Tushar Jain and Kyle Samani, managing partners of Multicoin Capital, discuss Binance, Binance Chain and BNB token, and why they believe Binance will become the first centralized company to successfully decentralize itself and migrate the value in itself to its token. We cover what Binance, the centralized company has so far achieved in terms of trading volume, fiat on-ramps, and regulatory arbitrage, and whether the company has any more regulatory risk than any other exchange. We also look at the features of Binance Chain, how they compare to other decentralized exchanges such as 0x, and why Multicoin believes that it will have more liquidity than previous dexes. We then explore BNB token — how it works now, the regulatory risk for BNB token, and how it will function on the dex. Finally, we touch on Binance’s decentralization strategy overall and how it could fail.
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Episode links:
Multicoin Capital: https://multicoin.capital
Kyle Samani: https://twitter.com/KyleSamani
Tushar Jain: https://twitter.com/TusharJain_
Multicoin Capital BNB report: https://multicoin.capital/2019/02/19/binance-coin-analysis-and-valuation/
Unchained episode with CZ: https://unchainedpodcast.com/how-binance-became-the-most-popular-crypto-exchange-in-5-months-ep-84/
Transcript:
Laura Shin:
Hi, everyone. Welcome to Unchained, your no-hype resource for all things crypto. I’m your host Laura Shin. I’ve got one more announcement about my live podcast recording with Vitalik Buterin. We have chosen a venue. On March 20, Vitalik and I will be on stage at Columbia Journalism School in the Joseph D. Jamail Lecture Hall on the third floor. As I said on Twitter, this is especially meaningful for me because I went to Columbia J. School and never imagined when I went there that I’d be holding an event in the same building 11 years hence.
This choice of venue actually has nothing to do with my alumni status. It is more serendipity, which makes it all the sweeter. The evening starts at 6 p.m. with food and drinks. Vitalik and I will start our conversation at 7, and we’ll wrap up around 8:15. There will be a short Q&A at the end, plus a few giveaways, and we’ll round out the night with more drinks and networking until 9 p.m. If you haven’t yet bought your tickets, I suggest you do so ASAP, as there are only a few left.
Go to the Eventbrite link inside your podcast player now to get a seat at what is shaping up to be a fabulous event. Also, if you’re a podcast listener not based in New York, you can pre-submit a video of yourself asking Vitalik a question. I’ll select a few to play during the event. Just record a short video of yourself, one minute max, stating your first and last name, location, and affiliation if relevant, and asking your question. Email it to Hello@UnchainedPodcast.com with the subject line video question.
Otherwise, I hope to see you on March 20 at 6 p.m. at the first Unchained Live for a night delving into the pressing questions about whether Ethereum is losing its lead, how Vitalik views the competition heating up in the smart contract space, governance, and more. It’s going to be a substantive, fabulous conversation, so get your tickets now, and I will see you at Columbia.
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Laura Shin:
The topic, or topics, of today’s episode are Binance, Binance chain, and BNB tokens. My guests who will be discussing this are Kyle Samani and Tushar Jain, managing partners of Multicoin Capital. Welcome, Kyle and Tushar.
Male Speaker:
Hey, Laura. Great to be on. Thanks for having us.
Male Speaker:
Hey, Laura. Great to be on again.
Laura Shin:
So let’s just be clear for the listeners. Your firm has invested in BNB tokens. So I just want everyone listening to be aware of that. In general, hopefully most listeners are aware that anytime I have investors on my show, of course they’re going to talk positively about anything they’ve invested in, but Kyle and Tushar, I wanted you to come on the show because Multicoin recently did a pretty in-depth look at Binance and its strategy to decentralize, and Binance is obviously a hugely important company in the crypto space, and there were a lot of really interesting observations and bold forecasts you guys made that I thought we could unpack.
And for listeners who haven’t listened to my episode with C. Z. from last summer, I urge you to do so to hear more about Binance’s background and also really just to get a flavor of what C. Z. is like. Honestly, I’m not going to lie, that’s probably my favorite interview I’ve ever done. He’s just the kind of person who really has strength in his convictions, and it really shows, and it was just a fabulous conversation, but so Kyle and Tushar, why don’t we start by describing the success of Binance and its centralized exchange so far?
Tushar Jain:
Yeah. Absolutely. So this is Tushar, and we’ve been watching Binance and their execution ever since they launched in 2017, and we have been incredibly impressed by how well they’ve executed and really just dominating the crypto spot trading market. They have, by far, the most volume of any other crypto exchange that offers spot trading, and in fact, they have more volume than the other top three competitors combined. Now, all of these numbers are subject to some modification to remove some of what we call wash trading.
