Original author: CHI ANH, JAY JO  YOON LEE

Original translation: TechFlow

Summary

  • Purpose of protogenesis links: Exchanges such as Binance and Coinbase adapt to the rapidly changing market environment by building their own blockchain platforms, strengthening the ecosystem and diversifying revenue models.

  • Types of protogenesis links: Protogenesis links can be roughly divided into two categories. The first category is token-centric protogenesis links, such as Binance’s ecosystem, which enhances the value of exchanges and ecosystems through their own tokens. The second category is technology-centric protogenesis links, which focus on the performance and functionality of blockchain technology without relying on tokens.

  • Challenges of native chains: Although Binance and Coinbase have demonstrated their significant advantages, developing and using native chains still faces huge challenges and regulatory risks. Huobi’s HECO Chain is an example of these difficulties and the need for significant resources to attract initial users and the product.

1 Introduction

The cryptocurrency market is known for its dynamics and rapid growth. Despite the rapidly changing market environment, centralized exchanges (CEX) have maintained their important position. From the past to the present, these exchanges have continued to expand their influence.

CEX plays a key role in the Web3 ecosystem, with a strong business model and a stable source of revenue. Recently, their role has been further expanded to become blockchain infrastructure providers. Typical examples are Binance's BNB Chain and Coinbase's BASE Chain, which have increased their market influence by developing their own Web3 ecosystems. HashKey Exchange's recent launch of HashKey Chain based on Ethereum Layer 2 further consolidates this trend.

This report explores the background and goals of CEXs developing protogenesis links and analyzes the impact of these strategies on the cryptocurrency market and the Web3 ecosystem. Through this analysis, we hope to provide insights into the evolution of centralized exchanges and the future direction of the Web3 market.

2. How does CEX generate revenue through protogenesis links?

CEX develops and operates native chains according to different strategic goals. Their approaches can be roughly divided into two categories. The first category is the token-centric Native Chain, which is the most commonly adopted strategy of CEX to build an ecosystem around its own token. The second category is the technology-centric Native Chain, which focuses on the performance and functionality of blockchain technology.

2.1. Token-centric Native Chain

Source: OKX

The Token-centric Native Chain is the most common approach among centralized exchanges (CEX). Exchanges like Binance, OKX, and Crypto.com adopt this model. They increase the value of existing trading models by issuing tokens, provide incentives based on token economics, and use tokens to attract numerous projects into their ecosystems. This strategy allows for rapid expansion of users and ecosystem participants. In addition, by linking various services and providing direct, visible benefits to users, they diversify their business models and lock users into the exchange.

For example, Crypto.com’s Cronos not only supports staking and network rewards, but also allows users to access DeFi features using its Token $CRO. The token can be used to obtain higher cashback and discounts, online shopping, and exclusive rewards. OKX offers discounted trading fees and helps users generate stable income through OKX Earn. Binance has expanded the value of its token by building a DeFi and GameFi ecosystem within its platform.

This token-centric model effectively positions the exchange as a comprehensive blockchain ecosystem, providing more value and incentives to users. However, it should be noted that this model is susceptible to token value fluctuations and regulatory risks.

2.2. Technology-centric Native Chain (non-token model)

Coinbase is a typical representative of technology-centric Native Chain. Coinbase's development of Native Chain brings multiple strategic advantages, especially the diversification of revenue models. The main source of income for this model is transaction fees. As the only sequencer of the BASE chain, Coinbase controls all transactions within the chain and earns considerable income from it.

Source: @sealaunch

BASE maximizes revenue and reduces costs by bundling multiple users' transactions into one transaction on Ethereum. As an L2, BASE needs to aggregate transactions to Ethereum (L1), which can reduce costs by bundling more transactions.

For example, if Chain A and BASE each charge $1 per transaction, Chain A earns $50 by bundling 50 transactions, while BASE earns $100 by bundling 100 transactions. If both pay $50 to Ethereum to make a transaction, Chain A only breaks even, while BASE nets $50. This efficiency enables BASE to maximize revenue by effectively bundling more transactions.

