Charles Dickens famously wrote about it being the best of times and the worst of times, but for centralized crypto exchanges, the past year has been mostly about the worst.
It’s not just that, following the blowups of 2022, new money has disappeared, volumes have stagnated, and regulators such as the US SEC have been on the warpath. Busts come and go.
This year has been hard because the FTX scandal questioned the very necessity of centralized crypto exchanges. A middleman at the heart of crypto contradicts the beliefs behind the creation of Bitcoin, deadens Ethereum’s psalm of decentralization. Meanwhile, decentralized exchanges, the DEX, have become practicable, if hardly mainstream. Down with the CEXs! cry the revolutionaries storming the barricades of institutionalism.
But we are humans, not data streams, and emotions guide our trades, even if they are connected by API. Centralized crypto exchanges are not disappearing, although Hong Fang, president of OKX, told DigFin, “Over time, DEXes will grow market share. So we must invest in the Web3 side and disrupt ourselves.”
She says OKX has escaped being caught up in the 2022 turmoil, including the collapse of algorithmic stablecoin Terra/Luna, the criminality of Celsius and FTX, and the massively unheroic collapse of Three Arrows. Fang acknowledges luck played its part, although she also cites certain choices, such as not having an affiliated hedge fund/prop desk.
OKX may have found itself in a Goldilocks position. It is big enough to count in the industry, but not so big that it’s walking with a target on its back.
According to CoinMarketCap, OKX is currently the sixth largest spot exchange, and number three in derivatives, behind Binance and Bybit (although if measured by average daily turnover, it’s number two). It’s second-tier players, such as OKX, Bybit and KuCoin, that may be the future of the centralized crypto industry.
Useful to DeFi
Fang says this means being more useful to DeFi. The exchange has been busy developing its wallet to be more user-friendly. It has rolled out multi-party computational (MPC) cryptography to make it easier for users to trade and self-custody many tokens across different blockchains.
It is also working on account abstraction, a way to represent customer accounts on layer-2 applications without users having to trade their tokens to pay for transaction fees or other services. Instead, users can pay for gas fees (on Ethereum or on layer-2 protocols such as Curve) directly from a holding of USDC or USDT, the leading US-dollar stablecoins.
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This puts OKX in direct competition with the likes of Metamask, a wallet that lets users interact with the Ethereum blockchain and related apps. Metamask has just announced that, finally, it is now integrated with Bitcoin and the Bitcoin payments network, Lightning. But Fang says OKX’s wallet has had this capability for months.
“It’s hard to settle assets automatically onchain, ensure data accuracy, address safety issues, and defend the wallet’s smart contracts against attacks,” Fang said. “But we now have 1 million active users in our MPC wallet” able to trade across layer-1 chains.
Unregulated to licensed
OKX is using the current market lull to build more infrastructure, with the aim of being the gateway of choice when the next bull market strikes.
In addition to tech build, OKX is changing its business model from a global, unregulated exchange to one with licenses in markets where it can get them. It has licenses in the Bahamas and a ‘minimum viable product’ license from Dubai’s VARA, with a ‘full market practitioner’ upgrade in the works. OKX is also applying for licenses in Hong Kong, Singapore, and in Europe.
Fang would not provide a wholesale business strategy for these licenses, but she notes that the past year’s events have led to regulatory scrutiny that is not going to disappear. OKX now has about 300 employees in various legal and compliance roles.
“We have to figure out how to make this scale,” Fang said. Each market has its own requirements. Most licenses are to serve institutional or professional investors, but some like Hong Kong are open to retail. OKX can operate without a license, but then it cannot market itself in that jurisdiction.
The new strategy may be a response to reality, but it creates the risk of fragmenting its business – and its processes – across many markets and customer bases. Fang didn’t have a neat response to this, as it’s early days. “This is a question we’re asking ourselves,” she said. “We want to solve for a global productized infrastructure,” with features that it can switch on or off in a given jurisdiction. This is difficult to do; especially knowing that regulators often update their rules.
Awaiting the next inflow
The crypto landscape is changing with lots of regulations and no clarity about where the next investor influx will come from.
Fang declined to detail OKX’s business strategy or say whether she expects retail or institutional to be the next driver for crypto.
But she left clues. First, she says the product-development team’s headspace is focused on retail. This is where there’s more scope for different products, as well as more regulatory scrutiny. But she also says the industry is waiting for the US to authorize the first spot bitcoin ETFs – and that’s an institutional product.
Getting custody right
Competition for these inflows, should they materialize, will be about that balance between operating a global platform and managing the complexities of multiple licenses. “Being able to scale and to remain flexible is the new competitive advantage,” she said.
If institutions do open the purse strings, the industry will also be competing on custody, as there are many institutions that are not prepared to self-custody. This can be true of retail as well, but for institutions it’s statutory.
Fang says OKX would prefer not to be a custodian, and she welcomes more third-party custodian platforms. But OKX has to offer this service to. “We want the customer to take control of their keys,” she said. “We have a self-custody wallet in the OKX app.”
Part of the firm’s investment in to Web3-related features is about encouraging people to self-custody. For example, the use of MPC means users don’t need to rely on seed phrases; instead they can rely on dividing their private key among several authorities, be it a treasurer or the device itself. OKX is also building recovery features in the app, to get around the problems of transacting on an immutable blockchain.
“We want to lower the threshold for entry,” she said.
Trust in a trustless world
The other aspect of managing a custodial business is to make OKX trustworthy. OKX is a centralized exchange, so it has the same trust issues as a bank or a traditional stock exchange. Post FTX, there’s a lot less trust to go around. OKX and other exchanges are responding with ‘proof of reserves’.
In OKX’s case it is preparing to publish its eleventh monthly PoR report, revealing what OKX holds across its addresses, for both cold and hot wallets. “These show real-time fund flows,” Fang said. OKX has also introduced enhanced cryptography techniques, including zkStark, a version of zero-knowledge proof, to ensure users’ privacy.
Amid these initiatives, one thing OKX isn’t working on is tokenization of real-world assets. “It seems like it only delivers a marginal benefit,” Fang said. But she says the exchange is in talks with a TradFi institution to partner. She won’t say more about this, but she tells DigFin that OKX is open to collaborating with traditional banks or asset managers.
“Our angle is about what the customer needs,” she said. “If the partnership provides that, we’re happy to pursue it.”
OKX’s to-do list assumes there will be another boom in crypto, with perhaps ETFs the trigger, assuming US investors are eager to invest in crypto exchanges overseas. If we are indeed in a Dickens novel, perhaps it is “Great Expectations”.