So if you go look on CoinMarketCap and you look at top exchanges, those numbers aren’t exactly accurate. So, in our report and in our research, we referenced some findings from the Blockchain Transparency Institute which looked at all of these exchanges and tried to determine the amount of real volume as opposed to, you know, just reported volume. Binance has also been incredibly aggressive in listing tokens, and they offer the most token pairs of any of the major spot trading exchanges out there. So, you know, their dominance in both volume as well as token pairs is unquestioned.
Laura Shin:
And one thing that I always just love about their story…and again, if you haven’t listened to the episode with C. Z. from last summer, definitely do so because he describes on there how he had never even heard of an ICO, and then within, like, I think…I forget the time frame. It was just a few weeks. I forget. Like, three weeks or 15 days or something after hearing of an ICO for the first time, he was holding an ICO, and he raised…I should’ve pulled these numbers up before we started again, but I think it was like…was it 15 million?
Male Speaker:
Yeah, it was about 15 million dollars.
Laura Shin:
Yeah, and then within five months, became the number one crypto exchange. So, I mean, you know, obviously, the cliché term to describe that is a meteoric rise. That is just such a good description of what happened there. So one of the things that you mentioned in your report was that what’s been especially impressive about Binance becoming so dominant is the fact that it doesn’t offer any fiat pairs. So why is that such an impressive feat?
Kyle Samani:
Yeah, so, you know, if you consider getting into crypto, right, assuming you have no crypto, you want to convert some of your fiat money into bitcoin, or ethos, or something else, and you need to be able to do that with a fiat-to-crypto exchange. So Coinbase in the US is probably the most dominant fiat-to-crypto exchange. In different countries around the world, there are other exchanges that have kind of local dominance for getting people onboarded in crypto.
But then a lot of the exchange like Binance…Binance, until very recently, did not have any fiat-to-crypto support at all. It only supported trading crypto to crypto, and so what’s actually probably more remarkable and really most counterintuitive about Binance’s rise has been that they became the world’s dominant spot trading exchange, despite the fact they did not have any fiat to crypto.
So that means people came in, you know, fiat to crypto on Coinbase, or on WaBi, or on Bithumb, or whatever exchange in their local jurisdiction, got into bitcoin or ether, and then went to Binance, and then kind of did most of the rest of their trading there, and it’s pretty remarkable that that’s led to, you know, Binance being the most dominant exchange.
Tushar Jain:
Yeah, and I’d like to add a few more stats here that we pulled up from the report that we published recently, and what we see here is that Binance is the top traded exchange for 82 percent of the top 50 tokens, and Binance is facilitating 36.6 percent of global crypto spot trading volumes. So those are just some numbers to help put that into perspective, and to have accomplished that without having any support for fiat currencies during the period that we’re describing is quite simply phenomenal.
Laura Shin:
Yeah, because, of course, at that time when Binance had just launched, you know, that was the summer of 2017. So, at that moment, kind of awareness of crypto maybe was sort of hitting the mainstream, but definitely it was before we saw the real massive run-up with all kinds of everyday people getting into crypto, which happened more in the fall. So after that crazy bull run, how has Binance been faring so far in this crypto winter?
Tushar Jain:
It seems, from our observations, that Binance did not make the same mistake that many other organizations in crypto made where they over-invested and they grew too large during bull market and had to go and you know, cut things back through crypto winter. From what we have found, Binance, you know, has not undergone any meaningful layoffs. They actually seem to be growing at a healthy pace, and from the latest information that we have, they have about 400 employees around the world. So I think that they have been quite disciplined in how they grew, and this is paying off for them now as they’re able to continue investing throughout the crypto winter, while some other organizations, you know, maybe are having to pull back.
Laura Shin:
Yeah, I wonder if some of that discipline you’re talking about is…I mean, I didn’t ask C. Z. this, but I do remember I asked him kind of about all his newfound wealth, and he said something about how it hasn’t really driven him to purchase or spend anything flashy, because he said just the knowledge that he could buy that was enough. So maybe if he has sort of a similar kind of attitude for his business, you know, to be pretty frugal or just to not let things go to his head, then that might’ve been the case, and what about trading volumes on Binance during this crypto winter?
Tushar Jain:
So trading volumes just, if you denominate in fiat, just are generally going to match market prices. So you can see that, you know, trading volumes across all exchanges are down about the same as the market is down, so that has definitely affected Binance just as much as it’s affected the other exchanges. From our analysis, this was all proportional, and none of the major exchanges, the Binance, Bitfinex, Coinbase, Kraken, and other top exchanges of the world seemed to have benefitted or been hurt disproportionately through crypto winter in terms of volume.
