Overview:
In the past year, the landscape of centralized exchanges (CEXs) in the crypto sector has showcased remarkable resilience, a response shaped largely by the fallout from the FTX collapse. This event, involving a key player in the crypto arena, has been a catalyst for significant shifts in market dynamics. In this research piece, our objective is to analyze and understand the far-reaching effects of this pivotal incident on the CEX landscape. To achieve this, we will conduct a thorough review of key quantitative metrics around exchange liquidity. Beyond examining the historical impacts, our analysis extends to projecting informed insights into the future trajectory of crypto exchanges. As the market evolves, this report aims to offer a nuanced perspective on how CEXs are adapting and what their role may look like in the emerging landscape of digital assets.
Part 1: Quantitative Analysis of Post-FTX Impact on Exchanges
Volume and Open Interest
Our analysis commences with a deep dive into the aggregate trading volumes of CEXs, encompassing both spot and perpetual markets. The data reveals a noticeable trend: since the peak of Bitcoin’s price in the previous bull cycle, there has been a marked decline in trading volumes across both market types. Interestingly, this downturn persisted even after a temporary surge in trading activity following the release of news about the FTX collapse. Current trading volumes in both spot and perpetual markets have not yet returned to the levels observed before the exchange’s downfall.
A noteworthy development, however, is the consistent increase in open interest for CEX perpetual contracts. Recently, this metric has even surpassed the historical highs recorded during the period of the FTX collapse. This surge in open interest is predominantly attributed to the influx of speculators re-engaging with the market, spurred by optimistic trends in crypto prices throughout 2023, and more significantly, in the latter half of the year. This pattern suggests a renewed interest and speculative confidence in the crypto market, despite the previous setbacks.
Furthermore, an integral part of our analysis focuses on liquidity fragmentation, best understood by examining the market share of the largest exchange, primarily in terms of spot and perpetual volumes. Historically, Binance has dominated this arena achieving the highest overall volumes across both bull and bear markets. This makes it an ideal benchmark for comparison with the broader market.
Post-FTX collapse, a notable shift occurred: Binance’s market share in both spot and perpetual volumes initially increased. This trend aligns with a typical market response, where traders gravitate towards well-established exchanges known for substantial trading flow and superior liquidity. However, this surge in market dominance was short-lived. In the following months, Binance’s share of the total volume across both spot and perpetual markets witnessed an almost 50% decline. This significant drop can be largely attributed to the growing caution among traders towards unregulated exchanges, compounded by a general erosion of trust in the industry. Furthermore, the scrutiny of Binance by various U.S. government agencies, each levying a range of charges, further deterred traders from using the platform.
Despite these challenges, Binance has managed to maintain its status as a market leader. Nevertheless, the market’s liquidity remains noticeably fragmented, as traders diversify their allocations across multiple exchanges to mitigate the risks associated with concentrating funds in a single entity. The accompanying chart underscores this trend, showing the growth in spot volumes of key competitors relative to Binance’s daily trading activity. Notably, exchanges such as Bybit, Coinbase, and OKX have experienced significant expansion, now collectively accounting for nearly 70% of Binance’s total daily trading volume. This fragmentation of liquidity highlights the ongoing dynamics and shifts in trader confidence and regulatory perceptions within the crypto exchange landscape.
Liquidity Metrics
When assessing the efficiency and health of a market, liquidity metrics, particularly those focusing on the ability to execute large trades, are crucial. Our analysis zeroes in on the 1% bid and ask liquidity depth for Binance’s BTCUSDT spot and perpetual markets. A minor yet important methodological note: we measure depth in Bitcoins rather than dollars, a choice that negates the potential distortion due to fluctuating cryptocurrency prices.
The BTC perpetual market on Binance has demonstrated remarkable growth in liquidity depth, both from the bid and ask perspectives. Since the FTX-induced liquidity collapse, the order book depth for Binance’s BTC perpetuals has grown approximately 3.5 times, with the bid depth consistently exceeding the ask depth throughout the observed period. This contrasts starkly with the BTCUSDT spot market on Binance, where no significant improvement in liquidity depth is observed. In fact, the situation has deteriorated post-FTX. This disparity can be partially explained by the nature of perpetuals trading, which, due to its leverage component, demands higher liquidity depth than spot markets.
Turning to bid-ask spreads, our analysis, limited by the available data starting from the beginning of this year, focuses primarily on ETH markets to avoid the noise present in BTC data. Both spot and perpetual markets on Binance have shown closely aligned bid-ask spreads, with a consistent downward trend. This convergence and trend are positive indicators, suggesting an improvement in market liquidity and more favorable conditions for trade executions.
To emphasize the disparity between spot and perpetual markets we graph the bid-ask spread difference. Notably, the ETHUSDT spot market consistently exhibits higher bid-ask spreads compared to its perpetual counterpart. This finding corroborates our earlier observation: perpetual markets, due to their inherent leverage, tend to offer more liquidity and accommodate larger trade sizes.
Overall, the analysis above highlights a resurgence in crypto interest, evident from the steady increase in open interest, though exchange volumes haven’t yet matched pre-FTX highs. Notably, there’s been a substantial improvement in the liquidity depth of perpetual contracts, alongside narrower bid-ask spreads, signaling a revitalized derivative market. Contrastingly, the recovery pace in spot market liquidity lags. Despite this, only a handful of exchanges continue to dominate, underlining their crucial influence in a still-fragmented market liquidity landscape.
