From Crypto Native to CEX Native: Why Are Exchanges Keen on Creating Their Own Chains?

Author: CHI ANH, JAY JO & YOON LEE

Compiled by: Deep Tide TechFlow

Abstract

• Purpose of Native Chains: Exchanges like Binance and Coinbase enhance their ecosystems and diversify revenue models by building their own blockchain platforms to adapt to the rapidly changing market environment.

• Types of Native Chains: Native chains can be broadly divided into two categories. The first category is token-centric native chains, such as Binance's ecosystem, which enhance the value of the exchange and ecosystem through their own tokens. The second category is technology-centric native chains, which focus on the performance and functionality of blockchain technology without relying on tokens.

• Challenges of Native Chains: Despite the significant advantages demonstrated by Binance and Coinbase, the development and use of native chains still face enormous challenges and regulatory risks. Huobi's HECO Chain is an example that illustrates these difficulties and requires substantial resources to attract initial users and products.

1. Introduction

The cryptocurrency market is known for its dynamism and rapid growth. Despite the swift changes in the market environment, centralized exchanges (CEX) continue to maintain their significant position. From the past to the present, these exchanges have continuously expanded their influence.

CEX plays a crucial role in the Web3 ecosystem, leveraging strong business models and stable revenue sources. Recently, their roles have further expanded to become providers of blockchain infrastructure. Typical examples include Binance's BNB Chain and Coinbase's BASE Chain, which have enhanced their market influence by developing their own Web3 ecosystems. The recently launched HashKey Chain, based on Ethereum Layer 2 by HashKey Exchange, further solidifies this trend.

This report explores the background and objectives of CEX developing native chains and analyzes the impact of these strategies on the cryptocurrency market and the Web3 ecosystem. Through this analysis, we aim to provide insights into the evolution of centralized exchanges and the future direction of the Web3 market.

2. How do CEX generate revenue through Native Chains?

CEX develops and operates native chains based on different strategic objectives. Their approaches can be broadly divided into two categories. The first category is token-centric native chains, which is the most commonly adopted strategy by CEX, building ecosystems around their own tokens. The second category is technology-centric native chains, focusing on the performance and functionality of blockchain technology.

2.1. Token-Centric Native Chains

Source: OKX

Token-centric native chains are the most common approach among centralized exchanges (CEX). Exchanges like Binance, OKX, and Crypto.com adopt this model. By issuing tokens, they increase the value of existing trading models, provide incentives based on token economics, and attract numerous projects into their ecosystems using tokens. This strategy allows for rapid expansion of users and ecosystem participants. Additionally, by linking various services and providing users with direct, visible benefits, they diversify their business models and lock users into the exchange.

For example, Crypto.com's Cronos not only supports staking and network rewards but also allows users to access DeFi features using its token $CRO. This token can be used for higher cash back and discounts, online shopping, and exclusive rewards. OKX offers discounted trading fees and helps users generate stable income through OKX Earn. Binance has expanded the value of its token by building DeFi and GameFi ecosystems within its platform.

This token-centric model effectively positions exchanges as comprehensive blockchain ecosystems, providing users with more value and incentives. However, it is important to note that this model is susceptible to fluctuations in token value and regulatory risks.

2.2. Technology-Centric Native Chains (Non-Token Model)

Coinbase is a typical representative of technology-centric native chains. The development of native chains by Coinbase brings multiple strategic advantages, particularly in diversifying revenue models. The primary revenue source of this model is transaction fees. As the sole sequencer of the BASE chain, Coinbase controls all transactions on the chain, generating substantial revenue from them.

Source: @sealaunch

BASE maximizes revenue and reduces costs by bundling multiple users' transactions into a single transaction on Ethereum. As an L2, BASE needs to aggregate transactions to Ethereum (L1), which can lower costs by bundling more transactions.

For example, if Chain A and BASE each charge $1 per transaction, Chain A earns $50 by bundling 50 transactions, while BASE earns $100 by bundling 100 transactions. If both pay $50 to Ethereum for transactions, Chain A breaks even, while BASE nets $50. This efficiency allows BASE to maximize revenue by effectively bundling more transactions.