Laura Shin:
And I know some people have been making noise about Coinbase seeming to have changed its philosophy entirely almost…some people are surmising it’s kind of reaching for revenue. Do you feel like Binance has changed any part of its operating ethos I guess due to the fact that volumes are down?
Kyle Samani:
No, we don’t really think it has. I mean, the most remarkable thing about Binance is that they really executed this regulatory arbitrage strategy from inception, right? They moved headquarters I think five times, if I’m not mistaken, and so they’re just kind of structurally a very decentralized organization, and they have been since inception. Their 400 employees are spread across 40 countries or so. So, given that, Binance has been pretty true to their mission of enabling people to…I think they call it…I think it’s exchange anything or…
Tushar Jain:
Exchange the world.
Kyle Samani:
Exchange the world. Yeah, that’s the tagline, and it’s been pretty clear from day one that that’s been the mission, and their growth path and trajectory has aligned very strongly to that. If you look at, you know, all of the new initiatives they’re rolling out over the course of 2019, those are all really just an acceleration of that mission. So things like Binance chain, and the decentralized exchange, the DEX, that has very large implications for the future of Binance’s team and employees, Launchpad as a capital formation and fundraising platform. Look at Binance research. Look at the fiat exchanges. I mean, everything they’re doing is in support of that mission, but you know, doing so in a way to do it in a compliant way and to do it in a way that bridges the old world to the new world.
Laura Shin:
Yeah, and we’re going to get into all of that more deeply in a second, but I want to establish a little bit more stuff about Binance before we get into its decentralization strategy. So, you know, we’ve been talking about kind of what it’s been doing or just how it hasn’t seemed to really change its strategy, but so what business moves has it been making this past year? Like, I know adding fiat is one of them. What are some of the things that you see it’s been putting into place?
Tushar Jain:
Yeah, I think Binance has been fairly aggressive in expanding out their business and taking advantage of this bear market as an opportunity to really build, and so a few of the key initiatives are, as you mentioned, fiat exchanges. They’ve brought on fiat exchanges in Jersey which supports euros and pounds. They, I believe, have also brought on their Singapore exchange as well as one in Uganda.
And from what we found in our research, it seems their plans are to bring on 10 crypto-to-fiat exchanges over the course of 2019. So that’s a fairly meaningful initiative on its own. On top of that, we have the launch of Binance Chain, which will offer a decentralized exchange for which they’ve released a testnet fairly recently, and this decentralized exchange is, in our opinion, the most important and largest initiative that Binance is taking on right now.
And just to show, you know, how committed they are to the decentralized exchange, in order to attract volumes to the decentralized exchange, the fees are actually lower on the decentralized exchange versus a centralized exchange, something that we haven’t really seen elsewhere. In addition to that, they’ve recently executed the first two successful sales on the Binance Launchpad platform, which is effectively a platform for ICOs, or initial coin offerings, and they have a schedule set out where they’re going to be doing one sale per month.
Both of the first sales that they did sold out extremely quickly, so they’ve shown some success with the Launchpad product, as well, and last but not least, they have been devoting a lot of energy to their research initiative and really sharing research with their clients and their users and trying to create a better informed crypto community. And while that doesn’t necessarily have the direct monetization opportunities as those first three initiatives, I think it’s also incredibly impactful, and you know, being a very mission-driven culture, I see how this fits with what Binance is doing.
Laura Shin:
And can you also describe the secure asset fund for users and why that’s important?
Tushar Jain:
Oh, absolutely. So, many exchanges have been targets of hacks or other types of security problems in the past. You know, everyone knows about the infamous Mt. Gox incident, and I mean, even more recently, we have things like Quadriga in Canada, and there were a few attacks last year, as well, primarily on some Asian exchanges, if I recall correctly, and so in response to those types of events, Binance has created what they call the SAFU fund, which I think is named after a typo that C. Z. had on Twitter.
Just like HODL, we in crypto love our typos becoming Memes, but they went and they created the SAFU fund, and I believe that it’s capitalized through some of the trading fees that Binance earns and is made available to ensure against losses in the event that Binance’s security is breached. However, as far as we are aware, we have no evidence that Binance’s security has ever been breached or that any funds have ever been lost, but it’s nice to know that there is an insurance fund in place in the event that that does happen.
Laura Shin:
And I also wanted to ask about this fact which I find pretty distinctive about Binance. It doesn’t have a bank account. So where does it hold its assets?
Tushar Jain:
So Binance holds their crypto assets in a variety of, you know, cold storage wallets. From what we understand, those are distributed across the world, and I believe that the Binance fiat-to-crypto exchanges count in the jurisdictions in which they’re domiciled. So, you know, you would expect Binance Jersey to have a bank account in Jersey, and Binance Singapore will have a bank account in Singapore, but the core entity is still free of the fiat system.
