As regulators and public exchanges are leaning towards accepting Bitcoin products and perhaps Ethereum or Ripple products in the future. There’s still hundreds of cryptoassets that might never be tradeable via the exchanges stock brokers currently have access to.
The key driver of demand for cryptos during the last 2 years was the advent of initial coin offerings (ICOs) for project funding. There is currently no clear path for customers of online brokers to participate in present and future ICOs, since the customers only ever trade in derivates and CFD contracts but never get into possession of the underlying which is needed to invest in ICOs.
The crypto economy thrives in the absence of regulation that favors established entities. Relatively small teams or companies deploy projects and offer products that normally imply extensive paper work and reporting requirements like lending, insurance or funds. Blockchains are merely the glue to connect all the different actors which deploy applications on top.
For example crypto currency exchanges provide interfaces to the blockchain adding the exchange functionality. The key difference to traditional exchanges is that they commit changes of balances to the decentralized ledger so that assets bought in one place can be further processed using a different user interface to the same underlying blockchain. Thus the analogy to the blockchain being the glue between services or the new internet. The blockchain does not only connect exchanges with similar services but every other product that is build on top of the blockchain, like transfer of funds, lending, borrowing or betting. Some but not all of these services have been implemented as decentralized protocols. Protocols are like formalized business processes programmed into smart contracts or encoded into the concensus rules of the underlying blockchain. They are comparable to SMTP for Email, HTTP for browsing or FTP for storage. In comparrison protocols in the context of blockchains tend to be build around transfer of value instead of transfer of information.
Exchanges currently act as gatekeepers as they decide which digital asset gets listed and require compensation from project initiators. Decentralized alternatives grow in volume since they don't require permission from any central authority to allow trade in a particular asset. Currently centralized crypto asset exchanges combine different functions.
- The crypto gateway: The user deposits crypto assets to the exchange which provides a wallet address for this purpose.
- The wallet: The exchange takes the received token in secure escrow and issues IOUs to the user instead that can be traded within that particular exchange, or send to affiliated services.
- The trading floor: The user trades the IOUs
- The fiat gateway: The user receives some USD denominated balance that he wants to transfer to his bank account. The gateway destroys USD IOUs and wires the money to the customer or vice versa. The key responsibility is the correct implementation of AML / KYC procedures.
- The market maker: To provide liquidity the exchange employs bots to arbitrage with other exchanges.
- The bank: To allow leveraged trades, the exchange will provide liquidity pools with funds for lending of either fiat or crypto assets.
New contenders to the market have to find ways of either implementing the functions of current exchanges or use existing frameworks for decomposing the application in roles and only implement the roles that provide the most value according to the existing business model.
The frameworks for decomposition are growing in numbers as most of the more interesting protocol layer fund raising projects centered around the gateway model to integrate different “communities”, effectively building whats is termed the “internet of blockchains”.
Using the second approach the provider of a new tool can choose to integrate existing building blocks and building a network of partners while focus on core strengths. For this he has to run a gateway. Exploiting the possibilities of running a gateway is easy using the the Ripple network which delivers one proven approach of decoupling roles and integrating services.
- The GateHub gateway provides users with a wallet for the most important crypto assets.
- Bitstamp among smaller participants provides the exchange of assets.
- Fiat gateways issue derivates denominated in USD or EUR to be transferred and used within the Ripple network. They are widely accepted only following negotiations between gateway providers.
Running a Ripple gateway thus provides the foundation to connect to the liquid market of the Bitstamp exchange and securely storing assets in the GateHub vault. This leaves open the implementation of a user interface to make these services accessible to customers, as well as providing the user with Bitcoin or cash denominated derivatives that are accepted by these other gateways. Using Bitcoin to transfer value immediately removes the need for negotiations since crypto is accepted by every gateway. It would be easy to flip exchange traded derivatives for BTC or ETH in the underlying asset effectively removing the need for negotiations with other gateways and counterparty risks.
Owning the wallet interface is comparable to owning the messenger like Whatsapp or WeChat as the primary interface of the customer to blockchain enabled services. Bitstamp allows to set Limit and Stop Loss orders for trading, but the simplest type of exchange is integrated into most wallet applications today by interfacing with the API of services that allow on the fly conversions between digital assets using current market prices. These services have referral programms paying a percentage of the fees for every conversion. (Changelly, ShapeShift)
Some of the future protocols that recently finished their funding though ICOs (ICON, Status, SMT) will have build in mechanisms for exchange of any connected currency to any other connected currency providing the user the same but currently expensive functionality without fees and with tighter spreads.
Different plattforms compete for future ICOs (SMT, Starbase, cofound.it) with token potentionally being marketed across different platforms. Gateways that participate in different plattforms can transparently bridge the different ecosystems and allow wallets to route the customer request through them in the most cost effective way. Currently users do this manually bridging different ecosystems by using Tether USDT or fluctuating cryptocurrencies like Litecoin or Dash that can be transferred fast and that are liquid on any other trading plattform.
One example of routing could be to trade on the decentralized exchange BitShares which requires you to have USD derivates called bitUSD. For this you need a gateway that flips your LYNX.USD derivatives from the Ripple network to bitUSD. For this you need a bridge between the Ripple and BitShares network. Using BitShares your trading fees are lower than on the BitStamp exchange, but spreads might be higher as long as no market maker provides the BitShares exchange with liquidity using arbitrage (in the works). Using BitShares you will be able to trade the top 10 crypto currencies very cheap, but not your newly minted ICO token.
The place to go for ICO token exchange might be the EtherDelta smart contract on the Ethereum platform which allows to trade all Ethereum based ICO token early on. For instance you would want to sell ICO token for USD. You can trade the token for ETH using EtherDelta, sell the received ETH for bitUSD using BitShares and flip bitUSD to LYNX.USD for withdrawal or storage. All this can happen in the background in realtime without telling the user of the wallet application about the hidden complexities. The transaction costs are limited to the relatively low and fixed network fees on Ethereum and Bitshares plus the conversion fee of the included gateways and the spreads on the markets. A hidden step in this conversion is the gateway that connects Ethereum to Bitshares and might incurr fees for its service as well.