Nansen Decodes the CEX Pattern: Crisis of Trust and the Way Out

Written by: Osgur Murphy O Kane, Frank Fu, Yohji Van Weert

Compiled by: Luffy, Foresight News

Key Points

• The collapse of FTX and the loss of customer funds have severely impacted crypto users' trust in centralized exchanges (CEX). Users are now demanding more transparency and protective measures from exchanges.
• Many exchanges have begun to provide proof of reserves. Exchanges like Binance and Bitget have increased their protection funds. Note that these do not guarantee the solvency of exchanges without detailed liabilities.
• Binance has maintained a dominant position in the market, but it is not the only beneficiary following FTX's exit. After FTX, Bitget's derivatives trading volume has significantly increased, while Binance and OKX continue to hold advantageous positions in the derivatives space.
• After the FTX collapse, the platform tokens MX, BGB, and OKB have performed strongly.
• In a competitive environment, successful exchanges will prioritize security, transparency, user trust, and ecosystem development. At the same time, meeting user needs, providing a robust feature set, and delivering an excellent user experience are also important.

I. Recent CEX Landscape Overview

FTX was a typical representative of CeFi, recognized by many prominent figures and even sponsoring sports venues. However, behind the scenes, the exchange had been mixing customer funds with its market maker Alameda, resulting in customer deposits losing $4 billion and ultimately filing for bankruptcy. The FTX incident sent shockwaves throughout the industry, causing a sharp decline in confidence in centralized exchanges. This report aims to examine the CEX landscape post-FTX and the overall trends we are observing.

II. Renewed Focus on Credibility

The FTX incident severely damaged user trust in CEX. Since then, users have demanded exchanges to enhance transparency, focusing on proof of reserves and protection funds.

1. Proof of Reserves

Many exchanges have begun to provide proof of reserves (PoR) to address the trust crisis. Proof of reserves refers to the act of CEX publicly declaring its reserve assets. This is typically done through independent audits, aimed at providing transparent and verifiable evidence that the exchange has sufficient asset reserves to cover customer deposits.

While this is a step in the right direction, PoR does not guarantee the solvency of exchanges without corresponding liability details. A Proof of Liabilities would be a more compelling approach, but it is off-chain and requires independent auditing. Moreover, audits themselves have proven problematic, as FTX had undergone audits before its collapse.

Here is an example of Binance's proof of reserves on Nansen:

Source: Nansen

For more data on exchange proof of reserves from Nansen, please check here.

2. Protection Funds

The purpose of protection funds is to provide a safety net in the event of customer asset losses. By establishing protection funds, exchanges aim to assure their customers that if a hacking incident occurs, the exchange will have the funds to cover deposits (as long as the fund size exceeds the scale of the hack). This scheme can be seen as an over-collateralization of customer deposits.

In addition to protection funds, implementing best practices in risk management, such as diversifying funds across multiple addresses, is also crucial for effectively mitigating the impact of various hacking attacks. After the FTX collapse, Binance increased the dollar value of its fund from $735 million to $1 billion. Similarly, Bitget raised its protection fund from $200 million to $300 million.

The table below lists the largest protection funds among industry exchanges. Notably, as of the writing of this article, Binance and Bitget are the only two centralized exchanges that have publicly disclosed their protection fund wallet addresses:

Proof of reserves should become the minimum standard in the exchange industry; however, as mentioned above, these positive indicators alone are not sufficient to guarantee solvency.

III. Changes in the CEX Landscape

1. Total Trading Volume

Binance has maintained relatively stable trading volumes, with the FTX collapse serving as a dividing line. The average monthly trading volume over the previous six months was $470 billion, while the average monthly trading volume over the following five months was $428.4 billion. This indicates that Binance's trading volume decreased by about 10%, remaining relatively stable. Note that trading volume can be an important metric for measuring an exchange's performance, but this metric can also be manipulated through wash trading and other means.

Below is the monthly trading volume of ten selected exchanges in the months following the FTX incident. Note that this does not represent the entire industry but rather exchanges that are popular and have a certain level of recognition.

Source: Nansen

Source: Nansen

2. Spot Trading Volume

Source: Nansen

Data shows that spot trading volume saw a slight decline in the six months following the FTX collapse. The significant surge in late March can be attributed to the Arbitrum airdrop frenzy. Most exchanges experienced a hit to their spot trading volumes, with Bybit and Kraken being exceptions, as they took measures to manage to increase their trading volumes.

Meanwhile, DEX trading volumes remained relatively stable during the same period. This may be due to the decline in trust in centralized exchanges following the FTX collapse, as well as further regulatory uncertainties.

Data as of May 31, 2023

3. Derivatives Trading Volume

Note that this does not represent the entire industry but rather some popular exchanges.

Source: Nansen

Crypto derivatives trading volume experienced a slight decline. Trading volume surged after the FTX collapse in early November, followed by a general decline. However, since mid-January of this year, trading volume has recovered and maintained levels seen before the collapse.