Laura Shin:
And so if they’re accepting payment for something, this other party has to pay them in crypto? Is that how that works?
Tushar Jain:
I believe so, and I believe they also pay people in crypto. Now, I know that a large percentage, I think the vast majority of their employees, take a significant part of their salaries in BNB tokens, but other cryptos that are used to pay employees, you know, most likely include assets like Bitcoin or USDC and other stablecoins. Those are quite useful for payments.
Laura Shin:
And why does it not have a bank account?
Tushar Jain:
I think that the regulatory arbitrage strategy which they undertook in the early days would’ve probably been harder to execute if they were reliant on a bank account, and given the fact that they were operating only a crypto-to-crypto exchange and didn’t have any fiat support, I think C. Z. and team probably made the determination that a bank account was more trouble than it was worth at the time.
Laura Shin:
And this goes back to I think a comment maybe it was Kyle made earlier which is about how it’s not clear which government has jurisdiction over Binance. So why is that not clear, and why is that significant?
Kyle Samani:
Yeah, so, I mean, it’s not that any one government doesn’t have jurisdiction. It’s just that Binance operates across many jurisdictions. They have now settled kind of a home base in Singapore and also have set up another, you know, HQ1, HQ2 kind of a thing in Malta. It appears they’re working on some sort of HQ3 in South America somewhere, although that’s still TBD where that’s going to end up. So, I mean, they are subject to jurisdictions in those local regions.
But they now have the level of scale such that they can negotiate with governments and you know, get favorable treatment, and guarantees that they’re not going to get like…Binance launched in China in July 2017, and two months later, the Chinese government shut down crypto. That was obviously a very scarring experience for Binance, and so now I think, as they operate on a go-forward basis, they’re going to try and structure deals with regional governments to ensure that something like that doesn’t happen again.
Laura Shin:
So this is something that I pressed C. Z. on in my episode with him, and I did recently see he tweeted that he felt like some of the questions were misleading, which, I have a feeling what he’s referencing is this point in our discussion where it wasn’t clear to me that he fully understood kind of like how a security is defined in the US, which is obviously different than other jurisdictions, or maybe he does know.
But you know, at least when it comes to C. Z., I think that they say if you’re serving US customers, then they have jurisdiction. So I noticed in your report, you said that you actually thought that Binance had little risk of being prosecuted for listing unregistered securities, and of course, with a huge amount of tokens, they have, most likely…at least a few probably are. So why do you think there is little risk of that?
Tushar Jain:
There’s a couple of reasons. One reason is that, you know, we have seen that the SEC and other American regulators are really taking a good faith approach to the industry. We haven’t seen the regulators really go after anyone who was operating in good faith, and you know, who did the best to comply with regulations given how gray the regulations really are?
And from our research, specifically looking into Binance’s listing process, it appears that they’re operating in good faith, and so we think that they are no more at risk of being in violation of listing a potential security than any other exchange, you know, an exchange like Kraken, or Coinbase, or Bitfinex, and so we don’t think that the SEC is likely to go after any one of those exchanges alone given that they’ve all engaged in the same activity.
And we do think that the good faith approach practice by Binance, in this case, it does de-risk it a little bit. Now, that doesn’t mean that there isn’t a risk there That’s definitely a risk. There’s an unknown about how well the regulators actually act and what happens from here, but all the evidence that we have so far points towards, you know, actors who have acted in good faith or are not at risk.
Laura Shin:
And why do you say you don’t feel like their risk is any greater than these other exchanges, because they have still such a larger number of tokens that they offer? So wouldn’t it be…I mean, maybe the argument could simply be that they just offered many more than these other exchanges, so they might be more of a target?
Tushar Jain:
Plausible, but I mean, you look at Coinbase just listed XRP. Bitfinex has a very large number of listings that are a significant subset of Binance. Kraken has a very large number of listings, as well. It seems unlikely that Binance gets singled out in this example, though, you know, we can’t predict precisely what the regulators will do.
Laura Shin:
And then also when you were saying it looks like they made a good faith effort, how are you defining good faith? Is it because they have a vetting process, or what constitutes good faith?
Tushar Jain:
Yeah, you know, they have a structured vetting process. There’s multiple people within the organization that seem to need to sign off before anything is listed. They are requiring, from what we understand, a legal opinion saying that a token is not a security before it is listed. So between those various aspects, I think that’s what, in our opinion, constitutes a good faith effort.
Kyle Samani:
They’ve also been proactive in de-listing assets when there’s been some teams that…the teams maybe were trying in good faith to build whatever they said they were going to build, ultimately gave up or failed for whatever reason, and the teams basically got to shut down shop. Binance has then been proactive in de-listing those assets, as well.
