of true believers and hodlers investing in these assets. But then you also have just totally whatever, agnostic, basically speculators and investors [00:07:00] who are there to make a profit. Somehow that’s that weird mix is what drives things, what provides fuel and liquidity and space for creation to happen.
Exchanges have always been just incredibly integral to this industry from when the industry was literally just Bitcoin, because They make the business model of belief work for both sides of that. For the speculators who provide that influx of capital necessary to get to the next milestone or the next wave, [00:07:30] whether it’s a technical milestone or more usually a social and belief milestone, or whether it’s a place for those true believers to live in the real world to be able to move their money around when they need to as well. In some ways, the story of this industry is you can write it in a couple of different ways, but one of them and one of, in some ways the most important one, is the history of exchanges.
What are they represented? What services have they provided? What is the level for growth? What is the perception of them been? How do they [00:08:00] relate to the larger financial system? How do they relate to regulators? It’s been ground zero for the broader idea of crypto assets in each case. In some ways, trying to write a history or just think through a history of exchanges, thinking through a history of the whole space just from a particular vantage point.
Clay: Also worth noting that exchanges for most people are the onboarding institutions into the crypto sphere. I mean you can read a bunch of stuff. [00:08:30] You can go to meetups, but most people don’t know someone who’s going to pay them in crypto, unless it’s weird, illicit activities done across borders online. There’s only a handful of things that could be, but for the most part, if you decide that you would like to have a stake in this larger ecosystem, for me it was going to Coinbase. That was the fiat on-ramp. They not only allowed me to purchase my first Bitcoin but they, [00:09:00] for a very long time, were the custodian for me.
Not only do exchanges onboard people into this whole ecosystem, but there are also institutions that most holders who are hodlers who don’t have hardware wallets or don’t have a Casa Node are very vulnerable to them because if they do get hacked, they’re out of luck. For the vast majority of people [00:09:30] who do own a crypto asset, it probably does make more sense to hold those assets in a respected, regulated exchange versus holding it themselves. In a lot of ways, the story of exchanges really is the story of crypto assets post Satoshi Nakamoto.
Nathaniel: It’s where everyone who walks to the door, in most cases to your point, where their individual story connects to the larger story. I mean, they literally are the exchange that is the point where they come in. [00:10:00] So yeah, again it’s really fascinating and their relationships with customers has followed and changed and the customer base has changed as well. There’s this whole other dimension where exchanges reflect the changes in the user base in terms of what they expect, what they understand, what they’re looking for, what they’re trying to buy, and how they’re trying to buy.
Clay: Crypto exchanges, there’s a lot of drawbacks versus traditional stock exchanges, for example. There’s a lot more that they do as well. For example, in some cases [00:10:30] they allow you to earn interest on crypto assets held there. Coinbase announced that and Binance has been doing that for a while. They allow you to stake, they custody the assets which is not something that traditional, old school financial institution exchanges have allowed you to do. Some of them provide loans and lending. It’s interesting when we talk about exchanges.
It can be everything from something like Coinbase Pro, which is [00:11:00] a traditional financial institution exchange to something that’s a lot more involved. We’re seeing this spectrum emerge around value added custody. If an exchange has assets, it has your assets. There’s a lot of services that they can provide to you once they hold those assets, that traditional exchanges haven’t been able to provide because there is no custody. They have the potential to be the most powerful institutions in the space really. [00:11:30]
Nathaniel: In some ways they already are. There’s certainly this huge amount of innovation. I mean, to your point, the business model innovation coming out of exchanges is so unbelievably breathtakingly quick. If you look just since the middle of 2017, which we’re really talking about like 26–27 months, the number of different shifts in terms of how exchanges make money, what they do, what they enable relative to the rest of the space. I mean, we’re talking three, four, five significant changes, often in a single business. [00:12:00] You had between the middle of 2017 and the beginning of 2018 an exchange become the fastest growing private company in history. Moreover, the fastest growing profitable unicorn in history. There’s plenty of companies that have become unicorns on the basis of valuation.
Binance actually was a profitable unicorn inside the span of six months. If they had just stopped there, they would likely have been totally relegated in some ways. I mean, there’s this weird contrast between [00:12:30] on the one hand, there are more network effects in an exchange business than in many other types of businesses because of the value of liquidity and the security and all that stuff. However, if you look at the success of patterns of who’s had the biggest volume at any given time, holding aside things like the wash trading and fraudulent volume that we talk about a lot as well, it’s shifted so quickly and it’s ever changing landscape. Even with such clear leaders in some ways like in Binance, there is [00:13:00] no guarantee that even six months from now they’ll be the leader in the same way.
So it creates this incredible cauldron for just mandated innovation in some ways. Now at the same time, you have a huge part of the industry that’s just filling in gaps and providing fiat on-ramps in particular jurisdictions, or is trying to differentiate on one point and obviously we see a landscape of hundreds of exchanges. But that competition at the top to really figure out what the market needs next and to provide that and to even [00:13:30] push the market in some ways, not to just ask what it needs but say, “Hey, you should have this,” makes it extra interesting.
Clay: In addition to that, a huge push to innovate or at least evolve. I don’t know how many of these ideas are net new to the space. Certainly it requires execution and the exchanges that have been able to execute the fastest while maintaining security standards have absolutely crushed it. In addition to that, we’ve seen a lot of really interesting developments from [00:14:00] the space around jurisdictional arbitrage, centralized versus decentralized. One might argue that Binance itself is a stateless entity. They’re really not located in one single place, but then they have all these fiat on-ramp businesses that are located everywhere. So, where is that business lo 1cated?
I think they’ve pushed the boundaries in just many different ways. It’s one of the most fascinating areas of business right now because it is custody, [00:14:30] it is banking, it is exchange, it is a whole bunch of other things combined with statelessness, issuing currencies. It’s like the privatization of the banking systems that have taken decades to evolve at least here in the United States. I can’t wait to see what comes of that.
Nathaniel: I would argue that When Harvard business study does case studies of Binance, it won’t just be about what they did in crypto, it’d be about them as an organizational structure in terms of their willingness [00:15:00] to actually move and play the regulatory arbitrage game in a way that hasn’t been done on that scale. They moved five times their headquarters I think. They started in Hong Kong and then they moved to, I believe it was Singapore, Japan, Taiwan, Cayman islands, and then finally Malta. Then meanwhile, no one knows where their servers are, so that’s a whole different area. On top of that, they’re working on something like nine different, locally regulated fiat [00:15:30] on-ramp exchanges like Uganda, Jersey, Singapore, Malta, South Korea, Argentina, Russia, Turkey, Bermuda, Lichtenstein. Those are all going to be there.
Clay: All of that and they’ve issued their own crypto asset (Binance Coin), which in of itself isn’t that innovative. But then, they turn that into the basis for Binance DEX, which is designed to be the evil twin that obsoletes everything else they’re doing, which is, in and of itself, pretty crazy that you would invent [00:16:00] the evil twin meant to destroy you.
Nathaniel: I was just rewatching a clip from CoinDesk or from Invest New York last year and there was Andrew Ross Sorkin in conversation with Muhammad Ibraham. Andrew Ross Sorkin said something to the effect of, “If it’s interesting technology, why wouldn’t Visa or MasterCard or whatever just do their own thing, take the tech, and ignore everything else?” Basically, his answer was his companies [00:16:30] don’t have the capacity to self disrupt. That’s 99 times out of a 100 or maybe 999 times out of a 1000. That’s true.
What you’re seeing with a company like Binance is, is it showing the capacity to self-disrupt? It is playing out multiple lines of potential self disruption to be prepared for whichever one is relevant for the market.
Clay: It’s a pretty gutsy position to say that if someone’s going to disrupt me, it’s going to be me. You don’t see [00:17:00] Hyatt hotels and inventing Airbnb. You don’t see taxi companies, for the most part, inventing Uber. It’s a pretty rare thing. I think maybe to some extent, Apple tried to cannibalize the iPod, which was an incredibly successful product that in a lot of ways brought them out of the doldrums of slow growth, but they disrupt that with the phone. Maybe that’s an example, but there just aren’t a lot of examples of businesses doing this [00:17:30] and doing it with gusto and conviction, and then doing it successfully.
Let’s kickoff Chapter 1, or Historical Wave 1, which is about the prehistory of Bitcoin.
Nathaniel: I was a history major in college. I think for me, it’s not an accident that in my professional life, when I’m working with companies on narratives I’m looking for big patterns because history is a lot about big patterns that give way to one another and influence one another. A lot of the study of history is trying to look at what actually happened and how it influenced the pattern. [00:18:00] I think what makes it different maybe than some other social science disciplines is that it tries, although not always successfully, to do that without just mapping its own pre-existing set of beliefs or categorizations onto the world.
Going back and looking at the history of exchanges, what’s interesting to me is how these waves and patterns give way to one another. In some ways, I see that accelerating now the more money, the more people come into the industry. I think those waves and patterns of disruption are happening even more frequently, and sometimes, [00:18:30] as we were just discussing with Binance within the context of a single company.
One of the things that’s really fascinating is when you go back and look at the history of exchanges in the same way that there was a pre-history to Bitcoin. For a lot of us, Bitcoin was the white paper, then […] on the brink of a second bailout, and that’s when it started. There was of course this huge lineage of people experimenting with electronic currencies and digital currencies in advance.
Obviously, there were people who were giving those currencies, [00:19:00] creating a mechanism for people to buy them. If you go back, though, and look, a lot of the story of those cryptocurrencies reads like the earliest and most persistent critiques of the crypto industry today.
