Bithumb's Losses vs. Binance' Gains: What Can Be Learned?

As the cryptocurrency industry continues to mature, the race for which exchanges will win and lose in the long run is on. The droves of users that flocked to onboard onto crypto exchanges have turned into dribbles--at the same time, regulations on crypto exchanges are heating up in many parts of the world.

While it’s nearly impossible to tell exactly which factors are affecting exchanges in what way, there are a few factors that can be measured in order to tell how a cryptocurrency exchange is faring--namely, profit.

So, here we have a tale of two exchanges: Binance and Bithumb. The former reported $446 million in profits in 2018 and $66 million in profits in just the first quarter of this year; the latter saw $180 million in losses over the course of 2018, although a 17 percent rise in sales revenues was reported at the same time.

When we look at these two exchanges--and others in the industry--what are they doing right? And what are they doing wrong?

Crypto Holdings Are Partly to Blame

According to a report from the Korea Times, the primary reason for Bithumb’s losses was not the fault of the exchange itself, but because of the bear market that plagued crypto throughout last year.

However, the story is actually more complicated than that. The exchange’s operating expenses nearly doubled from $59.8 million in 2017 to $119 million in 2018; other expenses rose explosively from $3.6 million in 2017 to $334.8 in 2018.

When taking all of this into consideration, the $180 million in losses doesn’t actually seem so bad--but the losses were heavy enough that Bithumb announced earlier this year that it would be cutting its staffing levels by as much as 50 percent, from 310 employees to roughly 150.

Security, Security

But high expenses weren’t the only cause for Bithumb’s losses. The losses can also be partially attributed to a $19 million hack that took place in March of this year--the third hack in the exchange’s history.

BREAKING ???
Bithumb is being hacked, at its EOS cold storage level!!! Over 3million EOS has been transferred out ??? Detail to be reported, confirmed by security firm who’s auditing for Bithumb — Dovey Wan ? ? (@DoveyWan) March 30, 2019

Hacks certainly aren’t unique to Bithumb--cryptocurrency exchanges throughout the world are hacked almost regularly. This is in part because of flimsy or nonexistent regulations. Most governments have not created rules that would standardize and enforce security measures on exchanges, which leads to a patchwork of security levels across the industry.

Thus, users don’t necessarily know what they’re getting themselves into when they onboard themselves onto an exchange. For example, it seems that no one knew how bad the security measures were at QuadrigaCX, the Canadian cryptocurrency exchange that lost access to $190 million of its users’ funds when its CEO suddenly died (only he had access to the funds.)

Bithumb’s Losses May Have Been an Unavoidable Bump on the Road to Future Success

But in spite of the hacks, and the other troubles, Bithumb’s losses last year can be considered as a necessary sort of ‘cleanup’ on the pathway to a more profitable future.

After all, “Bithumb just raised $200m from ST Blockchain ,” wrote Alex Mashinky, CEO & Founder of Celsius Network, in an email to Finance Magnates. ST Blockchain is a Japan-based investment fund. “So their losses or the bear market is not detouring investors from doubling down and betting on global expansion.”

Mashinsky explained that although the loss was “big,” the 17 percent growth in sales revenues is evidence that the losses “did not affect the company from continuing to grow revenues and taking market share.”

He added that “most of this loss had to do with mark to market for the BTC and other holdings Bithumb had, similar to what Galaxy reported in the last few quarters,” referring to Galaxy Digital, Mike Novogratz’ crypto investment bank. “There are paper losses, not actual losses.”

Binance Didn’t Bet On Crypto Assets

Even if that’s the truth, why was Binance able to collect $446 million in profits over the same time period?

Mashinsky explained that this has much to do with Binance’s strategy on money-making. While“many [large exchanges] took directional bets on the recovery of Bitcoin and altcoins,” they may have been better served to “[focus] on extracting tolls from trades the way Binance did.”

Indeed, it seems that Binance didn’t take any speculative risks on holding its assets in Bitcoin, Ethereum, or other external Cryptocurrencies . Instead, the exchange has stored much of its own value in BNB, its native cryptocurrency.