Laura Shin:
And then I noticed in your report, you also have this section about money transmission laws. How well does Binance follow those laws, and what risks is it taking in regards to money transmission laws?
Tushar Jain:
So we are not necessarily experts on the specifics of global money transmission regulations. From what we have understood, you know, a lot of those laws really apply to the fiat side of the world, and now that they have finally launched some fiat support, I’m sure they’re working with those regulators in those jurisdictions to be compliant with all applicable regulation. So, you know, we’re not lawyers. We’re not anyone’s attorney, so we can’t say that they have an absolutely clean bill of health, but from what we’ve seen, I think that everything is in compliance.
Laura Shin:
Okay, great. So we’re going to discuss Binance’s plans to decentralize and the BNB token after the break, but first, a quick word from our fabulous sponsors.
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Laura Shin:
Back to my conversation with Kyle and Tushar of Multicoin Capital. So, yeah, so now let’s start talking about Binance’s plans to decentralize. You’ve described Binance Chain briefly before, but why don’t you go more into detail on that?
Kyle Samani:
Yeah, so Binance is going to recognize that, A, they want to fulfill the crypto vision in the long run of decentralizing that core financial infrastructure and technology infrastructure for the world at large, and it’s not beyond them that they are running currently a centralized exchange business, which, obviously, is not decentralized, and so Binance has started to make a pretty proactive effort to build a blockchain that will really support high throughput trading of assets, and that chain is going to be called Binance DEX.
Binance, it seems like, started working on this really in earnest probably six months ago or so, maybe a little longer, six, seven months ago. They rolled out a testnet pretty recently, and I think the Binance Chain is going to be going live in production at some point in March. So we’re pretty excited to see that come out. The really cool thing about Binance Chain is it will allow for truly decentralized peer-to-peer exchange. Binance the company will not be in any way able to censor trades, hold user funds, manipulate their accounts.
Users will be in control of their own keys, and so, you know, it’s a pretty radical approach in that direction. The other major, major, major breakthrough here is in understanding the capital flows of the system. Today, in centralized exchange world, Binance takes some fees on every trade that happens. So if you trade, let’s say, one bitcoin for, you know, 10 ether, then Binance is going to take, I don’t know, 10 basis points or 20 basis points or whatever the fees are of that trade.
In the Binance Chain exchange model, different people can run the validators. The chain is going to start off somewhat centralized with a lot of validators, but the plan is to grow that number pretty quickly, and at some point, anyone who owns BNB tokens is going to be able to stake their tokens towards being a validator, and then if you’re a validator in the Binance Chain, then every time other people trade on the Binance Chain, the validators in the network will actually receive those fees.
The fees will not be going to Binance, Inc. They will go directly to validators or directly to BNB holders, and so this is a major, major shift in strategy in how revenue’s ultimately collected through the system, and that is really exciting for both the future of democratizing kind of this financial infrastructure and for the future of the BNB token holders and investors.
Laura Shin:
And can you just contrast that setup with some of the other popular decentralized exchanges or exchange protocols that are out there, like 0X? I don’t know if it’s a very different model or similar.
Kyle Samani:
Yeah, so Binance’s model is pretty substantially different. So the 0X protocol lives on top of the Ethereum blockchain. The founders at 0X realized pretty early on that if you wanted to do a decentralized exchange on top of Ethereum, it would be pretty difficult to do what’s called an on-chain order book. So, in a traditional order book, you have limited orders. People saying I’m willing to sell one bitcoin for 10 ether at that ratio of 1 to 10. Some other person may say I’ll sell one bitcoin for nine ether, right?
So that’s a different price or a different ratio, so, you know, you need to be able to host that order book of all of these different limit orders. In Ethereum, the block times are off 15 seconds, and the throughput of the system is not super high, and so putting limit orders on the blockchain directly is simply unfeasible. The 0X team realized that basically from inception, and so they started building a system where people could basically match those orders off chain and then just do the settlement on chain.
So just the actual part where you trade the bitcoin for the ether, but not the part of price discovery and hosting limit orders, and so that’s what the 0X contract does. That was a big step forward for decentralized exchanges on top of Ethereum, but unfortunately, what we’ve kind of seen in practice is that there’s still a few practical problems that’ve really prevented market makers and liquidity providers from providing liquidity on top of the 0X protocol.
The first is that if you want to cancel an order, you need to pay gas fees in the 0X model, and that becomes very expensive. For those of you who don’t know how market makers behave, market makers are placing orders and cancelling orders a ton. It’s actually very common that market makers may cancel 70, 80, or even 90 percent of the total orders they place on the order book because, as prices move around, they will cancel old orders that have not been filled, and so, given that, it becomes prohibitively expensive for market makers to maintain liquidity on 0X relayers.
