After the collapse of the FTX crypto exchange, markets such as CRYPTO.com and Huobi faced their own struggles, while Binance reacted swiftly and survived. Ahmet Faruk Aysan and Ahmet Semih Tunali argue that the wild west of crypto exchanges work under survival-of-the-fittest dynamics. Vulnerable, over-leveraged, and technologically backward exchanges may be eliminated from the market.
The world’s second-largest crypto exchange, FTX, which grew aggressively through acquisitions in the last two years, went bankrupt in a few days in November 2022. It is irony of fate that the tweet that started this sinking was posted by Changpeng Zhao (CZ), the CEO of Binance, the largest crypto exchange. In a 2021 article, we discussed the fact that, unlike traditional stock exchanges, cryptocurrency exchanges are subject to survival-of-the-fittest dynamics. Vulnerable, over-leveraged, and technologically backward exchanges may be eliminated from the market, which could result in a tendency towards a single universal exchange. After the collapse of FTX, rumours about struggles in exchanges like CRYPTO.com and Huobi also became relevant to our published paper. There could not be a better opportunity to demonstrate that academics are not just dealing with post-fact analysis. Our paper, published long before these recent events, highlights the survival-of-the-fittest dynamics in the wild west of crypto exchanges.
Universal stock market
In the post-COVID-19 quantitative easing environment, stock markets protected life savings and saw their popularity surge. Larger stock markets (in asset size) offer more active market liquidity, providing investors with better options for diversification and less risky, more appealing prospects. Due to a nationalistic mindset and concerns about legitimacy, many small countries tend to establish their own stock exchanges, despite the inefficiencies brought by the size of their markets. As a result, this may spark a conversation about the benefit of creating a single global market to improve the efficiency of stock markets. Indeed, theories and research support the notion that stock market efficiency and integration increase local market efficiency and economic growth.
Allowing all stocks to trade on all exchanges would be needless and impossible for traditional stock markets. Nevertheless, when all major cryptocurrencies are traded on all exchanges, they offer a chance to test how the exchanges evolve without boundaries and national regulations. For investors to trade cryptocurrencies without being constrained by state regulations, cryptocurrency exchanges offer distributed digital infrastructure. To test our theory of the survival of the fittest, we use the prices of the exchanges’ own cryptocurrencies as proxies and examine how they have changed over time. This is because the price changes of these coins reveal information about the acceptance and future potential of the crypto exchanges. Certainly, borderless and stateless cryptocurrency exchanges offer a convenient natural environment to observe how traditional exchanges would change without regulatory coercion from the states.
Binance is the most popular and largest cryptocurrency exchange in the world as of November 2022, with a daily trading volume exceeding $50 billion. It has its own BNB token, valued at over $40 billion. Its ultimate objective, according to CEO Changpeng Zhao, is to establish its own crypto community without gender, race, identity, religion, culture, or nationality discrimination. CZ says that the idea is to invest across continents to free communities from the constraints of established systems.
Our paper used the example of Binance’s influence over other cryptocurrency exchanges to discuss the applicability of the universal stock market. We wanted to test whether, in the absence of a state in the crypto exchange ecosystem, the fittest survive and grow more prominent, while the weakest are eliminated.
Although all cryptocurrencies have a long-term relationship with one another, Johansen cointegration tests show that Binance dissociated itself from others after moving its operations to Malta in March 2018. That creates a natural experiment setting that confirms our survival-of-the-fittest hypothesis.
Binance’s reactions to regulations
State regulations are one of the most vital challenges for crypto exchanges, which had a series of problems with national governments. In September 2017, China closed all the crypto exchanges and banned initial coin offerings. In the US, regulatory institutions like the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) sued cryptocurrencies (Ripple) and several crypto exchanges (Uniswap and Bitfinex).
Japan, which became Binance’s new headquarters after China’s ban, followed suit and ordered Binance and several other crypto exchanges to shut down their operations. Within twenty-four hours, Binance announced its new headquarters in Malta and the country’s prime minister wrote a welcome tweet. In addition to Malta’s pro-crypto environment having a positive effect on Binance’s operations, CZ’s effective and open crisis management and quick resolution raised trust in the company. That provides insights on potential future proactive responses that could enhance Binance’s credibility.
Following the crypto exchange’s relocation to Malta, traders and investors had high hopes for the company’s future growth in Europe and other regions. Binance immediately planned to launch ten exchanges in five different continents, in countries such as the US, Uganda, and Turkey, and to keep expanding from Brazil to Kazakhstan.
When the company first started, it only had a few non-Asian employers out of its 27 team members. Three months after relocating to Malta, Binance began to employ people from 39 different nations. Thus, Binance seems to have established a worldwide crypto community by employing an innovative, inclusive, and nomadic approach for its investors. Today, the company has groups in the Telegram app for 41 different countries and regions in order to keep its community tight. Even though Binance moved to the Cayman Islands later, moving to Malta was the most prominent structural change in its path, which made it the universal crypto exchange.
Hacking is another issue that could undermine the reliability of exchanges. The MT. Gox hack in 2014 was among the worst and most significant to the cryptocurrency market. During the early years of bitcoin, MT. Gox handled 80% of bitcoin transactions. The cost of the attack was equivalent to 85,000 bitcoins, or $58 billion dollars at the time when bitcoin was valued at $69,000.
Binance also witnessed these attacks several times. In July 2018, hackers gathered some users’ API keys to pump the value of SYS Coin. Nonetheless, the company’s AI fraud detection promptly halted trading and withdrawals to safeguard users. Following this incident, Binance established the Secure Asset Fund for Users (SAFU), a fund for insurance that is made up of 10% of the exchange’s trading fee revenue, in order to safeguard and insure the funds of customers against any upcoming attacks.
In 2019 and 2022, Binance became a victim of two more cyber-attacks, which cost $40 and $570 million respectively. None of them could shake confidence in the company. Instead, by overcoming these attacks, the exchange went on to become living proof of the survival of the fittest .
Our empirical findings suggest that Binance prominently dissociated itself from others after its move to Malta and hack attacks could not shake trust in the company. Several years after these incidents, some crypto companies and exchanges keep failing, as we have seen in the case of FTX, Luna, and many others. The fittest ones for this environment will survive. Binance has created an Industry Recovery Fund to invest in projects that have liquidity problems and continues on its path to become the universal crypto exchange. With a disclaimer that nothing is certain in crypto, we see historical evidence leaning in favour of the fittest in the wild west of the crypto world.
Given its borderless and stateless feature, crypto could be a natural experiment for conventional markets. Although it was written almost two years ago, our paper still provides valid, valuable, and ex-ante inspiration for many new studies to explore the recent collapses of many crypto exchanges. Accordingly, researchers are not only post-fact analysts after all, but pioneers raising the right questions at the right time.
* Authors’ disclaimer: We do not have any relationship (personal, professional, or financial) with Binance or its leadership.
- This blog post is based on Aysan, A. F., Khan, A. U. I., Topuz, H., & Tunali, A. S. (2021). Survival of the fittest: A natural experiment from crypto exchanges. The Singapore Economic Review, 1-20.
- The post represents the views of its author(s), not the position of LSE Business Review or the London School of Economics.
- Featured image by Mariia Shalabaieva on Unsplash
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