One of the big electronic currencies from the 90s to the odds, I guess the 2000s, was eGold, which theoretically was an electronic currency that was backed by gold, that was stored in vaults in London, Saudi Arabia, and a bunch of other places theoretically. [00:19:30] They were trying to play it a lot of the same ideas as when Bitcoin hit in terms of there being a separation between the protocol or the asset that was eGold and the companies that are built around to allow people to interact with eGold.
If you read that history, it is just law enforcement after law enforcement after law enforcement. So in 2004, the Australian Securities and Investments Commission shut down three different eCurrency sites for operating without a financial license.
This is a common thread, money [00:20:00] transmitter licenses, anti-fraud, not participating in anti-fraud stuff. In 2006, FBI raids Gold Age, which was probably the most high profile version of this in the US and later come out that something like 4 million of the 36 million that had flowed through the system was part of some big money laundering scheme.
If you actually read the statements from back then, you could take them out of context. It sounds like our president talking about this. Here’s a quote: [00:20:30] “The advent of new electronic currency systems increases the risk that criminals and possibly terrorists will exploit these systems to launder money and transfer funds globally to avoid law enforcement scrutiny and circumvent banking regulations and reporting.” That was from 2007. It was the FBI cyber division.
By the way, the guy who started Gold Age and who got five years probation for it went on to start Liberty Reserve. It had its own proprietary currency. Think of it almost like a Proto Tether in some ways. [00:21:00] Although not necessarily, it’s a lot less professionalized than Tether. Liberty Reserve was in the earliest crypto exchanges used as a payment processor or a payment on-ramp to get your money off of the exchanges after PayPal. PayPal was used at first, but then it pretty quickly shut all these exchanges down in 2010 and 2011.
Clay: Hey! I wanted to pause for a second to let you know that this episode of the Flippening podcast is brought to you by Nexo. Here’s a word from them.
Nexo is the only lender offering instant crypto credit lines, [00:21:30] which let you use digital assets as collateral to get cash in 45 fiat currencies and stablecoins. Nexo is also a strategic partner of exchanges, OTC desks, and crypto funds through its portfolio of structured financial products. Institutional counterparties can earn up to 8% annually on their idle stablecoins, enter into asset swap agreements, or directly borrow crypto. Individuals also park their cash and stablecoins in a Nexo’s interest-earning account to get an annual rate of return of [00:22:00] 8%. What’s more, interest is paid out daily and you can add or withdraw funds at any time. So if you are looking to borrow, lend, or swap digital assets, Nexo is your go-to partner. Definitely explore nexo.io or reach out to them at email@example.com
Olay, back to the show.
Nathaniel: Liberty Reserve was started by the same folks as Gold Age. The guy Arthur Bukovsky Bellanchak was eventually shut down in 2013. [00:22:30] He was arrested in 2016, was convicted, and sentenced to 20 years. The earliest story of these exchanges was, whatever the case, I’m sure that there was a huge amount of excitement. We know there was a huge amount of legitimate belief and excitement because the embers of those things got put into what we now know as Bitcoin in the cryptocurrency industry. A lot of the earliest, lets call it speculative behavior for those was that criminal element which would find itself moving on into the earliest exchanges in Bitcoin [00:23:00] as well.
Clay: It’s almost like the government. As long as there is a single throat to choke, will require regulation and all kinds of compliance. The second that doesn’t exist, if something becomes sufficiently decentralized, then they seem fine just throwing up their hands and letting certain kinds of behaviors and practices persist. They’re not trying to shut down Bitcoin. At this point they probably can’t, but from the very beginning they weren’t trying [00:23:30] to regulate it simply because they couldn’t. There was no door to knock on.
In a lot of ways, it feels like all of this centralized infrastructure that what the creators of Bitcoin were rebelling against, we have that in abundance today. Hopefully, it’s just bootstrapping the decentralized version of all these services that are built on top of it right now and that’s the future that awaits us. Hopefully, we’ll see.
Nathaniel: I think that you’re getting into an interesting point, [00:24:00] which is a common thread. After this conviction happened in 2016 on Bitcoin Talk, there were a number of threads like what makes Liberty Reserve different from Bitcoin? A lot of the answer had to do with the centralization and the single point of failure. Now there’s a million other reasons too. The fact that Bitcoin solved double spend problem and all these sorts of things. They’re substantively different as well.
However, functionally, practically that was one of the biggest differences. I mean, this joke is made every day on Twitter. Last week, [00:24:30] Zuckerberg said that he agreed that he was going to come and testify before Congress on October 23rd. Rhythm trader, who’s an excellent literary meme artist in the Bitcoin space said, “The CEO of Bitcoin, meanwhile, cannot be reached to answer his invitation.” You see that joke over and over and over again.
I do think there’s another important point that you’re making too, which is that the exchanges have this strange role because they represent the tension between a decentralized, [00:25:00] permissionless, unstoppable, uncensorable force that, at least some cryptocurrencies, bring into the world. They enable that on the one hand. On the other hand, they’re the tool that de-risks that through regulation for governments. You can functionally kill a cryptocurrency by making people unable to do anything with it. It makes it less scary.
There is tension. People have pointed out the tension before. There is hero worship of CZ and it’s hard not to, especially if you’re the type of person [00:25:30] who’s fascinated by business. Just from the standpoint of pure executional capacity, it’s hard not to be impressed. At the same time, the question that is ever present, or it needs to be at least, in the Bitcoin and in the crypto space is, what should the nature of power be? How much power should any one person or any one institution have? What is the resilience of the system when it’s organized around institutions that are ultimately single points of failure, even if they’re big, complex, successful, and seem [00:26:00] to be impervious to stumble and fall?
It’s pretty fascinating that we’re already seeing that some of those tensions around points of failure, from the earliest days before even Bitcoin was launched.
Clay: Let’s move to Chapter 2, AKA Historical Wave 2 which is about the first real crypto exchange.
Nathaniel: The original exchanges, in a lot of ways were people talking on Bitcointalk and there was tons of people used eBay. They used Craigslist, to your point. [00:26:30] I think it is cool, actually, in a lot of ways that that is, no matter how big these exchanges get, that continues to be a way that people exchange Bitcoin. One, there’s the whole dimension of how it’s almost entirely over the counter in China, because of the ban on exchanges since 2017.
Clay: Hey, this is Clay cutting in from the editor’s booth to shed some light on the Chinese ban of crypto exchanges. In September of 2017, China banned initial coin offerings. This [00:27:00] ICO regulation also restricted the activity of cryptocurrency exchanges domiciled in mainland China. Because of this ban, many crypto exchanges (e.g. Binance) moved out of China to preserve their businesses.
Okay, back to the show.
Nathaniel: That P2P base case has remained In some ways that each of these phases has an iconic, at least one really iconic brand or exchange. That was obviously for the early days was Mt. Gox. Their early story of Bitcoin exchanges that most people would reference back to was Gox.
That wasn’t actually [00:27:30] a widely accepted first exchange. That was an exchange called Bitcoin Market, on January 15th, 2010, a member of the Bitcointalk named DW Dollar says, “Hi everyone, I’m in the process of building an exchange. I have big plans for it, but I still have a lot of work to do. It will be a real market where people will be able to buy and sell Bitcoins with each other. In the coming weeks I should have a website with a basic framework set up, please bear with me.”
That was the first message about an exchange back on Bitcointalk. And I love that. I actually tweeted [00:28:00] it out the other day because it says I have big plans for it, but I still have a lot of work to do, which I feel like is the whole industry to this day.
Back in this day it was literally just like, “Holy […]. (1) How do we make this work? And (2) how do we make sure it is not completely broken constantly? How do we make sure that people don’t just lose their money? And at the same time, how do we deal with this incredible volatility?”
About a year later, PayPal was removed from the exchange. They stopped being able to use PayPal. That same day someone [00:28:30] on the forum was writing and they said, “This market is going nuts. Yesterday, I saw a guy selling Bitcoin on eBay for $20 bucks. I thought he wouldn’t sell any right away. Sold all 30 to four different bidders in 12 hours. Now this morning I see bitcoinmarket.com at $23.99. I’m usually a buy and hold kind of guy, but this rapid growth is freaking me out. I only own 75 BTC, but I feel like the rich guy.”
That’s from mid 2011. In the early days, it was just literally people watching this. By the way, I think this is a nice little segue for whenever someone says [00:29:00] that Bitcoin was the easiest trade in the world, all you had to do is be around early enough to know, […]. And here’s why. Because this guy is like, “You have a thing that you bought for $1, that someone says it’s worth $20 and now you’ve got 75 of them.” It’s like, “You know what? I’ve got to treat my girl to whatever. I’ll sell half of them.”
I think about this all the time because I was advising a company in San Francisco that went through YCombinator in the same class as Coinbase in 2012, and every [00:29:30] founder got a Bitcoin in their Coinbase wallet or whatever. I’m the guy who just ignored it. I didn’t really pay that much attention to it. I spent a little bit of time with it.
I started subscribing to CoinDesk and whatever, literally as soon as it launched in 2013. I was going back through the emails, but I just never paid attention enough. There’s a huge number of reasons for that, but anyways, I think that it’s when we go back and look at how people felt the same way that we felt in 2017 when things were going crazy with the ICO market, in 2011 [00:30:00] when it’s going from $20 to $24 bucks, to $30, to back down to $17. Volatility has always been the background.
Clay: Okay. Let’s transition to Chapter 3, or Wave 3 which is about Mt GOX.