Since the launch of the BASE chain in August 2023, BASE has generated approximately $65.1 million in fees. Of this, $16 million was paid to the Ethereum network, while $49.1 million was profit for Coinbase. However, BASE has a revenue sharing agreement with Optimism (the developer of the underlying OP Stack technology). Under the agreement, Coinbase must share 2.5% of BASE's revenue or 15% of its net profit with Optimism DAO, whichever is greater. In addition, the decentralization of BASE's sorters in the future may further limit profits.

Another important revenue strategy is to issue stablecoins within the chain. Coinbase has partnered with stablecoin issuer Circle to issue USDC based on BASE, generating revenue from the interest on the USD collateral behind USDC. In the first quarter of 2024 alone, this partnership brought Coinbase $197.32 million, accounting for 12% of total revenue for the quarter. Given that there is already $3 billion in USDC on BASE, Coinbase and Circle may have a favorable agreement for USDC issued by BASE. This could bring in significant interest income, which could even exceed the income from transaction fees.

The benefits of BASE to Coinbase are not limited to financial gains. BASE enhances Coinbase's brand image, demonstrates the exchange's leadership in industry innovation, and consolidates its unique position in the ecosystem. In addition, BASE serves as a foundation for business expansion, enabling Coinbase to expand its business into various industries based on blockchain technology.

3. Is protogenesis an attractive option or a bubble?

The strategy of establishing protogenesis links on centralized exchanges (CEX) varies depending on the goals and environment of each exchange. This approach involves a multifaceted decision-making process that goes beyond technology selection and takes into account complex real-world scenarios and various risks.

Advantage:

  • Flexible customization: Ability to build optimized infrastructure to meet the needs of the exchange and its users.

  • Revenue diversification: Create new revenue streams by operating a proprietary blockchain.

  • Ecosystem expansion: Expand business areas by developing independent ecosystems.

Disadvantages:

  • High development costs: Blockchain development and maintenance require a lot of resources.

  • Intense competition: The challenges of attracting initial users and achieving network effects are similar to other blockchains.

  • Regulatory risks: As a crypto asset operator, you need to deal with a complex regulatory environment.

Building a native chain is undoubtedly an attractive option, but it also involves many risks and challenges. For example, success stories like Binance’s BNB Chain and Coinbase’s BASE have demonstrated various benefits such as generating new revenue streams and expanding the user base.

On the contrary, failed examples such as Huobi’s HECO Chain show that success is not guaranteed. Achieving network effects and securing a meaningful user base in a competitive blockchain market is a difficult task.

Regulatory risk is also a key consideration. For example, Coinbase’s decision not to issue a native token for BASE may be affected by potential reactions from regulators such as the SEC. This shows that exchanges must carefully consider the regulatory environment when developing Native Chain strategies.

Building a Native Chain may be an attractive option for exchanges, but it is a complex strategic decision that cannot be simply viewed as a trend or a bubble. Each exchange must fully evaluate its strengths, target markets, regulatory environment, and technical capabilities to determine the suitability of this strategy.

4 Conclusion

Recently, the interest of centralized exchanges (CEX) in developing Native Chain has been rapidly heating up in the cryptocurrency industry. Hong Kong-based HashKey Exchange announced the launch of HashKey Chain based on Ethereum Layer 2. South Korean cryptocurrency exchange Korbit has also started the development of a blockchain platform, referring to Coinbase's BASE. This shows that blockchain designs centered on technical infrastructure are considered to have great profit potential.

In particular, given the restrictions imposed by South Korea’s Virtual Asset User Protection Act on tokens that have a vested interest in listing on exchanges, Korbit’s decision may be driven by the fact that it can generate sufficient revenue through a trading fee model alone.

Although blockchain infrastructure has been developed primarily in the Western world, Asian exchanges are now also beginning to enter the chain development field, strengthening the competition for global infrastructure. Asian exchanges have relatively abundant capital and stability, and their participation is expected to enhance the diversity and innovation of the blockchain ecosystem.

Ultimately, the success of these projects is expected to provide tangible value to users, achieve widespread adoption, and significantly drive technological advancement in the blockchain industry. In addition to expanding the exchange’s business model, these initiatives will drive innovation and growth across the entire blockchain ecosystem. It is crucial to keep an eye on how these developments will shape the future of cryptocurrency markets and the Web3 ecosystem.

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