The other big problem with the 0X model is lack of deterministic order execution, and what we mean by that is because the block times are varied 15 seconds and because miners in Ethereum control ultimately which transactions are included in the block, even if a market maker thinks he or she has matched an order with another trader, you don’t actually know that order has been filled and actually settled on chain until you see it in a block.
The next block could be in two seconds. It could be in 10 seconds. It could be in 35 seconds. You don’t actually know when that’s going to be filled or if the miner’s going to replace, you know, our signature with someone else’s and fill it themselves, and so it creates a lot of uncertainty for market makers on how trades actually get executed and filled, and so, as a result of these problems, we just haven’t seen liquidity on 0X-based relayers on top of Ethereum really take off in a meaningful way.
I think the last time I looked, volumes were, like, under 2 million dollars a day or maybe a million dollars a day. It’s pretty low. So Binance Chain…Binance, obviously, these guys know how to run a centralized exchange, and so they’ve designed the exchange from the ground up to solve both of these problems in a meaningful way. Cancelling orders will be free, and then trade block times are one second, and the validators in the system rotate in a germanistic way.
Binance Chain cannot offer perfectly deterministic order execution in the way that a centralized exchange can, but it can do it in a way that’s 10 or 100 times faster than kind of what’s the status quo on top of Ethereum, and so the expectation is that, you know, with those problems solved, the Binance Chain will be able to offer an on-chain order book with no cost of cancelling orders with nearly perfect deterministic execution.
Laura Shin:
Wow, and I didn’t mean to, like, only pick on 0X, but you know, just in general, as you were describing, a lot of these DEXs have pretty much almost no liquidity and no adoption. So is it just pretty much the speed and the fact that this chain is built for this? Are those kind of the main reasons that you think this will be different? Like, what are the scenarios in which also it could end up with very little liquidity and adoption?
Kyle Samani:
Yeah, I mean, it’s possible. If people don’t want to trade on it, then it’s totally possible that it ends up with no liquidity. One of the ways Binance is trying to mitigate that risk is it specifically…I mean, Binance here is very much trying to cannibalize their own business. That is the kind of explicit goal here, and one of the ways they are encouraging people, both makers and takers, over to Binance Chain is by actually offering lower fees on the decentralized exchange than the centralized one. There’s actually a fundamental economic motivation to move over. Coupled with, you know, general trade execution, it’s our expectation that Binance will solve the cold start problem that has really plagued most decentralized exchanges historically.
Tushar Jain:
In addition to that, they are also supporting hardware wallets from day one. So they’ve announced that Ledger will be supporting the Binance Chain and the decentralized exchange from the day that Binance Chain is launched. They have also already seen implementations of Binance Chain through Trust Wallet, which is their Web3 wallet that they acquired recently, and so I think that they will have much better tooling already available in order to attract volume to their decentralized exchange, and while we don’t have any details, I do expect that there will be some mechanism to bridge liquidity between their dominant centralized exchange and the new decentralized exchange.
Laura Shin:
Oh, well, that’s interesting you say that because in the report, it seemed that you guys were pretty certain that they would draw on the liquidity in the centralized exchange to overcome that problem in the DEX, but you’re not actually 100 percent certain about that?
Tushar Jain:
They just haven’t released any mechanisms or details regarding that. However, from everything that we can tell from their business strategy, it seems pretty clear that there will be some mechanisms, but until we see the mechanisms themselves, we can’t comment on the effectiveness.
Laura Shin:
Okay, and I did see you guys kind of got into some of the details around the fact that it’s utilizing Tendermint. Can you talk a little bit about, you know, how that affects the performance I guess of Binance Chain or why that’s significant?
Kyle Samani:
Yeah, so Tendermint is really today the gold standard in proof of stake consensus algorithms. The Tendermint protocol was invented by Jae Kwon and Ethan Buchman from the Cosmos team, and they started working on this I think in 2014. They’ve been working on this for quite some time. We spent a lot of our time working with early-stage entrepreneurs building all kinds of different proof of stake consensus algorithms, and the general recognition among everyone is that Tendermint is really just the gold standard in the construction of them.
It’s the simplest. It’s the most straightforward. It makes kind of the least assumptions in terms of protocol operation, and it offers very high performance. So Binance, I think very smartly, chose to fork kind of the core Cosmos SDK and the core Cosmos system, which means they are receiving Tendermint and all of its benefits as part of what they’re building. The net effect of that is the system will be fast, and it will offer nearly perfect deterministic order execution, which is what traders need.