Nathaniel: Bitcoin Market was the first to kick this off, but it’s really Mt. Gox that captured everyone’s imagination. Gox has a fascinating history. I think most people are somewhat familiar with the story and the fallout from the hack.
Mt. Gox, the domain, [00:30:30] was originally registered in 2007 by Jed McCaleb, obviously known for Ripple and now for Stellar. He registered the domain in 2007, as the Magic the Gathering Online Exchange. It was originally a place to buy and sell magic cards, which is […]. There’s lots of weird connections to Magic the Gathering and crypto, but that’s a whole different podcast. It became what we know it as now in July of 2010. That’s when it actually launched.
Importantly, [00:31:00] it was really the next year. It was still being run by Jed when it started in July of 2010, but then in March of 2011 it was sold to Mark Karpelès, who’s a French citizen. Mark’s story is the one that’s been the most wrapped up with Gox.
Actually, let me put a little bit of context, too, of just how early this is. We’re talking about all these things. Bitcoin didn’t reach a $1 billion market cap until March of 2013. We’re talking about two years before that. For more context, [00:31:30] Bitcoin didn’t reach a market cap of $1 million until November 6th of 2010, and it didn’t reach $1 per Bitcoin until February 9th of 2011. So that’s really how crazy early we are. Another thing that happened in early 2011 is SilkRoad opens and I think in some ways the SilkRoad story is dragging out that prehistory wrapped up in the exchange story, because exchanges were used to move money in and out. That was then moved to SilkRoad.
It was really interesting though, [00:32:00] if you look at that early period in 2011, it is just such a land grab. It’s really clear. If we go back to this idea of what did an exchange do to grow at any given point? Well, back then it did a couple of things. One, it existed. That was step one. There weren’t that many that were able to do this and willing to do it and could exist. Two, it was basically about how do I provide this for a different market? End of March, this is 2011, Britcoin opens. End of March 2011, Bitcoin Brazil opens. April, [00:32:30] BitMarket.au opens. You see all of the global people who are watching what’s going on with Bitcoin Market and then Gox starts to register their own domains.
Really the part one and part two, they existed and then they may be found their own somewhat geographically relevant or fiat denominated relevance. But then, the second thing that they tried to do is not lose money and not be victim to hacks. It was crazy. Before most of us knew that this even existed, they had come and gone. [00:33:00]
In early 2012 we already saw the number two exchange in the US, Trade Hill, had shut down because it was worried about regulatory issues. In May, the third biggest exchange in the US is hacked. Really, if you look at this history, mostly it’s just the story of people losing money because hackers did something.
Anyway, throughout this time, again there’s huge number of exchanges and different people were doing different things on them, but Mt. Gox was beyond a shadow of a doubt, the leader. At peak, it handled somewhere between 70% and 80% of all Bitcoin [00:33:30] transactions, which is unfathomable, more than any single exchange now, obviously.
Obviously the bankruptcy, the shutdown, and all that has been well-profiled. Peter McCormick did an entire six part, seven part podcast series on this. Books have been written and will be written about this.
Basically February-March 2014, it came out. The “it came out” part is really important, that something like 850 Bitcoin that were worth about [00:34:00] $473 million at the time, more than $3 billion now, which was 7% of all Bitcoins at the time, had disappeared. They were just gone. And the problem was two things. One was, I guess that’s a pretty evident problem, but the additional problems were two things.
The first was that it had known about this something like eight months before it admitted it publicly. That’s problem one. Problem two is that this had been happening since basically the fall [00:34:30] of 2011. From within months of Mark Karpeles taking over of Gox, the hack happened. Effectively, someone was able to access the wallets and then they had a spigot on, where, this is a quote from the research that came out after, basically from when the hack happened for the next 2 years, in 9 out of 10 instances, coins on Gox were being stolen as soon as they came in. So it was just literally they were just gone, which is extra crazy to think about that $473 million [00:35:00] in value. The estimates of what the hackers actually made away with is more like $20 million because they were sold literally instantly.
Anyway, the Gox story is ongoing to this day. I guess the one important other detail, the super abbreviated, go listen to Peter’s podcast or go read about it. They were able to discover 200,000 Bitcoins in a wallet that had been untouched for three years. Of that 850 that were just gone, evaporated into nowhere, 200,000 we’re [00:35:30] suddenly back.
so the company went into bankruptcy protection and Mark Karpeles spent a year in jail, he was arrested for something different. He was arrested for manipulating data within the system, which is a whole different thing within this because that’s still ongoing, so we don’t even have to comment on that. The interesting thing is that there are just these 200,000 Bitcoins sitting there, right now, and we’re dealing now with Japanese bankruptcy law. Effectively what would happen, [00:36:00] I think—feel free to scream at me in the comments if I’ve got the substance of this wrong, but I think this is the gist of it—is that in Japanese bankruptcy law, creditors were only able to claim the cash value of the Bitcoins, not the Bitcoin value. So if they were paid back, they would be paid back in the cash value.
The problem is obviously the 200,000 Bitcoins now are worth a hell of a lot more than the creditors who have come in, and based on Japanese bankruptcy law, what was left would go to [00:36:30] Karpeles, who was basically the biggest and effectively one of the only shareholders. So he would have this huge windfall, and he doesn’t want that because he’s like, “My life is already ruined. I would have even more death threats than I have now.”
So there’s this whole crazy plan. It’s one of the first times in history that a company has gone bankrupt, but the assets that it has on its balance sheet have accrued so much value in the interim that it would make money for the people who put it into bankruptcy.
And so it’s going through this whole process now. They’re trying to basically engineer what they’re calling [00:37:00] a civil rehabilitation, where they bring it back so that they can distribute the assets. But it’s crazy. To this day, it casts a shadow on the industry.
Bitcoin was in a bear market for two years after the discovery of the Mt. Gox hack. For some people it was still what Bitcoin is associated with right up there with the SilkRoad. It really wasn’t, in some ways, until the Altcoin movement began and Ethereum started to become a thing, and this idea of smart contracts enabling the easy production of new tokens [00:37:30] became a thing, that a whole new wave of exchanges who are offering something fundamentally different and coming at this from a different way, started to rise to prominence.
Now, of course, they were building. Kraken was around this whole time. Kraken even, at one point, was trying to help Mt. Gox solve it […] before it just peeled off and was like, “No thanks, guys.” Jesse Powell was there really early, and you had Poloniex, and you had Bitstamp and all these companies, they were starting around the same time, 2013, 2014, but again, I think if you look at the big [00:38:00] successive waves of history and what happened next, there was a long incubatory period before a new type of exchange and a new type of exchange activity storms onto the scene in 2017.
Clay: A few things stand out. One, I think you are spot on when you said that it was really hard to hang on to Bitcoin if you got it early. For one, say you bought something at 50 cents or a dollar, you see it go to 200, your reference point is just so low, you’re probably incredulous. [00:38:30] You might sell it, too. If you don’t sell it, there’s a good chance that it might be stored in Mt. Gox or in one of any other number of exchanges where it could have been taken from you, hacked, stolen.
In addition, you might have had either a paper wallet or gone the manual route and created a private and public key pair and maybe you lost the hard drive. There were a lot of things separating Bitcoin from people, or there have been along the way.
I’ve read an analysis saying, [00:39:00] I believe it is between three and four million Bitcoin have been lost forever. Or at least it appears that way based on chain analysis. That strikes me as pretty accurate. That is believable to me.
I think the other thing, before we get into Ethereum and the amazing amount of creativity and financial engineering, both good and bad that stemmed from that, both in terms of different token types in ERC 20 tokens [00:39:30] and also the ecosystem that allowed for the first decentralized exchanges to pop up. We should talk a little bit about Bitstamp. Bitstamp is the oldest running crypto exchange right now. Is that correct?
Nathaniel: Let’s put it this way. There’s a very small handful of exchanges who could plausibly say that. Bitstamp puts it up and center. They have a pretty good claim to it. Like I mentioned, Kraken has been in the game for a really long time. Coinbase has actually been in the game for an enormously long time, [00:40:00] but Bitstamp can lay some claim to that for sure.
I want to make it really clear that I’m using the classic historian tool of wiping out big entire things for the sake of making a narrative that makes sense in a limited time. There was a ton of stuff. Bitstamp is a great example. Coinbase is a great example. Kraken is a great example. Poloniex. They are great examples of there’s a huge amount that was being built in those dreary years of 2014, 2015, 2016. I don’t want to diminish them at all by not [00:40:30] having a name for that phase. I just think that in some ways it was, again looking at these really big broad brush strokes patterns, there was this fallout from Gox that was really only starting to pick up, I think, in 2016–2017.
Ryan Sulcus was maybe the first person, obviously since Ryan worked at Coindesk for a long time as NTCG, he runs Messari now, and he broke the story in some ways of Gox. On his Two-Bit Idiot Tumbler on February 24th, 2014, he wrote, “I have received [00:41:00] an unverified report from an otherwise reliable source, which is purportedly from Mt. Gox, the document, which is titled Crisis Strategy Draft, outlines the current situation at the exchange. I trust the authenticity, but have work to do to verify the document 100% by myself. I will do so feverishly.”
