The Profit Death-Spiral of Crypto Exchanges

Last year, new cryptocurrency exchanges seemed to launch almost daily. Operators sought huge profits as traders piled into new crypto investments. According to CoinMarketCap, $20 billion worth of cryptocurrencies were traded DAILY at times last year. Exchanges raked in profits and every financial-services company wanted a piece of the action.

Since that time, the crypto-exchange business has gone cold. Security concerns have wrecked the industry. A report in the Nikkei Asian Review, for instance, blames the well-publicized Coincheck hack for causing upheaval in Japan. Coincheck customers lost more than $530 million. Japanese regulators cracked-down on exchanges afterwards. The government eventually required 7 exchanges to severely tighten oversight. It additionally suspended 5 other exchanges that were awaiting official government registration. Those exchanges were required to also increase scrutiny to resume operations. Many will not however. The exchanges will likely cease operations altogether.

The remaining exchanges have experienced sky-rocketing costs. Operators have sunk money into better cybersecurity programs and more cyber experts. They have also greatly increased the number of compliance officers.

The costs have clearly cut into profitability. The crypto section of the Monex Group – which purchased Coincheck after the hack – reported a net-loss. Coincheck reported a huge profit margin approaching 90% only last year.

Times have certainly changed.

The Japanese experience is likely shared elsewhere. Nikkei commented, “Given the sluggish market for bitcoin, cryptocurrency exchanges no longer stand to reap easy profits.” The problem is further worsened by industry-wide consolidation. Coinbase and Robinhood are strongly positioned to weather the storm. Other exchanges, however, hope to be acquired. Others will simply shut down.