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*Author’s Note: this newsletter is taking a break next week - we’ll return to our normal cadence beginning Friday, July 9th.*
In July 2017, a well known face in the crypto industry decided to launch his own exchange.
Changpeng Zhao was best known for his role as chief technical officer of OKCoin, the second largest crypto exchange by trading volume at the time. In 2015 Zhao left the firm citing differences with its CEO & a legal battle over his employment contract.
“I’m pretty sure I will still be in the Bitcoin space,” Zhao quoted during an interview. “I think we’ve entered a winter phase in the bitcoin industry, but I strongly believe it will pass.”
Two years later Zhao made good on his prediction, raising $15 million to launch Binance out of Shanghai, China. Six months after launch, Binance was the largest crypto exchange in the world. 6 million users had signed up to the platform & Zhao had amassed a nine figure fortune. The exchange retains the world’s #1 spot to this day, with nearly $5 trillion in YTD trading volume.
Binance’s dramatic, nearly instant rise to the top of crypto may seem as fragile & mysterious as the industry itself. After examining Zhao’s past & experience with traditional market structure, his exchange’s success shouldn’t come as a surprise. Zhao was an exchange, market data & HFT expert long before he entered the crypto space, and Binance’s design mirrors its founder’s understanding of how markets work.
Where did Zhao’s expertise come from? How did this expertise catapult him to crypto’s most prolific CEO?
Incentives, Data, Speed
Zhao’s path toward Binance billionaire status began with an interest in computers. After graduating from McGill University in Canada Zhao took a job with a software company doing outsourced development work. His first peak into the world of market structure came when he was assigned the Tokyo Stock Exchange as a client, one of Asia’s largest exchanges with 3,500 listed companies and more than $1 billion in annual revenue. TSE’s flagship products include a large cash equities business, futures on the Nikkei Index & Japanese government bonds, and an extensive market data & connectivity unit. Zhao’s development work with the exchange included improving their core matching engine, the complex system that ensures trades are executed quickly & accurately.
A look inside one of Asia’s largest exchange systems gave Zhao a unique understanding of incentives. How does an exchange improve volume & market liquidity? They incentivize customers to trade certain products in a certain way, either through fee rebates or new market data services that help traders create new strategies. Zhao’s time at the Tokyo Stock Exchange gave him a foundation in market structure needed to make Binance what it is today.
“I very soon learned, wait a second, there’s a lot of money flowing through these systems, just a huge amount of money. So I never left that industry afterwards.”
- Zhao speaking about TSE in a 2021 interview.
After finishing his work with the Tokyo Stock Exchange, Zhao took a job with an equally critical part of the financial system: Bloomberg Tradebook. As many of us already know, Bloomberg is much more than just a newsroom. The Bloomberg Terminal is the largest financial desktop product in existence, and its electronic fixed income platforms rival Tradeweb & MarketAxess in size. Bloomberg also boasts a popular EMS, or execution management system, that gives institutional customers one place to trade across a vast array of markets & products. Zhao’s job focused on developing the EMS’s futures trading services, which were added in 2002.
A unique role like this gave Zhao a deep understanding of the importance of data to professional traders. It’s incredibly difficult to trade in a market without a complete view of that market, making expensive data feeds worth the money for many serious trading firms. Zhao rose through the ranks at Bloomberg to become head of Futures Research & Development, leading efforts to give traders as complete of a market picture as possible.
In 2005 Zhao quit his job at Bloomberg to help launch a new venture: Fusion Systems, an Asian high frequency trading service provider. Fusion’s core product suite included a system called Raptor, a high-speed direct market access network that connected trading firms to regional exchanges including the Hong Kong Stock Exchange, Australian Stock Exchange, Singapore Stock Exchange, and - look at that - the Tokyo Stock Exchange. Raptor helped customers trade across a fragmented field of international markets & thousands of miles of ocean with near-instant execution.
Zhao’s time at Fusion Systems helped him learn the value of speed among this new class of electronic traders. As we’ve discussed in this newsletter many times before, speed is a way of survival in high frequency trading - the first firm to spot & capitalize on a trade wins & makes money. There are no prizes for second place. Fusion Systems developed & sold high speed shovels as the HFT gold rush matured in the mid to late 2000s. Zhao had a front row seat to the the industry’s birth & growth in Asia, giving him valuable insight into an increasingly dominant set of market actors.
With a market structure resume as deep & well-rounded as his, Zhao arguably couldn’t be better prepared to launch an Asian exchange of his own. But what market could he disrupt? What asset class needed a new source of liquidity?
It wasn’t until 2013, when Zhao first read the Bitcoin whitepaper, that his opportunity presented itself.
Coming Out Party
Binance officially launched in July of 2017 with a $15 million capital raise in the form of an initial coin offering, or ICO. Zhao listed his Binance Coin token at the perfect time - ICOs were near peak popularity & demand for his offering proved more than healthy. What separated Binance’s cryptocurrency from the field were the incentives built into the token itself. Traders who used BNB to buy or sell on Binance’s platform received a substantial fee discount, driving demand for both the token & the exchange’s services. As Binance’s competitive fees boosted market share the price of its token rose in tandem, creating a powerful feedback loop of user interest & demand. Crypto’s first coming out party in late 2017 only magnified the exchange’s success. By December 2017, Binance was already trading more volume than Coinbase, America’s largest crypto platform with a four year head-start:
Zhao’s traditional exchange past has continued to show up in Binance’s strategy. In early 2020 Binance bought CoinMarketCap, one of the largest and most popular crypto price aggregator sites. The acquisition - to this day the largest in Binance’s short history - gave the exchange a treasure trove of data about CoinMarketCap’s users & the overall market. In an asset class as nascent & fragmented as crypto, sources of high quality data can be worth their weight in gold, as evidenced by CoinMarketCap’s rumored $400 million purchase price.
Even more recently we’ve seen how Zhao has built Binance to meet the market’s ravenous need for speed, especially when it comes to DeFi. While blockchain technology boasts plenty of innovative strengths, it sorely lacks in speed compared to traditional market structure. Blockchains that work in a truly decentralized way are notoriously slow & expensive to maintain, making them less than perfectly efficient. Ethereum is struggling with this dynamic today as growing transaction volume & high gas fees weigh down the network.
How did Binance overcome the speed problem? It built its own set of blockchains - first Binance Chain in 2018 followed by Binance Smart Chain in 2020. These blockchains, while controlled by Binance & not purely decentralized, are more than 5x faster than the Bitcoin & Ethereum blockchains, are cheap to interact with, and can handle large amounts of transactions with ease. As global interest in DeFi swells to record highs, more developers & users are opting for Binance’s ecosystem to launch decentralized applications - PancakeSwap, the largest decentralized exchange in existence today, is the most popular example of this.
Binance has even managed to launch an American subsidiary despite a spotty ethical & regulatory track record. Binance.US has been gradually rolling out in approved states throughout 2020 with the goal of full national coverage by the end of 2021. Trading volumes have already eclipsed $50 billion in monthly notional and are ~1/4th the size of Coinbase. Americans may soon view Binance as more than just a far-away global crypto behemoth, but a local one as well.
If you’re just reading the headlines, Changpeng Zhao & Binance may seem like crypto’s most famous Cinderella story - an everyday Bitcoin enthusiast with a knack for computers starts an exchange and becomes a billionaire in less than a year. When you look beneath the surface, however, it becomes clear just how much market structure experience it took for Zhao to become the global crypto exchange king. My guess is Binance’s dominace may only just be getting started.
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Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, NDAQ, COIN and VIRT. I am also long Bitcoin, Ethereum and Uniswap’s UNI governance token.