24 hours ago

Axios Pro Rata

Welcome to a new edition of our weekend newsletter! Hope you enjoyed last week’s.

  • As always, feel free to send me any tips or comments by replying to this email or on Twitter @imkialikethecar.
  • Some selections playing on my Spotify app yesterday: Jeff Buckley’s covers of “Yeh Jo Halka Saroor Hae” and “Strange Fruit,” and Doja Cat’s new joint with SZA, “Kiss Me More.”

This week (940 words, or a 3½-minute read), we’re extending the crypto high from Coinbase’s direct listing just a little bit longer, and taking a look at what’s next…

1 big thing: Crypto derivatives exchanges are the next frontier

Illustration: Rae Cook/Axios

Coinbase got the headlines this week for going public, but another crypto category is also booming: derivatives exchanges.

Why it matters: These exchanges are taking crypto investor appetite for speculation to the next level, enabling bets on a range of events and assets — even Coinbase’s own IPO, months before the actual float.

The big picture: “The defining companies in crypto are the exchanges,” says FTX CEO Sam Bankman-Fried, whose 2-year-old company has become one of the most popular derivatives exchanges. “That’s not necessarily true on Wall Street.”

  • Unlike in traditional finance, crypto exchanges provide services end-to-end, including the wallet, asset custody, matching engine and so on, putting them at the center of the industry's activity.
  • Coinbase, for example, started out as a digital wallet for storing and transferring bitcoin. Over the years, it added an exchange to trade digital tokens — while building out the services needed to support that.

Between the lines: The growing popularity of crypto derivatives, which are largely based abroad due to regulations, comes down to capital efficiency, according to Bankman-Fried.

  • Users can put up all kinds of collateral and get tons of leverage, 100x up to 125x, depending on the exchange.
  • FTX also managed to harness some of the stock market zeitgeist, debuting futures ahead of the public listings of companies like Airbnb, Coinbase and most recently Robinhood. It also launched tokenized stock for Tesla and a WallStreetBets index quarterly futures contract during the retail trading saga in January.

And that translates to big business for the exchanges.

  • BitMEX, a rival exchange founded in 2014 and derivatives trailblazer, was handling about $65 billion a month in trading volume by the summer of 2020, according to Bloomberg.
  • FTX (which also runs a spot exchange) saw roughly $10 billion in trades per day in April, raking in about $2 million in daily revenue from fees. The company says it currently has an $800 million run rate.
  • And according to FTX’s own tracking of other exchanges, there’s just under $100 billion in derivatives trade per day on Binance, over $78 billion on Huobi, and about $36.5 billion on OKEx.

Yes, but: Like much of the rest of crypto, the lack of a clear regulatory regime in the U.S., especially regarding newer derivatives like tokenized stock, is keeping crypto derivatives exchanges from being able to operate here.

  • The CTFC has signaled that crypto derivatives fall within its jurisdiction, but it's still behind on providing new rules and regulations.
  • U.S. residents can still trade some very limited derivatives, like bitcoin futures, via a few large regulated exchanges like the Chicago Board Options Exchange and the CME Group exchange.

Meanwhile, BitMEX has run afoul U.S. regulators for allegedly soliciting American customers without being licensed. But, again, there is no license to get.

  • CEO Arthur Hayes and three others also face criminal charges for failing to implement sufficient anti-money laundering measures and knowing of certain illicit activities.
  • The CFTC is also reportedly probing Binance for letting U.S.-based users trade derivatives.

The bottom line: We've entered a new era of cryptocurrency exchanges.

2. Decentralize everything (in finance)

Illustration: Aïda Amer/Axios

While exchanges like Coinbase and FTX are amassing huge success, another crypto industry phenomenon that’s flourishing is “DeFi,” short for “decentralized finance.”

What's happening: A crop of protocols that let participants execute various transactions directly with each other through the networks instead of using intermediaries has been exploding in popularity.

“The system as it exists today is still very inefficient,” says FinTech Collective principal Sean Lippel.

  • “DeFi flips the whole thing on its head and says ‘we don't’ need these intermediaries, let’s use the power of the blockchain to coordinate this,” Lippel said.

The key applications to watch, according to investors:

  • Borrowing and lending
  • Trading assets
  • Synthetics
  • Stablecoins

Yes, but: There’s still some healthy skepticism.

  • “I don’t think that everything is gonna move to DeFi, but I do think that there’s a world in which 10% of it does,” FTX’s Bankman-Fried, whose company also built a decentralized exchange, tells Axios.
  • “I also don’t think it’s automatic that it’s going to happen. … Decentralized systems are only going to take off if they’re really good products," Bankman-Fried said.
3. Don't sleep on NFT innovation

Illustration: Aïda Amer/Axios

Non-fungible tokens, or NFTs, pushed crypto into the mainstream in recent weeks thanks to some high-profile artists and sports fandom. But experts say underneath the seeming froth is an important innovation that shouldn’t be dismissed.

What they’re saying: “NFTs are taking digital content and making them into an ownable asset,” says CoinFund founder Jake Brukhman, whose firm has invested in the company behind CryptoKitties and NBA Top Shot, among others.

  • While buzzy art is highly speculative, a bevy of visual content like stock photography, font design and even a house deed, can benefit from better tools to digitize and manage their rights.
  • Brukhman adds that the companies that will endure will be focused on infrastructure. “Even if the art vertical fails, facilitating an NFT exchange is something that’s gonna be around for a long time.”

The bottom line: NFTs of silly memes may be selling for absurd prices, but the technology has the potential to help the less flashy digital content creators in the long run.

Bonus: Meanwhile, on the Hill...

Illustration: Eniola Odetunde/Axios

  • A new lobby in town: Fidelity, Square, Coinbase and crypto VC firm Paradigm set up a new trade group, the Crypto Council for Innovation. The group says that it will have a global outlook instead of focusing only on U.S. policy, and it aims to educate the public, along with policymakers.
    • In 2018, a group of companies formed the Blockchain Association to represent the industry in Washington, though an insider says CCI’s founding members felt they needed a reset and a separate group.
  • Another new approach: SEC commissioner Hester Peirce this week unveiled an updated version of her proposal for a safe harbor regulatory approach for digital tokens.
    • In short, Peirce proposes that teams developing new digital tokens get three years to work on the project, after which they’ll either get to prove that their network is sufficiently decentralized to qualify as a cryptocurrency or register as securities with regulators. The update adds reporting requirements, an exit report and outside counsel.
4. 📚 Due diligence
  • Is Coinbase the Next Netflix, or a Blockbuster Video-in-Waiting? (Coindesk)
  • Crypto industry to get first major U.S. stadium with Miami-Dade County approving FTX for Heat home (CNBC)
  • "Bad Idea": The Response Brian Armstrong Got When He First Pitched Coinbase (Decrypt)
5. 🧩 Trivia

Coinbase and Binance are among the best-known and most popular crypto exchanges today, but they're far from the earliest.

  • Question (courtesy of Castle Island Ventures' Nic Carter): What is the oldest continuously operating exchange in the industry? (Answer at the bottom.)
6. 🧮 Final numbers
Data: CoinMarketCap; Chart: Axios Visuals

🙏 Thanks for reading! See you on Monday for Pro Rata's weekday programming, and please ask your friends, colleagues and early Coinbase investors to sign up.

Trivia answer: Bitstamp, founded in Luxembourg in August 2011. (Check out Carter's excellent crypto industry quiz here.)