TL;DR

• Purpose of Native Chains: Exchanges like Binance and Coinbase use their own blockchain platforms to strengthen their ecosystems and diversify their revenue models, allowing them to adapt to the rapidly changing market environment.
• Types of Native Chains: Native chains are broadly classified into two types. The first is token-centric native chains, like Binance’s, which build ecosystems based on their own tokens to enhance the value of their exchange and ecosystem. The second is tech-centric native chains, which focus on the performance and functionality of the blockchain technology itself without using tokens as leverage.
• Challenges of Native Chains: While there are significant benefits, as shown by Binance and Coinbase, developing and utilizing native chains is challenging and carries substantial regulatory risks. Huobi’s HECO Chain example illustrates these difficulties, and substantial resources are needed to secure initial users and products.

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1. Introduction

The cryptocurrency market is characterized by its dynamic nature and rapid growth. Despite this fast-changing environment, the prominent position of centralized exchanges (CEX) remains steadfast. From the past to the present, these exchanges have continuously expanded their influence.

CEXs have played a crucial role within the Web3 ecosystem, supported by robust business models and stable revenue streams. Recently, their roles have further expanded to include blockchain infrastructure providers. Notable examples include Binance’s BNB Chain and Coinbase’s BASE Chain, which have increased their market influence through the development of their own Web3 ecosystems. HashKey Exchange’s recent launch of its Ethereum Layer 2-based HashKey Chain further solidifies this trend.

This report delves into the background and objectives of CEXs developing native chains and examines 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 CEXs Generate Revenue from Native Chains?

CEXs develop and operate native chains based on different strategic objectives. Their approaches can be broadly categorized into two types. The first type is token-centric native chain, a strategy most commonly adopted by CEXs, which involves building an ecosystem centered around their own token. The second type is tech-centric native chain, focusing on the performance and functionality of the blockchain technology itself.

2.1. Token-centric Native Chain

Source: OKX

The token-centric native chain is the most widely adopted approach among centralized exchanges (CEXs). Exchanges like Binance, OKX, and Crypto.com utilize this model. It adds value to the existing exchange model through token issuance, provides incentives based on tokenomics, and leverages tokens to onboard numerous projects within their ecosystem. This strategy allows for rapid expansion of users and ecosystem participants. Additionally, it enables the diversification of business models by linking various services and providing direct, visible benefits to users, thus locking them into the exchange.

For instance, Crypto.com’s Cronos not only supports staking and network rewards but also allows users to access DeFi features with its token $CRO. The token can be used to receive higher cashback and discounts, shop online, and access exclusive rewards. OKX offers discounted trading fees and helps users generate steady income through OKX Earn. Binance expands the value of its token by building DeFi and GameFi ecosystems within its platform beyond the exchange.

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

2.2. Tech-centric Native Chain (Non-Token Model)

Coinbase is the most representative example of a tech-centric native chain. The development of a native chain by Coinbase offers several strategic advantages, the revenue model diversification in particular. The most fundamental source of revenue for this model is transaction fees. As the sole sequencer of the BASE chain, Coinbase controls all transactions within the chain, generating substantial revenue from this control.

Source: @sealaunch

BASE maximizes revenue while reducing costs by bundling multiple users’ transactions into a single transaction on Ethereum. As an L2, BASE requires rolling up transactions to Ethereum, the L1, which can reduce costs by bundling more transactions together.

For example, if Chain A and BASE each charge $1 per transaction, Chain A would earn $50 by bundling 50 transactions, whereas BASE would earn $100 by bundling 100 transactions. If both pay $50 to Ethereum for the transaction, Chain A breaks even, but BASE nets a profit of $50. This efficiency allows BASE to maximize revenue by bundling more transactions effectively.

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 remained as Coinbase’s profit. 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’s revenue or 15% of its net profit, whichever is greater, with the Optimism DAO. Additionally, future decentralization of BASE’s sequencer could further limit profits.

Another significant revenue strategy is the issuance of stablecoins within the chain. Coinbase collaborates with stablecoin issuer Circle to issue BASE-based USDC, generating revenue from the interest on the USD collateral backing USDC. In Q1 2024 alone, this partnership yielded $197.32 million for Coinbase, accounting for 12% of its total revenue for that quarter. Given that there is already $3 billion worth of USDC on BASE, Coinbase likely has a favorable agreement with Circle for USDC issued on BASE. This could potentially result in substantial interest income, potentially surpassing revenue from transaction fees.

The benefits of BASE for Coinbase extend beyond financial gains. BASE enhances Coinbase’s brand, showcasing the exchange as a leader in industry innovation and solidifying its unique position as a key player within the ecosystem. Additionally, BASE serves as a foundation for business expansion, enabling Coinbase to extend its reach into various industries based on blockchain technology.

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

The strategy of establishing native chains by centralized exchanges (CEXs) varies depending on each exchange’s goals and environment. This approach involves a multifaceted decision-making process that goes beyond technical choices to consider complex real-world scenarios and various risks.

Advantages:

• Flexible Customization: Ability to build optimized infrastructure tailored to the needs of the exchange and its users.
• Revenue Diversification: Creation of new revenue streams through the operation of a proprietary blockchain.
• Ecosystem Expansion: Expansion of business areas through the development of an independent ecosystem.

Disadvantages:

• High Development Costs: Significant resources are required for blockchain development and maintenance.
• Intense Competition: Challenges in attracting initial users and achieving network effects, similar to other blockchains.
• Regulatory Risks: Need to navigate complex regulatory environments as a crypto asset operator.

Building native chains is undoubtedly an attractive option, but it also involves several risks and challenges. For example, successful cases like Binance’s BNB Chain and Coinbase’s BASE demonstrate various benefits such as generating new revenue streams and expanding the user base.

Conversely, failures such as Huobi’s HECO Chain illustrate that success is not guaranteed. Achieving network effects and securing a meaningful user base in the competitive blockchain market is a daunting task.

Regulatory risks are also a crucial consideration. For example, Coinbase’s decision not to issue a native token for BASE could be influenced by potential reactions from regulatory bodies like the SEC. This indicates that exchanges must carefully consider the regulatory landscape when formulating their native chain strategies.

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

4. Conclusion

Recently, interest in native chain development by centralized exchanges (CEXs) has surged within the cryptocurrency industry. HashKey Exchange in Hong Kong has announced the launch of the Ethereum Layer 2-based HashKey Chain. Korbit, a South Korean cryptocurrency exchange, has embarked on blockchain platform development, benchmarking Coinbase’s BASE. This indicates that the tech infrastructure-centric blockchain design is regarded to have significant potential profits.

In particular, considering the restrictions imposed by South Korea’s Virtual Asset User Protection Act on listing tokens with vested interests on exchanges, Korbit’s decision may be influenced by the potential to generate sufficient revenue through a fee model alone.

While blockchain infrastructure has predominantly developed in the Western world, Asian exchanges are now entering chain development, intensifying global infrastructure competition. The participation of Asian exchanges, which possess relatively rich capital and stability, is expected to enhance diversity and innovation within the blockchain ecosystem.

Ultimately, the success of these projects is projected to provide tangible value to users, achieve widespread adoption, and significantly contribute to the advancement of the blockchain industry’s technological landscape. Beyond expanding the business models of exchanges, these initiatives are poised to drive innovation and growth across the entire blockchain ecosystem. It is crucial to monitor how these developments will shape the cryptocurrency market and the Web3 ecosystem in the future.

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