It goes through the whole thing and the introduction to this document is insane. This is one of the quotes, “At the risk of appearing hyperbolic, this could be the end of Bitcoin at least for most of the public.” And then Ryan ends on, “This is catastrophic and I’m sorry to share this. I do believe [00:41:30] that this is one of the existential threats to Bitcoin that many have feared and have personally sold all of my Bitcoin holdings through Coinbase. To do so and I’ll give you the same information would be dishonest and amoral. I’m a risk tolerant investor, but I believe this will be catastrophic for Bitcoin, both as a currency and as a fledgling industry. If this is a hoax, it is one I am fully blindsided by. I fear however that it is not.”
He got […] for this big time for the next week or so before it actually proved to be true. It was bleak, man. It was really dreary. I wasn’t in the industry but you could feel it palpably [00:42:00] in San Francisco, just the wave of shudder. For people who were only watching casually, this is what it sounded like. It did seem apocalyptic.
Well, that concludes part one of my conversation with Nathaniel Whittemore. I hope you enjoyed it. Before you go, I want to mention that since we’ve started producing episodes at a [00:42:30] much higher rate, we now have room for a few more sponsors. If you like the work we do and would like to support this show, then a sponsorship might be a good fit for you.
I can say from our own experience that Flippening sponsorships work. Each and every time we put out an episode of this podcast, we mention our own API. To date, every single one of those advertisements has resulted in at least one customer. In fact, we would do these shows even if nobody else sponsored because of the business it brings to us. Over 80% of paying customers mention that they heard of us through our podcast. [00:43:00] If you’re interested in sponsoring the show, please hit us up at firstname.lastname@example.org.
Okay, that wraps up things for this week. Stay tuned for part two of my conversation with Nathaniel Whittemore which will be released next week. Until then, take care.
That’s it for this week. To sign-up for our free crypto investing newsletter, listen to other episodes, or get the show notes from this episode, please visit flippening.com. I also invite you to check out the startup that funds this podcast, Nomics [00:43:30] at nomics.com. Finally, if you got value from the show, the biggest thing you can do to help us out is to leave a five-star review with some comments and feedback on iTunes, Stitcher, or wherever you listen to podcast. Thanks for listening and see you next week.
Part 2 Transcript
Clay: Welcome to Flippening, the first and original podcast for full time, professional, and institutional crypto investors. I’m your host, Clay Collins. Each week, we discuss the cryptocurrency economy, new investment strategies for maximizing returns, and stories from the frontlines of financial disruption. Go to flippening.com to join our newsletter for cryptocurrency investors and find out just why this podcast is called Flippening.
Clay Collins is the CEO of Nomics. All opinions expressed by Clay and podcast guests are solely their own opinion and do [00:00:30] not reflect the opinion of Nomics or any other company. This podcast is for informational and entertainment purposes only and should not be relied upon as the basis for investment decisions.
Welcome to the final installment of this two-part series on the history of crypto exchanges. Once again, I’m joined by Nathaniel Whittemore, freelance crypto communications strategist and curator of Long-Reads Sunday on Twitter.
As I mentioned in last week’s episode, this [00:01:00] conversation is part of a larger series that we’re doing on crypto exchanges. As part of this series, we’ve already interviewed Binance CEO Changpeng Zhao, also known as CZ, Binance CFO Wei Zhou, Ivan Poon from Switcheo, Alex Wearn from IDEX, Sam Bankman-Fried from FTX–they’re also the creators of the FTT token–and John Jansen from Deribit.
Upcoming interviews include the CEO of Liquid and the founders of 0x.
[00:01:30] As a side note: if you run a top 50 exchange by volume, I want to speak with you as part of this series. Please reach out to set that up.
Now for a bit of background for this episode, for the past few years, I’ve been doing a lot of thinking about cryptocurrency exchanges, exchange data, and how to combat exchange spam. On top of this, all of the data on Nomics.com–which is my startup–comes directly from crypto exchanges or is derived from exchange data. [00:02:00] Because of this, we do a lot of interfacing with exchange businesses.
Given this interest, Nathaniel and I are teaming up to write an article about the history of cryptocurrency exchanges and this conversation reveals some of the things we’ve learned while writing this article.
In this two-part series that you’re listening to right now, we explore the main ideas from that article that Nathaniel and I are writing together and share our understanding of how cryptocurrency exchanges [00:02:30] and the crypto exchange ecosystem has evolved over the years.
This conversation is broken up into five chapters. In chapter one, we discuss the pre-history of Bitcoin and how regulation from that era still affects us today. In chapter two, we explore the first crypto exchange that launched only a year after Bitcoin went live. In chapter three, we dive into the Mt GOX debacle and the related fallout. In chapter four, we discuss the rise of ICOs and the rise of Binance. [00:03:00] Finally in chapter five, we close our conversation by exploring current trends in the crypto exchange ecosystem.
In last week’s episode, we covered chapters one through three. In today’s episode, we focus on chapters four to five. We’ll get right to this episode in just a second, but before we get started, I’d like to pause for a moment to tell you that this episode is brought to you by the good folks at Nexo, here’s a word from them.
Nexo is the only lender offering instant crypto credit lines, which let you use digital assets as collateral to get cash in 45 [00:03:30] fiat currencies and stablecoins. Nexo is also a strategic partner of exchanges, OTC desks, and crypto funds through its portfolio of structured financial products. Institutional counterparties can earn up to 8% annually on their idle stablecoins, enter into asset swap agreements, or directly borrow crypto.
Individuals can also park their cash and stablecoins in a Nexo interest earning account to get an annual return of 8%. What’s more, interest is paid out daily and you can add or [00:04:00] withdraw funds at any time.
If you’re looking to borrow, lend, or swap digital assets, Nexo is your go-to partner. Definitely explore nexo.io or if you’re an institution, you can reach out to them at email@example.com.
This episode is also brought to you by the Nomics API and CSV Data Export Service. If you need an Enterprise-Grade Crypto Market Data API For Your Fund, Smart Contract, or App, or if you need historical CSV dumps of trading data [00:04:30] or crypto market cap data from top exchanges, or even obscure ones, then consider trying out the Nomics API or our historical data export service.
Our cryptocurrency API enables programmatic access to clean, normalized, and gapless primary source trade data across a number of cryptocurrency exchanges. Instead of having to integrate with multiple exchange APIs of varying quality, you can get everything through one screaming fast fire hose. And if you’d like to order historical cryptocurrency data as CSV exports from top exchanges, [00:05:00] email us at firstname.lastname@example.org.
Okay, back to our regularly scheduled program. Here’s part two of my conversation with Nathaniel Whittemore. Enjoy.
Let’s transition to chapter four or wave four which is about the rise of altcoins and the ICO boom.
Nathaniel: [00:05:30] So then fast forward a couple years and people who haven’t been paying attention for a while, all of a sudden they’re hearing about money flowing into the system again. There’s these new things called ICOs that are happening, initial coin offerings. It’s not just little bits of money, first it’s $20 million here and people start to take notice, and then it’s 30 million, and then Bancorp raises $150 million. All of a sudden, everyone’s attention is pointed squarely back over in the crypto industry. And with it, obviously, came a new [00:06:00] type and a new phase of exchange.
This is the, I think in some ways, the next wave of exchanges where the ones who came up to, or in and around, or who were popularized, like a lot of these exchanges that existed for a while. But the shift to enable these ICOs and have such an emphasis on this idea that projects could announce a token sale, sell a bunch of that token, and then people would just sit feverishly waiting for an announcement about whether they would get listed.
[00:06:30] Talk about shifting the exchange model again. All of a sudden we’re not talking about just exchange fees, we’re talking about listing fees as a major source of revenue in ways that were not necessarily good for the market.
Clay: Absolutely. I experienced this firsthand. I was watching from afar. I was huddling a little bit before this, but this is when I came into it and I remember listening to Charles Hodgkinson I believe it is. The Cardona guy.
Nathaniel: Yeah, from Cardona.
Clay: [00:07:00] I remember listening to an interview with him talking about Ethereum. It was before it had launched, and it was one of the most interesting things that I had heard in a long time. The presale hadn’t happened yet. In lot of ways, it was a rebirth. It was a fresh start. A lot of developers that I knew had commented that there wasn’t much that they could do with Bitcoin other than buy, hold and watch the price. But with Ethereum, they actually could tinker around, they could start writing smart contracts. [00:07:30] It gave them something that they could interact with the ecosystem in a new way. It just breathes so much life into the space.
Of course, that came with its downside as well. But I think in the end it proved to be a net positive for the space. But yeah, this definitely is another epic in the story of crypto.
Nathaniel: All of these assets since the beginning of their existence, there’s been a never ending and will never end, by the way, narrative competition for what they mean. [00:08:00] But what’s inarguable is if you look at Bitcoin, it digitized value in a way that had never been possible before. It digitize the ability to exchange value. And because of that, developers got hugely excited in ways that they could program that digitized value in different ways and do things with it.
But a lot of them weren’t able to do what they wanted, and so Ethereum comes along and basically introduces this idea of being able to program that value in new ways and set the logic of exchange based on [00:08:30] predetermined ingredients. This is the idea of smart contracts.
Obviously, Ethereum wasn’t the first people to have the idea of smart contracts, that predated them quite significantly, but they operationalized it. And part of what they did was they created an easy way for people to mint their own tokens, and that ended up having just massive implications.
I think, again, I don’t want to get too far out of the scope of this exchange conversation, but part of what happened and why [00:09:00] I think there was such an explosion of tokens is that this coincided with if Bitcoin was a critique of the financial system and a money system that had since the 70s been off the gold standard, dictated by the US petrodollar, and was increasingly focused on central bank integration or interaction with the markets. Bitcoin represented a break from that, an answer to that.