As a result, Binance seems to have been to successfully weather the ebbs and flows of the cryptocurrency market--its business model doesn’t seem to depend so heavily on cryptocurrency prices. The exchange’s success is also reflected in the value of BNB. The coin has become one of the best-performing cryptocurrencies since the beginning of the year, rising from $6.20 on January 1st, 2019 to $23.50 at press time.

We made sure $bnb is supported in the BitTorrunt ecosystem. Also they are raising a big part in $bnb. #useBNB
— CZ Binance (@cz_binance) January 5, 2019

Binance May Not Have As Many Regulatory Headaches as Other Exchanges Do

It also may have something to do with where Binance is based. The exchange moved its headquarters to Malta last year, the “blockchain island” whose lawmakers have been working swiftly to make the tiny country one of the most crypto-friendly nations in the world.

This has made the country very attractive to cryptocurrency exchanges looking for a jurisdiction to base themselves in. “What exchanges are doing is jurisdiction shopping,” explained Gil Luria, director of research at financial services firm D.A. Davidson, in a report for Breaker Mag. “They are going to jurisdictions that have the most favorable regulatory structure.”

On a practical level for Binance, this means that the exchange is able “to move more quickly, innovate faster, and make decisions otherwise unavailable” to exchanges facing heavier regulatory requirements than what Malta demands at the moment, wrote Aaron Lasher, the co-founder and Chief Strategy Officer of leading crypto wallet BRD, to Finance Magnates.

And indeed, the South Korean government has tightened its regulations on the cryptocurrency quite a bit over the last several years--at one point, it was even rumored that domestic cryptocurrency exchanges would be banned outright.

In any case, the lower costs associated with compliance in Malta allow Binance to charge lower fees on trades and therefore attract more users.

Which Exchanges Will Survive Long Term?

And indeed, it seems that the sheer volume of users that Binance has attracted is the primary cause for its profits. But the exchange’s low fees aren’t the only reason that its pool of users has continued to grow.

“Exchange management is all about providing liquidity,” explained Ricky Li, co-founder and head of North America at Altonomy, to Finance Magnates. “Binance is no doubt the most liquid spot exchange with the most active pool of users at this point in time.”

Alex Mashinsky said that ultimately, liquidity would be a major determining factor in which exchanges survive--and which do not. “The smaller exchanges that don’t belong to any of the major groups that share order books will not survive as they can’t provide the liquidity or price needed to compete,” he said.

Indeed, “Retail investors rely on exchanges to enter or exit positions in highly volatile moments,” Ricky Li added. “[An] exchange’s failure to provide liquidity in these moments will drive such investors away.”

Therefore, Binance is in a particularly good position for the future--with each new user that comes, the exchange’s trading volume increases a bit further. As the volume increases, the liquidity naturally follows.

And Binance’s trading volume is one of the largest in the industry--or even the largest in the industry, depending on where you are getting your data (there has been some debate as to whether sites like CoinMarketCap are accurately reporting trading volumes.)

What’s Next for the Exchange Industry?

As players like Binance continue to grow larger and larger, Alex Mashinsky says that we can expect to see the number of cryptocurrency exchanges decrease over the next several years. “There is definitely a consolidation going on in the exchange business with room for just a few winners among the over 400 crypto exchanges that operate worldwide,” he explained.

“80% of global profits will be concentrated with the top five players in the next two years,” he added. “It will look similar to the stock and bond markets where ICE and Nasdaq dominate the revenues and income from security exchanges.”

As it stands now, Binance has a great chance at becoming one of these top five, particularly if it successfully manages to transition into a fully decentralized exchange (DEX.)

Soon. #DEXChangeTheWorld pic.twitter.com/q0ro75DDdL
— Binance DEX (@Binance_DEX) February 20, 2019

But if a hack strikes or the regulatory tide takes a turn for the worse, things could change. And as long as regulations are heavier in certain parts of the world, jurisdiction-specific exchanges--like Bithumb--are likely to survive in the longer term, too.