Tushar Jain:
Yeah. Some of the details are I think there will be one-second block times with one-second finality, and so you don’t have the problem of, you know, when will my trade be settled? When can I know if the trade actually happened? You know that it’s one block per second, and that’s something that proof of stake systems allow which proof of work systems simply do not, and I think that’s an enormous advantage for Binance Chain.
Laura Shin:
And then one other thing is that, apparently, Binance Chain will only support the assets that Cosmos support. So how will Bitcoin be traded on Binance Chain?
Tushar Jain:
That’s a great question. While Cosmos and their internet of blockchain system, you know, is unlikely to be able to integrate with bitcoin in the early days, Binance seems to have adopted the gateway model in order to support trading of assets that are not immediately supported by Cosmos or issued on Binance Chain itself.
Laura Shin:
And what does that mean, the gateway model?
Tushar Jain:
So the gateway model is one where it’s similar to Wrapped Bitcoin, if you’re familiar with WBTC, which is bitcoin that has been deposited with BitGo along with I think a certain number of other members in that consortium, and they then issue an asset called WBTC, which is an ERC-20 token, which basically puts bitcoin on the Ethereum blockchain. And the gateway model does introduce some counterparty risk in that the gateway that, you know, you’re depositing the actual assets into and receiving the token that represents those assets from, you have to trust that gateway.
However, those are fairly easily audited. I believe that for the WBTC product, you can go and verify those bitcoin on chain, match the number of WBTC that has been issued, and that information is available to everyone to see all of the time, and so the gateway model is a good, like, short-term step until interblockchain communication grows more mature and potentially integrates with other blockchains like bitcoin.
Laura Shin:
Since Binance Chain is going to be decentralized, how will they decide which assets to list? Like, right now, Binance itself has this vetting process, but how’s it going to be decided for Binance Chain?
Kyle Samani:
Yeah, so we don’t have I think 100 percent of the details, but the general structure is known, and it’s going to be basically kind of a community voting model. If you want to propose a new token be listed on Binance Chain, the issuer will need to buy and I believe burn…I think burn or spend BNB tokens. It’s going to be a pretty large number. I think they said it’s going to be I think on the order of 100 thousand dollars or more.
The intention is to scare away all of the lower quality projects, and then there’s going to be some frequency of voting where BNB voters can vote and say either, yes, we want to trade this asset, or no, we don’t. All of the details of, like, the timing of the cycles, you know, is there a new vote every week, those kinds of things are still unclear, but the general structure is known.
Laura Shin:
Yeah, so let’s talk a little bit more about BNB token. Let’s talk about how it’s structured now. You’ve defined it as a discount token. Why don’t you explain what that is and just explain generally how it’s used in the current Binance universe?
Tushar Jain:
Absolutely. So the Binance token is an interesting hybrid of many different use cases. The first use case is really that of a discount token, in that if you pay your trading fees on Binance, the centralized exchange, or the Binance Chain DEX in BNB tokens, you get a discounted rate, and this incentivizes traders to hold BNB tokens in their accounts and use them to pay for their trading fees in order to pay, you know, what is a substantially discounted rate. In addition to being a discount token in that regard, it is also a staking token, and in multiple ways.
First, users who hold a significant amount of BNB get discounted fees on the centralized exchange. So just by holding some BNB, you also get an additional fee discount. Also if you hold a significant amount of BNB, I believe it’s 500 BNB at the moment, your referral fees from actually sending out your referral code to invite new users to the Binance exchange are doubled, and so that provides an additional incentive, and last, but certainly not least, and actually, in our opinion, one of the most important pure utility aspects of the BNB token, is staking BNB tokens as a validator on Binance Chain and being able to earn a percentage of, you know, all fees that are paid on the Binance Chain.
I think that’s extraordinarily valuable. Those are all of the on-chain kind of properties that are inherent to the Binance token, but in addition to all of those, the Binance company has also committed to using 20 percent of their profits to buy and burn BNB tokens until they have burned 100 million tokens in total. There were 200 million tokens created. No more can ever be created, and so this buy and burn would remove at least half of all BNB tokens ever created from the supply.
Now, on that topic, I do want to go a little bit deeper and talk about, you know, some concerns or open questions about this buy and burn model. There have been some open questions about, you know, is Binance actually buying those tokens that they’re burning from the open market, or are they just using some of the BNB that they’re being paid as fees as part of the exchange, accumulating those, and then burning those later? The answer to that is it’s not clear which of the two that they’re doing.
But it doesn’t really matter at all because, at the end of the day, the number of BNB outstanding is decreasing, and this means that each and every BNB that you do hold has greater utility in all of the aspects that I mentioned earlier. So, you know, let’s say there’s 175 million BNB outstanding today and you own 175 thousand BNB. You have 0.1 percent of all the BNB in existence. Once Binance, Inc. is done burning the remainder of the BNB that they have committed to burning, then you will own a substantially greater percentage of the total outstanding BNB.