Ethereum represented, and a lot of the projects that would come to be built on Ethereum, I don’t want to ascribe this to the [00:09:30] founders of Ethereum necessarily, but what it came to be for a lot of people was a potential liberation from these web 2.0 platforms, which at their earliest days had theoretically been about empowering people.
The difference between web 1.0 and web 2.0 was that all of a sudden people weren’t just consumers of content and things on the internet, they could create them as well. That’s why you saw Bloggr, and you saw WordPress, [00:10:00] and you saw people start to write, and then you saw these photo platforms. And then pretty soon you started to see the social platforms. The social platforms turned out to be content platforms and social things all wrapped up together.
Obviously we know how the story goes, but these were originally about giving people more ability to create the world around them. But what happened accidentally is that they created some of the most powerful business monopoly opportunities that have ever existed in the history of human existence, because of how [00:10:30] powerful the networks are around social networks or anything that is dictated by a social network, the lock in effects and the ability to create incredible switching costs. Both from the standpoint of social pressure in the case of something like Facebook, or sheer data in terms of something like an Amazon, created just this huge challenge.
If you look at Chris Dixon from Andreessen Horowitz, he wrote this essay called Why Decentralization Matters In Early 2018, and he effectively talked [00:11:00] about a thing which I called the extraction imperative, which is that at a certain point, these networks, businesses, grow so big that there’s not enough room anymore to expand horizontally or linearly in terms of just getting more users. They have to expand vertically by extracting more from their users.
In his estimation, we had hit that point. And so the only thing left was for each of these networks to start to extract more and more. Sometimes that was in a direct dollar value in the case of Amazon. [00:11:30] Other times it was actually just in terms of data, which could be converted to value.
The idea of crypto networks or crypto mediated networks was to blow up the distinction between a network owner, the Bezos and Amazon Board, and whatever, and a network participant, IE, the Amazon user. And the way that you would do that is by having a token. So all the value basically would accrue to the token, not to an equity. So everyone who was a token holder was effectively a network owner as well.
No differentiation between network owners and network participants? [00:12:00] Boom, no more extraction imperative. This was the dream. This was the idea. This created an incredible momentum for people being excited about, okay, well then how do we decentralize? This was the tokenize the world era. This was the decentralize everything era. And so people were looking at how do we decentralize SoundCloud so that artists own everything? How do we decentralize content production, so that instead of the value accruing to the network owner, it accrues directly to the people who are creating the content itself? Tokens were the mechanism for all of this.
[00:12:30] We forget actually sometimes that the legitimate original idea, at least from an intellectual standpoint, of why have a token sale at the beginning, was you needed a way to distribute enough tokens that there were actually this critical mass of owners. Basically, tokens allow you to bootstrap the value of the network. It allows for, instead of having this very long slow ascension where it’s only true believers who are willing to put in time, you create this new layer of incentive by giving people a financial incentive to also spend time there.
[00:13:00] What happened in practice obviously was a little bit different. Tokens had going for them something else too, which is that they were the easiest fundraising mechanism that had ever existed. We’re talking instantaneous, we’re talking global, we’re talking unregulated by and large. They’re being retroactively regulated now.
It was a fricking bonanza. You saw, in the course of a year, the amount of money flowing into early stage projects through crypto tokens [00:13:30] radically outstripped the amount of money flowing into projects through traditional early stage VC. Because everyone was a potential buyer. Out of the scope of this conversation in terms of the good, bad, and ugly of that, but a huge part of the fuel of that fire was the fast liquidity that came from exchanges. A lot of the exchanges that we know now were either born, literally, in terms of their timing or came into their own during that period.
Clay: It was a fascinating time. I think one of the problems it solved among people who really didn’t understand the technology, I think there was a real desire to get in at the ground floor of something new, and yet, and simultaneously, be able to have liquidity to be able to turn around and sell that asset. If you’re not an accredited investor in the United States, you’re not getting access to early-stage exciting deals, and a lot of people want access to that and never even know that they could.
[00:14:30] VC funds and early-stage equity, you’re typically having to hold on to that for at least five to ten, sometimes twelve years. That isn’t good for consumers either. It allowed for early-stage access and combined it with liquidity, I think de-risks any investment.
Of course, the upshot was now you had some of these projects that have raised tens of millions, hundreds of millions, in some cases a billion-plus dollars that had a public relations situation on their hands similar to a public company. [00:15:00] You had hordes of people in Telegram asking about what was happening, many of whom spent money that they really couldn’t afford to spend on a project, and it might tank. There was a public relations overhead. People were getting death threats, and you had sudden movements.
You had a group of people that still hadn’t shipped up a project. In some cases, or in most cases, they hadn’t shipped anything at all, having to deal with the investment interests of folks, [00:15:30] a lot of consumers that had invested millions, hundreds of millions, or billions of dollars. Of course, that can prove to be really distracting. Just look at the example of Tezos for example. Yeah, this was just a crazy, crazy, crazy time. I still look back at the numbers that were raised back then, and it’s just dumbfounding. It’s absolutely absurd, but it was filling a need.
Nathaniel: Let’s go back to this idea of each [00:16:00] of these phases has an iconic exchange, or at least one iconic exchange.
Nathaniel: Unarguably, the iconic exchange from this period was Binance. I mean, again, people were using lots of different exchanges, but Binance came out of nowhere and I mean literally, within months, just had soared to become the biggest exchange in the world.
The story goes that CZ was at a dinner party and someone told him about ICOs, and he was like, “Well, I can do that. [00:16:30] We can totally do that.” CZ had been building software for other exchanges for the last year or two. He had been in exchanges for a while at that point. He had an intimate understanding of the business. He had an intimate understanding of the technology behind the business, and he had been looking for his own ideas.
Then he saw this ICO thing. Something like two weeks from the night and this is all self-reported, obviously. This is what he said on another podcast, and you actually interviewed him, so maybe you got into the story too. Anyway, two weeks from that, they had written the white paper [00:17:00] and they did their ICO, and they raised what was, in comparison to a lot of these companies, a modest $15 million in BNB. I think that thus begins the ways that Binance started to push this field.
BNB, fast-forward to now, during last year’s bear market it was one of the best-performing assets of the year. It might’ve been the best-performing asset. I can’t really remember. BNB brought with it all these innovations inherently in the exchange business model. [00:17:30] You could use BNB to pay for your trading fees to get a discount on those trading fees. Depending on how much BNB you held, you could get an even further discount. If you actually locked some of that BNB up.
Binance’s profits, part of it was distributed back to token holders in the form of quarterly, or monthly, I can’t remember, burns, where a preset amount of the total profit was burned in BNB. The idea there being less supply means potential positive price pressure on [00:18:00] BNB itself, which is effectively a very interesting and roundabout way to distribute value to your shareholders, in a world where there’s no shares and there’s no shareholders. You have all of this starting, and exchange tokens rewrite the game for everyone. Every other exchange looks over and says, “Well, shit, we should do that.”
Then I guess there’s one other part. There’s multiple phases, I think, to the Binance story. We’re still just at the early ICO one. I think that a couple other things that I think are worth noting is, one, they were avowedly, at the beginning, just digital currency to digital currency. They weren’t the first to do that. [00:18:30] Others were doing that as well. They really embraced that as the operating model and what the implication of that was, which is if you deal completely outside of fiat, you can also potentially play the regulatory arbitrage game in a way that no one else has. The company was started in Hong Kong, moved to Singapore, moved to Japan, moved to Taiwan, moved to the Cayman Islands, finally landed in Malta. This is before all of the changes that we’ve seen in the last year as they’ve started to build their own fiat-based exchange like that.
[00:19:00] As they were becoming basically the fastest-growing startup in the history of the world, which they were in their first six months, and as they were becoming the biggest exchange in the world within their first six months, and as they were becoming basically the first unicorn to reach that status profitably as they were in their first six months, they were also doing so building this global team that was everywhere and nowhere all at once, effectively. That combination of both immediate innovations around the way that you could use a token in the context of an exchange, [00:19:30] as well as that really fleet-footedness when it came to where an organization is built and how an organization is built, just catapulted it into a totally different place in the world.
Clay: I interviewed CZ. It was one of the best interviews on the Flippening podcast. I have some of the notes from that that I think puts all of this into perspective. It’s important to note, a lot of people have wondered why Binance grew so quickly. I have really grappled with this. [00:20:00] It’s again the fastest-growing, probably, startup in the history of the world. To do that bootstrapped is just pretty amazing.
It’s worth noting that the trading system and the matching engine and all that, that Binance launched, was the fifth generation of a trading system that CZ had been working on with others. Prior to launching Binance, CZ and his team provided white-labeled crypto exchange infrastructure for exchanges [00:20:30] that would handle regulatory stuff. They would handle liquidity. If there were fiat onramps, they would handle those. Binance would either fork the code base or provide a version of it in the cloud.
They had a lot of these scaling issues dialed in. Not only did they have them dialed in, they had them dialed in for different types of exchanges, that each came with their different kinds of problems and challenges [00:21:00] technically. They were able to focus on execution. They didn’t have to spend as much maker time just staring into the abyss, trying to solve difficult technical problems.
When it comes to the ICO, they had around 50 people working on it. I can give you a timeline of the ICO. Here’s how it went down. CZ heard about ICOs at a potluck, 14th of June, 2017. Within three days, [00:21:30] he had a white paper written in both English and Chinese. The ICO began nine days later. Within one week the ICO was wrapped up, and they had raised $15 million.