Data as of May 31, 2023

FTX was initially known for its leading derivatives business. While derivatives trading volume has decreased among top CEXs, Bitget is an exception, as it achieved growth in derivatives trading volume in the six months following FTX.

Exchanges that performed relatively well for some time after the FTX collapse include:

• Bitget
• Bybit
• Binance

Overall, Bitget has excelled in managing to capture more trading volume. Bybit and Binance saw slight declines but overall retained most of their trading volume (and expanded their market share), while other exchanges experienced larger declines. This may also be due to the general trend of declining trading activity in the crypto bear market.

4. Variety of Listed Tokens

Different exchanges adopt different listing strategies. For example, Binance only lists projects that have demonstrated significant market interest and trading volume elsewhere. In contrast, Gate.io has taken a more lenient approach and has listed a large number of tokens for initial exchange offerings (IEOs) that have not yet been listed.

Since the FTX collapse, some exchanges have become more sensitive to user demands and market trends. Taking BRC-20 as an example, it grew to a market cap of $1 billion within three months of its launch.

The first four exchanges to list BRC-20 were Gate, Bitmart, Digfinex, and Bitget.

• Gate.io: Listed ORDI on May 8
• Bitmart: Listed ORDI on May 8
• Digfinex: Listed ORDI on May 9
• Bitget: Listed ORDI on May 10

Quickly listing new tokens is key to meeting users' ever-changing demands, and many traders can benefit from new tokens. However, exchanges must balance listing tokens while protecting users from scams. This is crucial for maintaining the exchange's reputation, which is why the largest exchanges like Coinbase, Binance, and Kraken adopt a more conservative approach to listings. However, slow token listings may adversely affect exchanges, such as missing out on trading volume from popular tokens and recent memecoin trends.

5. Compliance

Upcoming regulations targeting DeFi and cryptocurrencies may pose significant challenges for exchanges. SEC Chairman Gary Gensler believes that nearly all tokens are securities, which could lead to many exchanges being unable to operate in the U.S. If the U.S. adopts this official stance, it could pose serious issues for CEXs globally.

Exchanges also have different requirements for KYC and anti-money laundering measures. These are crucial for the legitimacy of exchanges and ensuring they can continue to operate in various jurisdictions. Additionally, CEXs found to have inadequate protective measures that facilitate criminal activities will suffer reputational damage. One example is zachXBT, who claimed to have registered an account named "Kim Jong-Un" on Gate.io using an email associated with the North Korean hacking group Lazarus.

Source: Twitter

6. Platform Tokens

Some exchanges have launched their own platform tokens to incentivize users on their platforms. The following chart shows the top 10 platform tokens by market cap and their performance after the FTX collapse. Notably, MX, BGB, and OKB have performed very strongly during the bear market, maintaining levels near their historical highs.

Source: Nansen

(1) MX

MX provides additional utility and returns for users of the exchange. Additionally, MEXC allocates 40% of its profits each quarter to repurchase and destroy MX to keep the circulating supply at 100 million tokens.

(2) BGB

BGB's utility involves improving the user experience on Bitget through reduced fees, exclusive products, and more. Bitget is expected to launch a repurchase and destruction plan for BGB soon. Read more about it here.

(3) OKB

OKB also serves as an access token for many products and benefits on the platform. It undergoes a repurchase and destruction process each quarter based on "seasonal market and operational performance." In the previous report, they repurchased and destroyed the equivalent of $177 million in OKB over three months.

The impact of repurchase and destruction on token prices is controversial, with some arguing it does not create any value. However, with stable cash flow, the purchasing power of repurchases may contribute to stronger token performance.

(4) BNB

BNB is the largest CEX token by market cap to date. It is the gas token for BNB Chain and can unlock various features and benefits on Binance. BNB has a destruction mechanism to maintain a supply of around 100 million tokens, with the amount destroyed depending on the price of BNB and the number of blocks generated on BNB Chain during the quarter.

Data as of May 31, 2023

The table above shows the market performance of CEX platform tokens from December last year to May 31 of this year. MX, WOO, and BGB performed exceptionally well, while HT saw the most significant decline.

7. Performance Records

The performance records of exchanges are crucial for their legitimacy. In fact, most CEXs have experienced hacking attacks, some of which never recovered. Since 2012, losses from hacking attacks have exceeded $2.85 billion. Since the FTX collapse, no top exchange has been directly hacked. However, hacking incidents still occur frequently, including:

• GDAC was hacked in April 2023, resulting in a loss of $13 million.
• Bittrue was hacked in April 2023, resulting in a loss of $23 million.

CEXs remain vulnerable to hacking, making strong risk management and protection funds more important than ever to ensure customers do not suffer losses in unforeseen circumstances.

