Coming mostly from a background in traditional finance, when I first heard about transaction mining I was astounded. My initial reaction was basically RUFKM?
Some images in this post, including the one above, come from this Bitcoin.com article, which does a good job summarizing the negative view on transaction mining. Some people call it trans-fee mining.
After a bit of thinking, I started talking about it with our team. Our company Slack at Konstellation was peppered with questions like:
- So you mean tokenholders get paid for trading?
- Uh, how does the exchange make any money?
- How does this free token you get for trading retain any value?
- Are you sure that’s even legal?
To say the least, we were skeptical, as were many in the blockchain industry. But, as with a lot of new and unfamiliar ideas we’ve encountered on our interstellar journey across the cryptoverse (Hey man, my company is named Konstellation, so I get to be liberal with the star-related puns!), engaging with this community and the game-changing technology of blockchain, you have to be willing to change your tune.
That doesn't mean that I think every exchange that uses transaction mining is doing it in a legit fashion. It just means that I don't think transaction mining is as bad as I thought it was when I first encountered it. The world and its financial ecosystem are changing so fast that new paradigms become old ones and old frameworks get rendered obsolete, all in the blink of an eye.
Fcoin began the transaction mining movement in June 2018. It was a major disruption for the crypto markets. As such, the existing crypto market institutions derided it primarily because it was a threat to newly established crypto players, which had themselves displaced previous exchange powerhouses like Bobby Lee’s BTCC. I don't know who owns BTCC any more but I know good ol' Bobby is long gone. Whoever owns BTCC now can't even spell.
Nice plateform, guys!
At its height, Fcoin saw $17 billion of trading volume in one day. That's what happens when people not only can trade for free, but get paid for doing it, too!
Innovation is almost universally met with resistance. Moreover, it is the first movers that often get tossed aside once the new business model has been refined and accepted by the masses. Does anyone still use Friendster or Myspace?
It turned out that the token economy of Fcoin was an extremely poor design. There was absolutely no incentive for holding the native FT token on the Fcoin exchange. The result was disaster for anyone who decided to hold the FT tokens they had acquired for free.
Other exchanges that quickly adopted this model were Bitforex, Coinbene, Coinsuper, and Bgogo. Boy, just clicking through those links you'll notice one overarching theme. These Chainup guys must be rich! Since most modern crypto-to-crypto exchanges originate from the same white label exchange service provider, the only distinguishing characteristic that differentiates these products is the token economics behind the native exchange token on each of these "3rd generation" exchanges.
As somewhat of a regulatory nerd myself, I eventually came to realize that the true innovation in transaction mining is that it allows for the wide distribution of tokens without passing the Howey test.
What is the Howey test? Despite what you may have heard, it is the ONLY method by which regulators can determine whether or not an "investment contract" is indeed a security. The test is derived from Supreme Court case law and was issued in the landmark case SEC v. Howey Co. on May 27, 1946. It still is the main determinant of what is and is not a security in the United States today.
The so-called "test" looks at four factors. These four aspects must ALL be met in order for an asset to be considered a security according to US law:
- An investment of money...
- in a common enterprise...
- with an expectation of profits...
- to come solely from the efforts of others.
The case goes on to state that "if that test be satisfied, it is immaterial whether the enterprise is speculative or nonspeculative, or whether there is a sale of property with or without intrinsic value."
Once one properly understands the parameters of the Howey Test, one can see the beauty of the trans-fee mining model. While the first 3 conditions of the Howey model are easily satisfied, the 4th condition is avoided when token holders must ACTIVELY do something to acquire the token. In this instance, for crypto exchanges at least, tokens are acquired via trading, thereby ensuring that native exchange tokens (from exchanges that utilize this business model) can never pass the Howey Test. Therefore, such tokens can never be considered a security.
The first exchange to really advance this thinking in token economic design is Bitmax. They have employed what I call the "kitchen sink approach" to token economics. Not only do they use transaction mining on select pairs, right now it is only offered on two stablecoin pairs, they also have developed a unique "reverse mining" approach for all other pairs. This innovation means that they don't have to dilute the BTMX native token by compensating traders with it on every trade. They just return the trading fee to you in a main coin like ETH and deduct the equivalent from your BTMX balance. This combination creates a two-way trade for BTMX tokens, rather than the one-way down down down that plagued FT tokens on Fcoin.
In addition to these two methods of "mining" BTMX, Bitmax offers a ridiculously high "dividend" for those token holders that lock their BTMX up on the trading platform. Note the air quotes around "dividend" please. Because Ariel and George, the finance industry veterans who founded Bitmax, are not stupid enough to actually call it that. Instead they use the term "Data Usage Reward." By ACTIVELY allowing them to use your trading data (for what, no one knows) they avoid the designation of security according to the Howey Test.
It's a smart way to go about it.
There is, however, one flaw in their model. And it is this flaw that makes me certain that we have not seen the end of "liquidity innovation" on crypto-to-crypto exchanges.
For the longest time, the "data usage reward" had been unreasonably high. The annual percentage rate (APR) given to BTMX token holders that locked up their tokens on the platform was between 70% and 100%. In order to bring this number down to more reasonable levels, the BTMX token price had to be pumped. Remember, as price increases, yield decreases. As of today, the APR is now a much more reasonable 33.3667%.
However, in order to achieve this much more reasonable yield, they now have to have 3-4x more volume on the two stablecoin pairs (USDC/USDT and PAX/USDT) in which you can conduct trans-fee mining. That is just what has to happen in order for the exchange to maintain the previous pre-pump inflation rate of the BTMX token supply. This inevitable truth leads to some pretty ridiculous looking charts:
Remember that is a stablecoin pair you are looking at!
$1=$1, right? Not on Bitmax.
So this token design has led to some rather unbelievable volume numbers since the initial pump in BTMX price. Let's take a look at today's top 10 exchanges according to reported volume on CMC:
So Bitmax ends up being the #1 exchange according to reported volume, even though it is the #49 exchange when it comes to adjusted volume. That's because 99.32% of their volume is recorded in the two stablecoin pairs that allow transaction mining of the BTMX token.
I don't know about you but I find it extremely unlikely that there is $7.29 billion worth of capital out there willing to chase bips on the limited volatility in stablecoin pairs on an exchange most people have never heard of.
Nevertheless, I can't wait to see what the next iteration of the trans-fee mining model will bring. Transaction mining is a good idea that has yet to come into full flower.