Within five months, Binance was the world’s number one crypto exchange by volume. From there on out, it takes Binance three months to get 120,000 users, another three months to get to 1 million users, and one more week to reach 2 million users. [00:22:00] It’s just an incredible execution path, but it’s also coming from someone who had been working on trading systems in the traditional financial world and then crypto for 10-plus years. He had really put in the work, but man, did they ever execute.
Nathaniel: They were in the perfect position to capture it, and they just did. They were able to leverage that and just create so many more options for consumers. People wanted to be able to buy all these different things. People were passionately researching [00:22:30] coins. People were in Telegram groups looking at coins. Binance was the place. It was the long-tail market, right? It’s where you could go for all of that stuff. The rate at which they were adding coins also was an execution question for most exchanges.
Clay: Let’s kick off chapter five or wave five which is about the current trends in the crypto exchange space.
Nathaniel: Throughout 2018, the price of Bitcoin had been decreasing. For the first month when it went precipitously down from its peak of 20,000, [00:23:00] people were able to just write it off, and ICOs were still happening, so whatever, right? Then it got down a little bit farther and it hovered at 6,000 for a while.
When it stuck there, ICOs were starting to peter off. Bitcoin had been at 6,000 for a really long time. Then it went even lower, right? It eventually got down into the 5,000s and then 4,000s and then the 3,000s even. While that was happening, obviously the altcoin exchanges had to think differently and they had to start [00:23:30] thinking about different approaches, because you couldn’t just get huge listing fees and have that same ecosystem. You couldn’t raise pre-listing rounds from private investors by telling them how many people you had in your Telegram group anymore, let’s just put it that way. Of course, exchanges aren’t just about spot trading, right? Exchanges in the traditional world offer an entire different set of ways to bet on assets and bet on the price of assets.
[00:24:00] I think that the exchange that was the most closely connected in a lot of ways, in terms of the broad public narrative within the crypto community and within the Bitcoin community in the back half of 2018 and the beginning of this year, was BitMEX. BitMEX stepped into the “Just waiting for alt season to come back” void by offering more traditional margined products and futures products and derivative products for Bitcoin and for a small handful of the other assets. [00:24:30] Obviously, there were many other exchanges that allowed trading with margin, right? Bitfinex, for example. We haven’t even talked about Bitfinex and Tether, but the difference was a couple things.
One, speaking of monster executors, Arthur Hayes, I think, has that eye of the tiger in a way that CZ does and a few others do in this space, right? He’s loud, aggressive. He built a brand really quickly.
Clay: Hey, this is Clay cutting in [00:25:00] to give a bit of context about Arthur Hayes. Arthur is the CEO of BitMEX. At the time of this recording, BitMEX does 1.7 billion dollars of volume each day. Ok, back to the show.
Nathaniel: Beyond that, they were innovating within that different space, right? Their experience was a little bit different. They had come out of traditional financial markets. They were traders, through and through and through. Right?
Arthur Hayes, one of his favorite phrases and sayings that you see him post on Twitter all the time is “Good traders go both ways.” [00:25:30] The idea of this is that if you’re a good trader, you can make money if the market’s going to […] or if it’s going great, right? In a lot of ways, the best traders prefer when markets aren’t that good, because it crowds out, blocks out a space for a lot of the others, right? When everything’s going up 20% overnight, everyone makes money on that.
One, they had the DNA of a different type of trader that was much better designed for a bear market in a lot of ways. Second, they were innovating around what a derivatives product [00:26:00] might look like for something like Bitcoin, right? They invented this perpetual swap mechanism where there was never really an expiry on the futures. They were just continually expiring and restarting, which created a totally different dynamic. I mean, from an addictive perspective, you could always be on, right? It’s a very different type of future. That was their innovation.
Then thirdly, and I think really importantly, they allowed a whole different level of margin. They allowed something like up to 100X margin, which is [00:26:30] obviously crazy. You were seeing, in some of the other people that you could trade with margin, you were talking about like 3X margin as compared to 100X. I think that it was fascinating to me. This I was something I was watching as it was happening, not just in the context of going back and looking at the history. There was such a clear, distinct shift, where everyone was hanging out on Binance in 2017, and then all of the action and energy around trading was BitMEX last year, especially the back half of last year. [00:27:00] Which I think is just fascinating, and shows again just how quickly things move.
Clay: When there is permissionless innovation around financial products and financial instruments, people will create them and people will use them, and money will be there to be made. I think coming off the ICO craze, where there were so many different projects and so many different things you could get involved in, when that all came crashing down, people still wanted options around investing in this [00:27:30] new asset class.
You’re right, there was no option really for shorting. There was no option for getting leverage. If you had a great deal of conviction, there was a cap on the amount of money you could make with your investible assets. This really gave investors or degenerate gamblers what they wanted. They absolutely met that need and scratched that itch.
As part of this interview series I’m doing with exchange operators, [00:28:00] one of the things that I’ve learned is how hard it is to start a leveraged derivatives exchange versus a traditional spot exchange. That’s why for a very long time, there was only one player in town when it came to shorting and leverage, really, and it was BitMEX. One of the reasons why it’s hard to do this is just because of the enormous liquidity demands that are required to operate this kind of exchange.
It is often [00:28:30] the case that these derivatives exchanges are doing far more volume than anyone else on a given day. I mean, I don’t know what it’s like today, but three months ago, six months ago, BitMEX was routinely outperforming every other exchange in the space in terms of volume. It was just crazy the kind of numbers that they were posting.
Nathaniel: Yeah, which I think is reflective of this idea of the story of exchanges, in this space in particular, is constant innovation. [00:29:00] What is the product that is going to actually get people excited? I think different products have that. Let’s take an example which is interesting because I would argue that the growth in derivatives and derivatives trading is one of the major shifts and trends that we’re in right now as it relates to exchanges, with a couple others that I think we should get into.
Then there was another one that seeped at the beginning of the year. It was a big hotness, [00:29:30] but that is a thing but it’s like not nearly as significant, I don’t think, in terms of scale and size, which is the idea of IEOs (Initial Exchange Offerings). Again, innovation coming out of Binance. They started Binance Launchpad, which was effectively like an initial coin offering where the first listing was all bundled into it. It was very different than ICOs in some ways, in the sense of there were very serious caps on how much you could spend. There were caps on the number of different people who could spend, [00:30:00] who could buy, all these things which prevented it from being this big, crazy thing.
I don’t think that IEOs have gone away. I think every week it seems like there’s some new analysis about how IEO coins are performing, because it’s still such an open story. IEOs, I think in some ways, if you are not cynical in looking at them, are I think trying to get back to that idea of there needs to be a mechanism for these networks to distribute and bootstrap their network, which comes from a token sale, [00:30:30] but it needs to have some limits imposed on it so it’s not just a crazy thing like the ICO boom was.
I think that the verdict is I don’t think it’s totally in yet on IEOs. If anything right now, they feel like a part of the ecosystem, where places that are doing token sales often look to IEOs as part of them, but in some ways it’s a small percentage of the totals tokens are selling. It’s largely signaling, and it seems like it’s much more in line with [00:31:00] a rational market.
IEOs, when they first came out, people were like, “Oh, crap, is this ICO 2.0? Is this going to be the big thing?” In the meantime, I think if you’d just look at the actual volume of activity, IEOs didn’t create a new alt season, but derivative markets have created a demand for everyone to get into that space.
Clay: I think IEOs are really fascinating, and something where if this trend does continue or if this gets figured out, I think this [00:31:30] does belong in the history books. Traditionally when companies went public or got listed on exchanges like the New York Stock Exchange or NASDAQ, companies like Goldman Sachs would take them public, investment bankers who would underwrite all of this. Yes, they did have a stake. There was alignment around the success of the IPO.
IEOs have taken that to a whole new level. In some cases, you’ve got a company like [00:32:00] Binance which will own some percentage of the total thing, like a VC would. They have some stake in the project itself, and they can bring to that distribution for the tokens. Simply getting listed on Binance is enough to have the value of your tokens pump quite a bit. One, it exposes you to a whole lot of people that are interested in that kind of thing. [00:32:30] Two, it lends legitimacy.
Binance has several hands in this pot. They own a percentage of the tokens, they’re getting trading fees, and they have the ability to really, really promote this. While I don’t think IPOs are perfect, I do think that there is a nice separation of interest. The New York Stock Exchange wants to list it because they make money on data and trading fees. [00:33:00] Goldman Sachs has a different set of interests. The company has a set of interests. It doesn’t seem to all be as conflated as it is with IEOs.
That said, these exchanges do have some skin in the game. They are putting their reputation on the line. They are investing a great deal every time they list a new token, probably more so in terms of opportunity costs than anything else. It’s an interesting phenomenon. It still doesn’t feel totally right to me. [00:33:30] I think it’s interesting that an exchange that came to be and really blew up during the ICO age is pioneering a lot of these things. It’s really hard to shake your own origin story or the preconditions that led to your success.
I can’t help but imagine that you’ve got an entire team of people at Binance that grew their personal wealth quite a bit during the ICO era, doing a lot of things [00:34:00] to set the stage for this with IEOs. A fundamental part of this is Binance Chain and Binance DEX. I mean, you simply could not pull this off on a centralized exchange without incurring a whole lot of regulatory risk. When you put it on a decentralized exchange and you set up something where there is no single throat to choke and where no one can actually stop what’s happening, you do get rid of some of that risk. [00:34:30]
It’s fascinating and I can’t wait for the perspective that a couple more years will bring to what’s happening, because again, it’s so many things that were previously separate, centralized under one roof. It’s interesting how a lot of things are being decentralized in this new financial system, but a lot of things are being centralized, like custody and trading and a whole lot of other things. IEOs is one of these [00:35:00] things where it does seem to be like a lot of things are being consolidated that weren’t before.
