Welcome to Deep Dive! The centralized exchange space has experienced two major shocks in the past two weeks, first with Binance ending zero-fee trading for most BTC pairs, then with the CFTC alleging Binance has violated U.S. federal laws. This week, we'll see what the data can reveal about Binance's user base and why U.S. institutions may have wanted to use the exchange.
Binance is the world’s largest crypto exchange by a huge margin. It has achieved consistent growth since its founding in 2017, but its increasing dominance has been striking to watch since 2020, when it held around 25% of spot volume market share. Its market share approached 50% at the tail end of the 2021 bull market before retreating and again expanding to peak over 70% this year. Last week it was down to just 57%, much of which was due to changing fees and an outage.
The first hit to Binance came in February when the New York Department of Financial Services (NYDFS) ordered Paxos to stop issuing BUSD while the Securities and Exchange Commission (SEC) sent a Wells notice to Paxos. A NYDFS spokesperson said that Paxos hadn’t met its obligation to conduct due diligence of BUSD customers to prevent bad actors from using the platform (whether “platform” refers to Binance or Paxos isn’t clear). I’ve covered this saga more in-depth here.
The second and far more explosive hit came this week as the CFTC announced that it was charging Binance and its CEO/Founder Changpeng Zhao (“CZ”) with willful evasion of federal law and operating an illegal digital asset derivatives exchange. The allegations include:
Binance took a calculated approach to increasing its presence in the U.S., first by bringing in retail and later by bringing in institutional customers.
Binance directed retail customers to use VPNs to obscure their location and allowed them to continue trading without submitting proof of identity.
When in 2019 Binance began to restrict users from certain jurisdictions it left a loophole to allow customers to use the exchange without undergoing KYC.
As of January 2020 19.9% of Binance customers were located in the U.S.
Binance has traded on its own exchange using 300 “house accounts” linked to CZ.
Binance used Binance.US to identify important U.S. clients and then push them to onboard with Binance by using new KYC documentation associated with a shell company.
Binance used “prime brokers” that allowed U.S. institutions to trade spot and derivatives on the exchange.
This case may take years to play out and we won’t make judgements on whether the allegations are true or not but instead investigate what the data shows about Binance’s user base and consider why U.S. institutions may have wanted to use Binance – as well as why Binance would rather large traders use Binance than Binance.US.
Where are Binance's Users?
Binance trading volume is disproportionately skewed towards U.S. trading hours (orange) and is in fact quite similar to Coinbase, a U.S.-based exchange. In 2018, 35% of its BTC volume occurred between 1pm and 8pm UTC (9am to 4pm ET) while Coinbase’s figure was 41.5%. Thus far in 2023, 43.4% of Binance’s BTC volume comes during U.S. hours, slightly lagging Coinbase’s 47.5%.
It’s also possible to pinpoint when Binance’s volume distribution changed: late Spring and early Summer 2021 as China cracked down on crypto trading. In just a few months, Binance went from a relatively flat hourly distribution to one that clearly favors European and U.S. trading hours, with over double the volume at 10am ET compared to 1am ET.
It’s true that Binance facilitates the plurality of its volume during U.S. trading hours, though it isn’t clear that this is purely the result of the exchange specifically targeting U.S. traders. However, a U.S.-based trading firm has already come forward to confirm some of the details in the suit, and thus it’s worth considering why some U.S. institutions would opt to use Binance. It appears there are three main reasons:
Access to derivatives
More spot pairs
Better liquidity
Access to Derivatives
Binance is a relative newcomer to the derivatives space, listing its first instrument in mid-2019. Thus they were positioned perfectly when BitMEX – previously the largest crypto derivatives exchange – ran afoul of the CFTC in October 2020. Binance was apparently well aware of the implications of the regulatory action against BitMEX, with its Director of Operations allegedly telling a colleague that “the recent Bitmex incident has had a great impact on the industry. Please remove US data from all our charts… Everyone in the future will not see our US data, except for financial and very few people.”
Binance has been aggressive with perpetual futures listings, and since 2021 has only ever been surpassed by FTX, which had 182 instruments when it met its demise.
U.S. users have limited options for crypto derivatives – retail can use exchanges without KYC checks (which may not be safe or legal) while institutions can either use a small number of licensed derivatives exchanges like CME (which is limited to BTC and ETH) or opt for the method laid out in the suit against Binance, which would give them access to over 200 perpetual futures instruments.
Binance has dominated futures volumes for years and since the fall of FTX has consistently facilitated more than half of all BTC perpetuals volume on exchanges Kaiko covers. (Note that its market share has actually decreased since December as both OKX and Deribit have grown.)
The combination of significant volumes and the most instruments available made Binance an attractive venue for institutional trading and market making. However, this space may be in for a shakeup depending on how the suit plays out and whether Coinbase and Gemini launch international derivatives exchanges as has been rumored.
More Spot Pairs
In a more general sense, Binance has another advantage over U.S. exchanges in its freedom to list new tokens for spot trading. As of today, Binance has more than double Coinbase’s actively traded pairs, four times Kraken’s, and six times Binance.US’s.
Institutions have access to a wider array of tokens if they use Binance as it has nearly 600 more spot pairs than its U.S. affiliate. However, all these pairs wouldn’t be a draw unless Binance has deep liquidity, which it does. The token listing advantage looks like it may tilt further in international exchanges’ favor if the SEC alleges that Coinbase has listed unregistered securities as its Wells notice suggests.
Deeper Liquidity
Liquidity is paramount in crypto, particularly for institutions that are building or selling large positions or trading frequently. On this front, Binance again scores well, with spreads 36 times tighter than Binance.US and 8 times tighter than Coinbase as of this writing. Unsurprisingly, Binance has the tightest spread for both BTC-USDT and ETH-USDT.
This naturally serves as a draw for institutions that are making frequent trades. Binance’s altcoin liquidity is also extremely deep. Below is charted the slippage for a simulated $10k sell of ATOM, a top 25 token by market cap that is offered on all three exchanges. Slippage on Binance rests at 0.03% and never exceeded 0.1%; slippage rests at 0.11% on Coinbase and has fluctuated between 0.1% and 0.3% on Binance.US.
What's Next?
Binance’s market share has already dipped and will likely decrease in the coming months, though it will be difficult to tell how much of this is because it reinstated fees on its most traded BTC pairs as opposed to U.S. institutions ceasing to trade on the exchange. Luckily, Kaiko has a variety of liquidity and trade metrics that will give us insight into how the exchange responds to its recent changes and this regulatory action.
Normally I would speculate that U.S. exchanges – particularly Coinbase – would absorb some of the U.S. institutional spot volume that leaves Binance. But right now the regulatory environment is simply too unclear to make any prediction. In the near term it seems likely that other exchanges – namely Deribit, Bybit, and OKX – will continue to capture some of Binance’s derivatives volume. The fight for this volume could become even more interesting if Gemini and Coinbase decide to jump into the fray.
Kaiko's research newsletter is written by the Kaiko research team: Clara Medalie, Dessislava Aubert, Riyad Carey, and Conor Ryder, CFA. This content is the property of Kaiko, its affiliates and licensors. Any use, reproduction or distribution is permitted only if ownership and source are expressly attributed to Kaiko. This content is for informational purposes only, does not constitute investment advice, and is not intended as an offer or solicitation for the purchase or sale of any financial instrument. For any questions, please email research@kaiko.com.