Since the launch of the BASE chain in August 2023, BASE has generated approximately $65.1 million in fees. Of this, $16 million was paid to the Ethereum network, while $49.1 million was profit for Coinbase. However, BASE has a revenue-sharing agreement with Optimism (the developer of the underlying OP Stack technology). According to the agreement, Coinbase must share 2.5% of BASE revenue or 15% of its net profit with the Optimism DAO, whichever is greater. Additionally, the future decentralization of BASE's sequencers may further limit profits.

Another important revenue strategy is the issuance of stablecoins on-chain. Coinbase collaborates with stablecoin issuer Circle to issue BASE-based USDC, generating revenue from the interest on the USD collateral backing USDC. In the first quarter of 2024 alone, this collaboration brought in $197.32 million for Coinbase, accounting for 12% of the total revenue for that quarter. Given that there is already $3 billion in USDC on BASE, Coinbase and Circle may have a favorable agreement regarding the USDC issued on BASE. This could generate substantial interest income, potentially exceeding revenue from transaction fees.

The benefits of BASE to Coinbase extend beyond financial gains. BASE enhances Coinbase's brand image, showcasing the exchange's leadership in industry innovation and solidifying its unique position within the ecosystem. Furthermore, BASE serves as a foundation for business expansion, enabling Coinbase to extend its operations into various industries based on blockchain technology.

3. Are Native Chains an Attractive Option or a Bubble?

The strategy of centralized exchanges (CEX) establishing native chains varies based on the goals and environments of each exchange. This approach involves a multifaceted decision-making process that considers not only technical choices but also complex real-world scenarios and various risks.

Advantages:

• Flexible Customization: The ability to build optimized infrastructure to meet the needs of the exchange and its users.

• Revenue Diversification: Creating new revenue streams through the operation of proprietary blockchains.

• Ecosystem Expansion: Expanding business domains by developing independent ecosystems.

Disadvantages:

• High Development Costs: Blockchain development and maintenance require substantial resources.

• Intense Competition: The challenge of attracting initial users and achieving network effects, similar to other blockchains.

• Regulatory Risks: As operators of crypto assets, they must navigate a complex regulatory environment.

Establishing native chains is undoubtedly an attractive option, but it also involves numerous risks and challenges. For instance, successful cases like Binance's BNB Chain and Coinbase's BASE demonstrate various benefits, such as generating new revenue streams and expanding user bases.

Conversely, failed examples like Huobi's HECO Chain indicate that success is not guaranteed. Achieving network effects and ensuring a meaningful user base in the highly competitive blockchain market is a daunting task.

Regulatory risk is also a key consideration. For example, Coinbase's decision not to issue a native token for BASE may be influenced by potential reactions from regulators like the SEC. This indicates that exchanges must carefully consider the regulatory environment when formulating their native chain strategies.

Building native chains may be an attractive option for exchanges, but it is a complex strategic decision that cannot simply be viewed as a trend or bubble. Each exchange must comprehensively assess its strengths, target market, regulatory environment, and technical capabilities to determine the applicability of this strategy.

4. Conclusion

Recently, the interest of centralized exchanges (CEX) in developing native chains has rapidly increased within the cryptocurrency industry. HashKey Exchange in Hong Kong announced the launch of HashKey Chain, based on Ethereum Layer 2. The South Korean cryptocurrency exchange Korbit has also begun developing a blockchain platform, referencing Coinbase's BASE. This indicates that blockchain designs centered around technological infrastructure are considered to have significant profit potential.

In particular, considering the restrictions imposed by South Korea's "Virtual Asset User Protection Act" on tokens with vested interests in exchange listings, Korbit's decision may stem from the ability to generate sufficient revenue solely through transaction fee models.

Although blockchain infrastructure has primarily developed in the Western world, Asian exchanges are now also entering the chain development space, strengthening global infrastructure competition. With relatively abundant capital and stability, the participation of Asian exchanges is expected to enhance the diversity and innovation of the blockchain ecosystem.

Ultimately, the success of these projects is expected to provide tangible value to users, achieve widespread adoption, and significantly advance technological progress in the blockchain industry. In addition to expanding the business models of exchanges, these initiatives will also drive innovation and growth across the entire blockchain ecosystem. It is crucial to closely monitor how these developments will shape the future of the cryptocurrency market and the Web3 ecosystem.