Nathaniel: We’re now kind of shifting into the “Where we are now” section. This is a living history that’s going on right now. I mean, these things are happening so quickly. We started with this theme of self-disruption that you were just bringing up, too. You have the derivatives piece we were talking about. You have DEXes and this idea of decentralized exchanges and what they represent. They’ve been around for a while, but they’re really started to have their breakout moment, [00:35:30] I think, particularly with Uniswap this year, and are going into new places now as well.
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Okay, back to the show.
Nathaniel: Then you have this third aspect which I think is worth noting as well, which is compliance. I feel like you have the same companies that were the most aggressive about playing the regulatory arbitrage game before, are now, while simultaneously doing that, also playing the regulatory compliance game. This is a major trend that you’re seeing nasty listings now of assets [00:37:00] where people are getting rid of tokens that they think are going to be securities.
You have some companies that are moving from the US for lack of regulatory clarity. Then you also have companies like Binance, who in some ways is like the poster child for regulatory arbitrage, who has geoblocked US users now from its site, or is in the process of doing so, but who simultaneously has opened binance.us, with seven assets to start, and is doing so with Catherine Coley at the helm [00:37:30] and is doing things in an extraordinarily compliant way, trying to really compete with Coinbase.
I wouldn’t go so far as to say that the Wild West phase of this market is over. I think that there’s going to be people who are going to work around the cracks and find the opportunities, and we haven’t even touched on still the continued rampant issues in terms of data transparency and everything there. You do seem to see a shift where effectively, regulators are starting to catch up, and a lot [00:38:00] of these exchanges are coming to meet them as they join the party, so to speak.
Clay: They have the money, too, now. It’s funny when startups are small and movements are new and there aren’t incumbents, no one’s for regulation. Everyone’s for permissionless innovation. The second you have a big pile of cash and a staff of attorneys, now regulation turns into a really convenient moat to defend your existing position. The treasuries of these exchanges are no joke. [00:38:30] I mean, they have the money to play with the big boys in terms of regulation, and they’re ahead on technology and product roadmap and such.
I feel like we’re seeing the shift from these leading exchanges as cowboys to, in some ways, defenders of the status quo, because they can lean on regulation or regulatory compliance as a competitive advantage. It’s something where other new entrants can’t play right now unless they start a decentralized exchange, [00:39:00] which has its own set of challenges.
Nathaniel: How do you see this evolving over the next few months? You’re really living inside the world of exchanges in a lot of ways now. You think about data all the time. You work with them around their data. You’re seeing what’s happening in terms of push for greater transparency. You’re watching their business models evolve in front of you. What do you think are the big trends pointing forward?
Clay: When we first started, if we were ingesting data from about a handful of exchanges, say around five, we could capture [00:39:30] 50% of the trading volume on any given day. Now in order to get 50% of the trading volume on any given day, you need to integrate with well over 50 exchanges. We are seeing this ever-growing long tail of volume. I think there was a time when a lot of people thought that there would be sort of this consolidation because of network effects around liquidity and such. I’m just not seeing that happen, especially when [00:40:00] you consider non-fungibles, security token exchanges, the ability for innovative exchanges to create their own financial products. You’ve got like FTX has created a bunch of index-based derivatives products where you can bet on a basket of […] coins and you can either go long or go short.
Whenever an exchange starts being weighed down by customer growth and supporting a huge customer base, [00:40:30] and then now they’ve got to deal with regulatory requests from various governmental bodies, that can weigh them down and it creates openings for new exchanges to come in and create novel products that the market is hungry for. And so we see this over and over and over again that every time we think there’s going to be consolidation, instead, what happens is the incumbents get blindsided by someone else who’s giving people what they want.
So there was a time that I thought that trading fees [00:41:00] were going to get squeezed out, or at least they were going to get smaller and smaller and smaller. Trading would become effectively free, like it is on the NASDAQ and the New York Stock Exchange. And all these exchanges would try and make money with their data.
And what we’re finding out is kind of the opposite, that data in a lot of ways is distribution for your trading pairs in your market. So if you’re a newer exchange, or you’re an exchange that’s on the rise, [00:41:30] you want as many aggregators of tickers, news sites, to have access to your markets. Because in a very real way, your product is these trading pairs. And you make money every time someone trades across them.
So you want as many people as possible to know when you’ve listed new tokens, when you’ve listed new trading pairs, when you’ve listed interesting derivatives products that allow you to get leverage, or sort of long or short, or do swaps, or own a basket of an underlying asset, [00:42:00] or at least a derivatives product that’s based on an index.
This creativity continues and marches forward. And if you’ve just come into the space, you might see Binance as utterly and totally dominant. But the truth is that they have been around for, I believe, just over two years here. And we continue to see new entrants come into the space and swallow up large pieces of the pie. So I hope it continues.
And I think, at the same time, [00:42:30] that there is sort of this proliferation of exchanges, some of which don’t look like traditional exchanges at all. They might allow you to trade domain names, or domains on the Handshake network, or whatever, other kinds of CryptoKitties non-fungibles. At the same time that there’s this proliferation, it’s becoming much, much easier to create an exchange. I mean, you could start one up. It wouldn’t have liquidity, and it wouldn’t have a lot of features, but you could start an exchange over a weekend. And using something like [00:43:00] 0x. I mean, there’s essentially sort of scripts that will allow you to create these fairly quickly. So anyone who can start an exchange can now. It really just comes down to liquidity.
And then I think maybe kind of sort of a third factor here that’s leading to the creation of all these exchanges is the opportunity for people who live in underrepresented markets to create fiat exchanges. I was talking to someone the other day who was interested in our data, [00:43:30] and they had started the largest fiat on ramp in, I believe, New Zealand. And it’s not a traditional spot market. There aren’t two sided order books or anything like that. They’re essentially running at like an OTC desk, and buying and selling their own Bitcoin. But no one else was providing fiat on ramps in New Zealand at the time that really understood that market. And it was just one guy working evenings and weekends.
So we’re seeing more and more of those pop up [00:44:00] in different places. It might not be a huge market, but it’s something where someone can come in, and have a fairly low barrier to entry, and start making a lot of money very quickly. So I see innovation in this space just absolutely continuing, not consolidating, not slowing down.
And while all of this is happening, we have entrants like BAKT that everyone was really excited about. And yeah, it’s [00:44:30] ICE which owns the New York Stock Exchange, that this was going to lead to a wall of institutional capital coming into the space. And so far that hasn’t proven to be the case. And what we found working with our customers is for the most part traders, even institutional traders in this space want to go to where the liquidity is.
They care less about the sort of all the institutional status markers, and they care more about can they make [00:45:00] the trade they want when they want it, and is there going to be someone on the other side of that. And if they need to quickly enter or exit a position, are they going to be able to do that without moving the market too much. So it’s really fascinating. And I see innovation continuing and the proliferation of exchanges continuing. I don’t see it slowing down, and I definitely don’t see it consolidating.
Nathaniel: I think that the next phase that we might be in for [00:45:30] is a fundamental reevaluation of what an exchange is. We had this idea of them as things like the New York Stock Exchange. Then all of a sudden everyone could start an exchange sort of in this kind of crypto world. And we saw the long tail exchanges and the derivative exchanges, and all this sort of stuff.
And then, what we’re seeing now is this programmable exchanges, and smart contract mediated exchanges. And I think that you are right that we’re going to see asset-specific type exchanges, like things like NFTs. [00:46:00] Exchanges might be built into other types of businesses. I mean, I just can’t imagine that it’s not. I mean exchanges can be built into wallet.
There’s just so much that could happen in terms of how the movement of this value occurs. It feels like for all this history it’s crescendoing. It’s getting louder and it’s getting faster. We could reasonably in this conversation, although still [00:46:30] kind of glossing over a lot, talk about these big waves that lasted three or four years at a time, two years at a time, then all of a sudden we’re down to six months at a time. And then all of a sudden we’re in three month intervals. And then all of a sudden everything is just shifting in front of our face simultaneously, and every week it’s not clear.
I mean, and we haven’t even gotten to, there’s so much competition, to what extent businesses are exchange businesses versus custody businesses is totally changing in front of our eyes right now. In some ways, it’s almost like a desegregation [00:47:00] of the exchange functionality is happening simultaneous to these incredibly powerful new institutions being built.
Clay: It’s fascinating to watch. And I think the kind of the regulatory is one that I think from a strategy perspective, it’s hard to know how this is going to go. I know Coinbase has definitely fallen on the side of being a regulated US institution. They have custody products, they’re doing. They have OTC desk, they’re doing everything they possibly can [00:47:30] to be compliant.
And at the end of the day, is that the strategy that’s going to win out, or is the the Binance strategy of kind of just, I don’t want to say throwing caution to the wind, but playing regulatory arbitrage, and sort of moving as quickly as you can, is that strategy going to win out? Maybe they both will, and the pie is just going to be so big that it doesn’t matter. I guess we are kind of caught up to today in terms of this conversation. Are there any other epics or phases that we haven’t covered, [00:48:00] or maybe just blips on the radar that you think merit some kind of mention?
Nathaniel: A couple of things. One is I think that the DEX stuff that’s happening right now is worthy of its own consideration. Because in some ways it feels like, I wouldn’t be surprised if it’s a break from the tree of exchange history in some ways. Where it kind of starts its own entire different thread where it really changes.
