Why business strategy matters for crypto

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Although 2018 has been named the “year of decentralized exchanges”, they haven’t taken off yet. Instead, exchanges are busy with other activities such as buying banks, setting up funds, or starting charities. Did they say good-bye to the crypto vision of a decentralized world? No, it is all about business strategy.

Early this year, Binance announced that they are working on a decentralized exchange (DEX) (see Binance’s blog). And last week their CEO Changpeng Zhao showed a demo of this DEX (see Speed of acquisition, diversifying exchanges, Blockchain’s changing face (Blockchain & Crypto news CW31))

Binance is not the only exchange working on a DEX. In fact, 2018 has frequently been named the “year of DEXs”. And there has been some activity. For instance, about one week ago Radar Relay’s (another DEX) announced their $10 Million funding. Moreover, beginning of July Vitalik Buterin said that he hoped that “Centralized Exchanges Go Burn In Hell”.

Read More: Market map: blockchain startups working on decentralized exchanges

However, DEXs haven’t yet taken off as much as some have wished. But if they are so important the question is why? The most obvious answer is that DEXs are technically complex. Whereas this is true, it does not explain why Binance hasn’t started working on their DEX earlier or why other big exchanges like Coinbase are not active at all.

It is certainly not a question of resources. Just recall that in 2018-Q1 Binance was more profitable than Germany’s biggest bank, Deutsche Bank (see ccn). Rather, it is a question of priorities. Exchanges are busy with other projects. Coinbase is politically active by forming a PAC, using e-gift cards for expanding their payment services or starting their charity GiveCrypto.org.

Read More: Why Coinbase and not Bitcoin will replace Mastercard

Read More: The Importance And Impact Of Crypto Donations

And several exchanges, among them Coinbase, Binance, and Huobi are launching crypto funds (e.g. Huobis ETF) or incubators (e.g. Binance Labs). Binance is even investing in a bank.

Read More: are cryptocurrencies and related companies banks?

Some see in this de-prioritization simply a despicable departure from the crypto vision of a decentralized future. However, I believe that another argument is worth exploring; business strategy. There are two aspects to business strategy here. First, the target market; centralized and decentralized exchanges serve different use cases and investors. Secondly, go-to-market timing; the market for DEXs should be targeted after the market for centralized exchanges (CEXs).

Centralized and decentralized exchanges serve different investors and use cases

Whereas some believe that DEXs will eventually be the only type of exchange, I doubt that. Based on their features, centralized and decentralized exchanges address different investors and use cases. Centralized exchanges are more convenient (e.g. no private key-management) and faster (almost immediate settlement). DEXs on the other side have greater anonymity and security.

As Stefano Bernardi from Token Economy believes, one use case for DEXs are unregistered tokens. Tokens that are (or could be) considered securities can list on DEXs without the fear of outside interference.
As Binance’s CEO implies:

“On the decentralized exchange we’ll have less control. More likely anybody can list any coin. That’s the philosophy of the decentralized exchange, it’s freedom of choice, freedom of investments,” Zhao said in an interview over Skype. “But with freedom there will be people who are scammers. That’s not something we can control.” – Bloomberg

Side note: Only in theory would unregistered securities operate completely freely; authorities will want to have a say. In fact, recently Coindesk quoted Aaron Wright, associate clinical professor of law saying:

[…] Conversely, decentralized prediction markets and exchanges that facilitate the trading of binary options would likely be deemed to violate existing laws like the Commodities Exchange Act.” (Coindesk)

Moreover, the Monetary Authority of Singapore (“MAS”) published a consultation paper evaluating the regulation of exchanges, among them also “platforms that allow peer-to-peer trading”.

Read More: Crypto regulations and decentralized exchanges

Centralized exchanges, on the other hand, will always remain the primary exchange of the mainstream investor. As Megan Hernbroth, a communications representative for Coinbase told Coindesk:

“We believe allowing Coinbase to manage security of digital currency on behalf of users is a better solution for most users than managing their own storage.” (Coindesk)

Whereas these investors and use cases might change, no exchange type will serve all of them; different exchange types will serve different investors/use cases. This explains partially why some exchanges are not exploring DEXs; some investors simply do not want DEXs, they want CEXs.

Find out more: Researchly’s Exchanges Insights

The other answer to the question why some exchanges are not exploring DEXs is rooted in go-to-market timing.

Go-to-market timing: DEXs are too unprofitable for market entry

In general, when marketing any new technology, companies can either start in a niche or target the mass market. The niche is smaller but also more lucrative. Startups can use these dynamics and follow a niche-strategy; they start in the niche where they serve a wealthy clientele and once they have generated enough profits they move into the broader market. For each of these markets, a company needs a different product. In the Automotive Industry, this is, for instance, the strategy behind Tesla. Elon Musk started with the premium Tesla Roadster for a wealthy clientele. Then the profits from the Roadster funded the development of the less expansive models [see The Secret Tesla Motors Master Plan (just between you and me].

Read More: Blockchain in the Automotive & Mobility industry: the current state

In the case of exchanges, the niche product are DEXs and the product for the mass market are CEXs. Based on the niche-strategy just described, DEXs should have come before CEXs. But they didn’t. This is due to their business model. DEXs incur almost no profits. As such it is impossible to use this niche as a springboard for the mass market. Instead, exchanges must start in the mass market (where they can make a profit) and then work their way into other fields.

Therefore, Binance’s strategy makes a lot of sense; they started with their centralized exchange in the mainstream market, built a competitive moat, made a lot of profit (recall from above that Binance was more profitable than Deutsche Bank), and are now exploring other avenues, including DEXs.

Final words

Many centralized exchanges have received a lot of heat from those that believe in the crypto vision of a fully decentralized world. There is nothing wrong with believing in this vision, but it needs a more refined approach; despite the engineering-heavy crypto industry, business strategies still apply.

Find out more: Researchly’s Exchanges Insights

Read next

Photo by Vek Labs on Unsplash

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