IV. Latest Trends in CEX

CEXs are increasingly investing in the development of Web3 products. For example, Coinbase not only offers custodial wallet services but also plans to launch an L2 (Base) running on the OP stack. Binance has clearly launched BNB Chain and is actively investing in a broader ecosystem. Similarly, Bitget has launched MegaSwap, a DeFi aggregator that allows users to conveniently swap tokens, similar to typical DEXs. Additionally, given the tremendous success of the NFT market in the last bull run, major exchanges like Binance and Coinbase have launched their own NFT platforms aimed at capturing a portion of NFT trading volume and associated fees.

1. Copy Trading

Another popular feature of CEXs is copy trading. It allows users to replicate the strategies of top traders on the platform.

A significant difference from on-chain copy trading is that traders need to explicitly authorize the exchange to allow others to copy their trades. In contrast, on-chain copy trading does not require permission, and anyone can copy trading strategies from any address.

Some exchanges offering copy trading include:

• Bitget
• ByBit
• OKX
• Gate.io

The above exchanges provide copy trading services for both spot and futures trading.

According to official data, Bitget's copy trading has over 100,000 lead traders and 490,000 copy traders. Lead traders can earn up to 8% commission by sharing their strategies and must meet specific requirements and application processes.

Bybit reports that 150,000 copy traders have used their copy trading feature, allowing them to replicate strategies from over 7,000 traders. Lead traders can be ranked by 7-day win rate, 3-week win rate, and 7-day PnL, and are entitled to 10% of the profits generated by copy traders. Various parameters, including fund size, leverage, stop-loss, and other relevant factors, can be customized.

OKX offers 58 tokens for copy trading, with 1,489 lead traders available for selection. Fees are the same as regular trading fees, and lead traders receive a 10% profit share. Users can copy up to five different traders. This feature provides spread protection and allows for setting a maximum investment amount. Lead traders can execute up to 50 trades per day and can only close positions with market orders.

Gate.io currently has 828 lead traders, charging 5% of the profits generated by copy traders.

Considerations when engaging in copy trading include performance records, performance metrics, trading strategies, risk adjustments, and community engagement (number of followers). Diversifying the selection of traders to copy to reduce overall portfolio risk is also considered a good practice.

2. Exchange Ecosystem Business

Many users increasingly expect CEXs to participate in and contribute to the broader crypto ecosystem.

(1) Coinbase

In February 2023, Coinbase announced the launch of the BASE testnet, an Optimistic Rollup built on Ethereum using the OP stack. It aligns with the vision of Superchain, where there will be many interconnected Rollups built using the OP stack. Coinbase has collaborated with the Optimism core development team and committed to decentralizing the sequencer in the future. This seems to indicate Coinbase's progress in the on-chain and broader ecosystem.

(2) Binance

After the FTX collapse, Binance deployed a $1 billion "recovery fund" to provide funding for projects that were struggling due to market turmoil but performing well otherwise. As of March, 18 organizations had joined the fund, bringing the total to $1.1 billion. This demonstrates the exchange's commitment and responsibility to the broader industry.

(3) Bitget

In April of this year, Bitget announced a $100 million venture capital fund focused on Asia. It has begun to expand into the crypto ecosystem and acquired Bitkeep in March 2023. The exchange has also partnered with fetch.ai and CORE DAO to jointly develop its ecosystem.

V. Who Will Be the Winners?

History tells us that people are reluctant to "put all their eggs in one basket." Different exchanges serve different purposes, and depending on the development of global regulations, there may be some large, geographically and legally decentralized exchanges. Exchanges that actively contribute to the ecosystem should gain more favor and trust from users. Most importantly, in addition to a robust feature set and excellent user experience, exchanges need to prove themselves to be safe, transparent, and "trustworthy." Furthermore, exchanges must ensure their operations comply with upcoming regulations, as global regulators are seeking to implement their digital asset frameworks. This could have a significant impact on the operational models of many exchanges.

VI. Conclusion

The collapse of FTX has been a catastrophic event for the entire industry, especially for CEXs. It has posed greater challenges for CEXs in terms of transparency and depositor protection. Since the FTX incident, proof of reserves has essentially become the industry standard. However, some exchanges are taking further measures, such as protection funds, with Binance and Bitget increasing their protection fund allocations after FTX's collapse.

Binance has maintained its leading position; however, it has not monopolized the market left by FTX. Compared to DEX spot trading, we observe a relative decline in CEX spot trading. Most derivatives trading platforms have seen a decline in trading volume, with Bitget being an exception, as it experienced a slight increase in trading volume in the months following FTX.

Despite exchanges striving to become more transparent, they still must adhere to higher standards. Proof of reserves and protection funds are improvements, but they do not guarantee safety. Successful exchanges need to consistently provide the best features for users while building trust through increased transparency, protection funds, and ecosystem participation.

This report is co-authored by Nansen and Bitget.