And I think you have a whole history of that with innovations that originally came from companies like Bancor that then got shifted. [00:48:30] It’s fascinating to look at innovations that were from a technology perspective programmed into Bancor, but really didn’t hit exactly until Uniswap because of just the different decisions in terms of how the system was architected, in terms of having a native token and things like that.
So I think that there could be an entire micro history of DEXS that that would be worth doing at some point that even though we’re only a couple years in is probably incredibly rich and fast moving as well. I certainly think that there’s [00:49:00] a whole open conversation to be had around Tether. And I shudder to even wander into that just based on the intensity of the feelings that it provokes on Twitter. But the reality is is that it’s another exchange.
I mean, it’s more complicated. BNB is officially the token of Binance, whereas obviously Bitfinex and Tether have a complicated and contested, let’s say, relationship that is being contested literally [00:49:30] week in and week out in the courts right now. But at the same time, what is pretty clear is that the team behind this exchange created the stable coin, which set the template for a huge amount of innovation in this space, which provided a huge amount of liquidity to the space. I mean Tether has had an integrity, whether you think it’s a systemic risk to Bitcoin, or the greatest thing that ever happened to Bitcoin, there’s no denying the important role that Tether has had in the Bitcoin story. [00:50:00]
So I think that’s one where again, it’s almost, I don’t know exactly where it fits into the epic. It almost kind of, to some extent, I guess it’s part of the kind of Allcoin and BNB story, but from a different perspective if were really creating a kind of liquidity mechanism for Bitcoin trading. I think it would be remiss to talk about the history of exchanges and business models without at least giving some mention of that.
Clay: I agree that those are kind of the two that stand out, [00:50:30] I think with decentralized exchanges. It was something that people were really bullish on, I think, in 2018, the end of 2017. I don’t know how many layers of decentralization we can all absorb. Just having decentralization of the underlying asset custodying that, that brings a whole set of challenges. But then to add decentralized exchange on top of that, it can be complexity on top of complexity for a UI that just isn’t there. And anyone who’s ever used MetaMask [00:51:00] can kind of attest to that.
So I think it’s a really important shift. And I think if there is a company that can pull this off it, it is going to be Binance just because they have the deep pockets, and they can kind of straddle these two worlds. And Coinbase also has a decentralized exchange as well.
With the Tether story, man, it’s so fascinating. To me, it just goes to show how important it is to meet consumer demand over all of this [00:51:30] what some people would consider regulatory mumbo jumbo and hand waving. On many days, in fact on some months, most days there is more volume for Tether than there is for than there is for Bitcoins.
So I’m looking at the nomics.com homepage right now, and we’re showing $15 billion in volume for Tether versus $12 billion in volume for Bitcoin. [00:52:00] And like most days, it’s kind of like that. And we’ve seen regulated coins come on the scene. There’s USD coin, there’s Paxos, there’s TrueUSD, which actually have no idea how regulated or not regulated that is. But nothing seems to have really caught up to Tether.
And maybe it’s just because they were the first actor, network effects around that token and the addition of trading pairs. You can only add so many [00:52:30] “currencies” in “currency trading pairs.” But it’s something that just continues to blow my mind and prove out the fact that when there is a need in this space, that need will get met no matter how unsavory the solution seems to be.
Nathaniel: There are a lot of folks that, I would say that the part of the Bitcoiner community that is pro-Tether or supportive, whatever, if not currently just in general, the reason for it is that permissionless. All those stable coins you just [00:53:00] mentioned are trying to play by the rules and trying to create a regulated type of offering that does some of the same things.
And they’re looking at cross-border settlement and things like when Wells Fargo announces that it’s making a stable coin for cross-border settlement, that it’s basically kind of taking the innovation from this and making its own system work better. Whereas what people are excited about Bitcoin for, and what people are excited about Tether for a lot of cases is the ability to move that type of [00:53:30] value quickly outside of the traditional system.
I think it’s interesting, there’s so much more even on the stable coin thing that we could get into. But just in Devcon this week, Mariano Conti from Maker gave a talk about how he’s avoided 50% inflation in Argentina by taking a salary exclusive in crypto since basically 2014. First in Bitcoin, and then Ethereum, or in Ether rather, and then now in Dai, which he’s been doing forever.
And you hear those stories, and obviously [00:54:00] he’s on the very bleeding edge of that being technologically sophisticated enough not only to receive his salary that way, but also to run Oracles and smart contracts for Maker. But at the same time I think that, again, that it’s easy to lose sight of the permissionless sort of this especially as one of these big trends is the compliant trend.
And in fact it seems entirely possible to me that one of the bifurcations that we see in this market is people stop trying to live in this semi-regulated space. There’s been a lot of semi-regulation [00:54:30] and people playing nice, but then also kind of trying to do their own thing as well. I wouldn’t be surprised if we see a really aggressive bifurcation where if you’re going to be a big business who’s playing in the exchange space in a traditional way, you’re going to do it in this regulated fashion. I think that Binance US supports that thesis to some extent. But then on the other hand, you’re going to have this totally different set of things that lives as a smart contract, that doesn’t have an organization that can be sued. That’ll be fascinating to watch that split. [00:55:00]
Clay: I think another interesting side note in this story about exchanges is the kind of the advent of exchanges as spammers. I think we have this idea, or at least I have traditionally of exchanges as regulated institutions. There might be some amount of blue collar crime, but over time that’ll be found out and eliminated. [00:55:30] And anything that does look sort of shady is some form of high frequency trading or wash trading. Something that has a fairly sophisticated set of terms and sort of financial concepts around it.
But what we’re seeing now with aggregators like CoinMarketCap, with the rise of sites like ours as well, kind of being at the top of the funnel, being the most trafficked websites [00:56:00] in this space, that is the aggregators, we’re seeing these exchanges engage in outright spamming. I don’t even think it deserves to be called wash trading because in many cases it’s not. It’s simply taking an open, close, high, low in volume sort of data, candles, and doing things like just multiplying the volume by a hundred, or by 50, or by what have you, so you can get to the top of the rankings so that you can get sort of clicks from these [00:56:30] traffic providers. That’s something that I think is new.
I have never really thought much prior to being in this business about exchanges as spammers. But that’s what we’re seeing, and it’s really unfortunate. And I think the solution is really to just open up the spam combat playbook like Google has. It’s a never ending war. It’s not about sort of having a be-all-end-all, sort of one algorithm that sort of solves this. [00:57:00] It’s something where every time you sort of fill a hole, or sort of come up with a solution for filtering out spam, spammers come up with another way of trying to get through it. It’s something that I didn’t think about when I first got into this business.
Nathaniel: Right now, is it getting better or worse? I think you spend more time on this, but I could give my impression of one positive thing that’s happened is that this is a conversation. This is no longer just swept under the rug. This is now kind of a, I don’t even know if open secret is the right idea. It’s kind of like [00:57:30] open knowledge. It’s just hasn’t been fixed yet. I mean that’s my perception is that, what do you think?
Clay: So Bitwise, with a report to the SEC really blew the lid off this one. And we’re all really grateful that they did. But I think people in the know, people who are kind of somewhat deep in this space, or come from an institutional background, I think they know what’s going on. I don’t know that the average person does. So if you go to the exchange rankings on CoinMarketCap [00:58:00] right now, even if you look at their adjusted volume rankings, you’ve got an exchange called P2PB2B ranking number one.
Nathaniel: I know, I was looking at it today. It’s ridiculous, actually.
Clay: Bitforx is number two. BKEX is number three. Just to share a little bit about our own website, one of the top search terms that people are coming to us right now is BKEX review because for like three weeks or so, [00:58:30] BKEX was dominating the top of a CoinMarketCap’s exchange rankings. And people didn’t know what the hell it was. So they were searching for reviews, and they found that on our website. I think our rankings are a lot more sane. But there’s no perfect way to do this when there’s so much egregious behavior.
So I think that people are becoming more aware of it. But I think that this is like an arms race where if you are faking volume, or willing to fake volume, [00:59:00] you now have to be able to out fake a whole bunch of other people who are faking volume. And then when they want to be at the top of the charts, they have to get a lot more gutsier about what they’re doing.
So we’re seeing things like just absurd ratios between Alexa ranking and trading volume where you might have a website that really is only being visited by a few hundred people or a few thousand people a day posting $1.5 billion a day in trading volume. And it’s just absurd with far [00:59:30] less traffic than a Coinbase or a Binance.
So I don’t see this getting solved any time soon on CoinMarketCap and I don’t see sort of a universal solution to this being arrived at anytime soon. You can’t just sort of state sort of a fixed set of standards for whose volume you’re going to include an exclude, and believe that two months later that that’s going to still effectively filter. It’s kind of like the Google algorithm, it by nature changes as people get [01:00:00] better and better at gaming the search engines. I think it’s going to be a never ending war. It’s not something where a handful of smart people can get in a room, bang out an algorithm, publish a paper, and be like, we have figured this out. It’s just going to keep on coming as long as there are incentives for doing that.
[01:00:30] Well, that concludes part two of my conversation with Nathaniel Whittemore. I hope you enjoyed it. This two-part series is now wrapped up. Before you go, I want to mention that since we’ve started producing episodes at a much higher rate, we now have room for a few more sponsors. If you like the work we do and would like to support this show, then a sponsorship might be a good fit for you.
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Okay. That wraps up things for this week. Stay tuned for next week’s episode. Until then, take care.
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