How cryptocurrency market booms can be bad news for exchanges
A rising tide lifts all boats, but Bitcoin prices aren't tides and cryptocurrency exchanges aren't boats.
Poloniex was the world's first cryptocurrency exchange to reach $1 billion in daily trade volume, and its active trader count and volumes increased by more than 600% in the first few months of 2017. But overall industry growth throughout the year also attracted much more sophisticated competition, and Poloniex wasn't really geared to keep up. When Circle bought Poloniex in 2018, it arrived to a backlog of almost 160,000 customer service requests.
Today, Poloniex is believed to be one of the top 10 cryptocurrency exchanges by real volume, but its market share is still only about 1%. Before the boom of 2017, it was the world's highest volume exchange. After the boom, it woke up as one of the smallest big players.
Now the markets are booming again, and the cryptocurrency exchange business naturally is too. And yet, many exchanges are still facing an uphill battle.
"We regret to inform you about the loss of liquidity," it said.
So, how is it that exploding prices can actually be bad news for cryptocurrency exchanges? And what makes this time different to previous ones?
Easier said than done
Throughout 2017, most existing cryptocurrency exchanges were the beneficiaries of all the hype, but today the benefits of growing markets are more concentrated around a small handful of prominent exchanges.
One reason for this is the natural industry consolidation that tends to occur everywhere. Another is that there's a lot more reliable cryptocurrency information in the world now than there was in late 2017, which helps the most reliable exchanges further rise to the top.
Then there's also the fact that customer expectations for crypto exchanges are a lot higher now than they used to be. As former Cryptopia (RIP) CEO Alan Booth said, the pinnacle of the industry in late 2017 was an exchange that could simply stay online.
But these days, customers are looking for a nice user experience, competitive fees, wide selection, additional features and so on.
Customer expectations have grown rapidly and there's a sense of security in using established exchanges, which naturally favours incumbents.
Then there's the ongoing problem of handling rapidly shifting customer volumes. Exchanges aren't getting the white-knuckle ride of December 2017 anymore, but the thin and hype-sensitive markets are still prone to sudden shifts, which can make it extremely difficult for exchanges to anticipate customer behaviour.
For example, when Bitcoin recently took that sudden $1,200 plunge from $14,000, Coinbase suffered an outage believed to have been caused by a sudden influx of logins. Robinhood experienced similar disruptions.
Expecting the unexpected
So how is a new exchange meant to properly anticipate its traffic?
Consider the new arrival Beaxy. It launched on 11 June, despite fending off a hacking attempt, and on its first day in operation saw trade volumes of more than $2 million in the first 24 hours. For perspective, Poloniex's BTC volume that day was less than $4 million. They were rough equivalents. Indeed, just a few months before Poloniex's total daily volumes were averaging well under $2 million.
But the markets change fast.
Poloniex's trade volumes have multiplied about 25-fold between then and now, while Beaxy's has fallen to a fraction of what it was on launch day. In the exact same booming market conditions, some exchanges are multiplying volumes while others are dealing with declines.
Part of the reason in this case might be the peculiar market conditions around this rise, which is another factor that exchanges somehow have to account for.
Bitcoin vs altcoin rises
Bitcoin dominance is currently sitting at 65% and showing signs of climbing. At its previous peak in December, Bitcoin dominance was 66%.
But in 2017, Bitcoin's dominance (market cap of Bitcoin relative to non-Bitcoin cryptocurrencies, or "altcoins") actually peaked well before prices did. Here's what the frenzy looked like at the time.
If you look at what the other coins (the non-gold lines) were doing at the time, you can see that the immediate run-up to Bitcoin's peak price, and the peak of the mania, was actually driven mostly by altcoins rather than Bitcoin itself.
This made a major difference to how exchanges competed for customers. Coin selection is one of the factors people consider, and it presented a useful value proposition for less well-known exchanges to differentiate themselves.
But the rising markets of today are doing no such thing, and are actually having the opposite experience. Here's what it looks like today.
The rise is largely concentrated on Bitcoin itself, and it's coming especially at the expense of smaller cap coins – collectively represented by the faint grey line in these charts. The mania of late 2017 was driven mostly by altcoins, but this time around it's just Bitcoin slowly sucking the air out of the rest of the market.
Consequently, that key value proposition for smaller exchanges – variety – is a lot less important this time around.
Back in 2017, you had a natural kind of customer arbitrage effect as verification queues stretched out for weeks, exchanges outright stopped accepting new registrations and would periodically conk out. The customer overflow naturally spread to the exchanges that still had capacity.
That won't be happening again, as all the most prominent exchanges specifically used the bearish downtime of 2018 building up their infrastructure to handle the next big rush. Brief outages like Coinbase recently experienced aren't enough to see customers go elsewhere.
While conventional wisdom holds that anytime the markets boom it will be good news for all exchanges, and that's probably still more true than not, signs say the markets are tougher for exchanges this time around in many different ways.
Disclosure: The author holds BNB and BTC at the time of writing.