Part 2: Future Prospects for Centralized Exchanges
Having analyzed the current state and recent history of the CEX landscape, our focus now shifts to the future. This section explores our projections and insights on the likely direction and evolution of CEXs in the near term. Building on our understanding of past trends and present conditions, we aim to outline potential developments and strategic shifts that could shape the CEX landscape in the forthcoming period.
Regaining Trust in the CEX Landscape
The axiom “not your keys, not your crypto” has long been a foundational principle in the crypto world, underlining the importance of ownership and trust. This principle is particularly relevant for active traders relying on CEXs, where trust in the trading platform is crucial. Following the FTX collapse, many exchanges moved swiftly to adopt Proof of Reserves, a measure allowing users to cryptographically verify their holdings with the exchange. While this represents a step forward in transparency, it’s not an infallible solution, as it doesn’t fully account for off-balance sheet liabilities and the intrinsic risks of the exchange.
Addressing these gaps, several innovative projects are emerging. Credora, for instance, offers real-time metrics on counterparty credit scores and facilitates regulated lending opportunities. Similarly, Arbelos is developing a transparency engine that provides proof of solvency and enhanced visibility into its balance sheet without compromising sensitive market information. These initiatives mark a significant move towards restoring trust in centralized entities, by augmenting transparency while balancing the need for competitive discretion.
Moreover, the move towards a more institutionalized crypto market is driving growth in the prime brokerage and custodian sector. Trading in crypto is currently marked by capital inefficiency due to the need to distribute funds across multiple exchanges, without the ability to aggregate and offset risks across different positions. Innovations like Hidden Road’s prime brokerage model and Copper’s ClearLoop for off-chain collateral management are at the forefront, enhancing capital efficiency and operational security in trading processes. As the crypto infrastructure market matures, we expect to see an increase in collaborations between these services and centralized exchanges, benefiting both retail and institutional clients.
Shift Towards Traditional Markets
Ironically, the crypto industry, which is fundamentally built on the ethos of decentralization and a departure from traditional finance, is witnessing a significant shift. Insights from Velo Data reveal a marked increase in open interest for BTC futures on the CME, surpassing those on other trading venues. This trend marks a critical turning point, highlighting the reluctance of larger investors to commit substantial capital to unregulated centralized exchanges. For many institutional investors, constrained by regulatory and internal compliance policies, CME’s crypto derivatives provide the only viable avenue for compliant market exposure.
In parallel to the improvements in spreads and liquidity observed in CEXs, a somewhat analogous trend is noticeable in the CME futures markets, particularly in terms of trading costs. Since 2022, the cost of trading CME BTC futures has remained fairly stable, with only a slight decrease. Recent times have seen a rise in these costs, likely attributable to increased market volatility amid Bitcoin’s price fluctuations, though the bid-ask depth has stayed consistently steady throughout the years.
This trend of growing CME dominance in the crypto trading arena is likely to persist, with traditional finance venues expected to continue outpacing the volumes of unregulated CEXs. The shift towards more regulated, traditional platforms may be further accelerated by the potential introduction of spot ETFs for major cryptocurrencies such as BTC and ETH. This indicates a future for the crypto market that is increasingly regulated.
The Rising Influence of DeFi
While CEXs currently dominate the market in terms of liquidity flow, the landscape is ripe for disruption, with decentralized finance (DeFi) at the forefront. In recent years, DeFi exchanges have seen a gradual yet noticeable increase in trading volume. Initially spearheaded by Uniswap’s automated market-maker (AMM) model, the decentralized exchange (DEX) landscape has since evolved, introducing a variety of innovative models for liquidity provision in both spot and derivative markets. Presently, Uniswap on Ethereum commands a significant portion of this volume, but the landscape is changing, with emerging projects developing their own application-specific chains on different protocols to enhance transaction speeds and reduce costs.
Data from DeFiLlama illustrates that DEXs are steadily increasing their market share relative to CEX spot market volumes. While AMM models have proven effective in establishing liquidity for new tokens, we posit that for DeFi to truly rival CEXs in both spot and derivative markets, a shift towards a request for quote (RFQ) or order-book-based approach is essential. This would enable traders to achieve comparable spreads and execution speeds to those in CEXs. Historically, DeFi’s approach to more complex financial products like options, primarily via variations of AMM models, has shown success only at smaller scales, encountering scalability challenges with larger volumes. Recognizing these limitations, many DEXs are now adapting their strategies, incorporating elements of traditional order books into their models. This pivot is expected to enhance user experience, bringing DEXs closer to the functionality and efficiency of CEXs.
Conclusion:
The CEX landscape has demonstrated remarkable resilience, successfully navigating through a year marked by significant challenges. Encouragingly, the data indicates a positive trajectory: trading volumes are on the rise and are expected to surpass previous highs in the next bull market. There’s also a noticeable trend of decreasing spreads and increasing liquidity depth in derivative markets. While we hope to see similar improvements in spot market liquidity, such advancements are likely as the market moves into the next phase of the bull cycle.
Looking ahead, the path for CEXs involves not only regaining but also sustaining user trust. This will be achieved through strategic partnerships with service providers offering innovative prime brokerage and custody solutions. Additionally, while CEXs continue to play a crucial role in the crypto ecosystem, the prominence of traditional exchanges like the CME, especially in futures trading, cannot be overlooked as it may shift liquidity away from perpetual products. Finally, the DeFi sector, still in its nascent stages, warrants close monitoring. This rapidly evolving domain is poised to capture a significant share of crypto-native liquidity in the foreseeable future.