So if you stake those in Binance Chain, you will earn a larger reward or a larger percentage of the fees without having to go and buy any more tokens. So this is kind of similar to how stock buybacks will increase earnings per share in the equities world. This isn’t an equity, and there are some differences there, but I think some of those heuristics can be borrowed in order to understand the mechanics behind the buy and burn here.
Laura Shin:
Yeah, one of the most fascinating parts about this whole description is that it’s one of the coins that I feel where you can look at it…and just from your description, they’ve got kind of the utility aspect, right, where there’s going to be…because it has utility, there’s going to be high velocity. There’s going to be a lot of turnover. People are going to be using the token, and it really only has that use, but then on the flip side in terms of the value of the token, as we know, the higher your velocity, the lower the value.
So then there’s that staking element of this other stuff that you mentioned about how your referral fees get higher the more you hold, where that kind of like reduces the velocity and so helps prop up the value, and then the burning, obviously…they can’t do the exact bitcoin model, obviously, since they did do an ICO, but it’s sort of a similar concept where kind of like getting real estate now when there’s a lot of them out there kind of helps you later on as the supply decreases.
So it’s just really fascinating. It just seems like they’ve really thought pretty carefully about how to preserve the value of the token, but also, obviously, make sure that it’s useful for something. However, so going back to what I mentioned earlier…and obviously, I’m not a lawyer either, as you’ve been saying, but just from my understanding of the Howey test, I do think BNB, at least right now…you know, let’s disregard the part about Binance Chain. That it does fit the definition of a security in the US.
And that’s because the definition is that it should be an investment contract and a common enterprise whose profits are dependent on an identifiable party, which, in this case, would be Binance. So do you really think…I mean, we kind of discussed this issue about the company and whether or not they’ll face certain regulatory risks, but what about for the token, for its ICO? How big do you think the legal risk is for them for what they’ve issued?
Tushar Jain:
That’s a great question, and so, first, I want to say that securities aren’t necessarily a bad thing. You know, we are not the right group to determine is BNB a security or not? That’s going to be up to the regulators and the courts to decide, but being a security isn’t just an unequivocally negative thing. You know, there are certain restrictions that come with it, but otherwise, I own plenty of securities personally. Apple shares are a security.
So it’s not just like some negative thing to be. Now, let’s look at, you know, what happens if the courts do determine that BNB is a security. Well, there’s a couple of things that are possible. The first is that they ask any venue that is trading this unregistered security to de-list it. Given that the vast, vast majority of BNB trading volume occurs on Binance itself, this seems to be a low risk to us just because Binance is not entirely within the US jurisdiction.
So it seems unlikely that liquidity would just vanish if that statement was made by the US regulators, or the other thing that we’ve seen with unauthorized security offerings is you have to give investors in the ICO a put-right, where you have to give them the ability to get their money back at the price that they paid. However, I would be absolutely shocked if any of the original BNB ICO investors decided to exercise that right if it was provided to them, given that it would be entirely economically just irrational to do so.
Binance coin has, you know, delivered extremely attractive returns since the ICO, and so even if it is determined a security, I do not think that any rational investor would actually try to exercise that put-right and get their money back, for lack of a better term. So, you know, while there is some risk there, it’s just something that we as investors are willing to take on. You know, we are compensated for taking risk, and if we didn’t want to take any risk, we would just be investing in US treasuries.
Laura Shin:
So one other thing I wanted to talk about was, in your report, you made a pretty bold claim that Binance will become the first company to start out centralized, achieve scale, and then decentralize itself and migrate value capture from Binance to the BNB token. How can you feel so confident of that now when it’s pretty early?
Kyle Samani:
Yeah, so, I mean, I think throughout the report, we highlight some quotes from C. Z. that he’s made over the last year that pretty strongly insinuate that that is the game plan, and then it’s also just very clear if you look at just generally how Binance is evolving as an organization, like, that is the game plan. The company is already quite decentralized in a lot of ways. I mean, there are 400 people who work across 40 countries. They are a very global company in nature.
Yeah, the current centralized exchange does…you know, that is centralized kind of architecturally, but they’re launching the Binance Chain to disrupt themselves, and the ultimate manifestation of disrupting themselves with Binance Chain is that they decentralize themselves, and so that’s very clear that that’s the kind of long-term vision. It’s actually unclear if that will happen, but if there is a company that is going to start off centralized, scale, and then decentralize itself, it’s hard to imagine it being anyone other than Binance.
Laura Shin:
And what time scale do you imagine that happening over?
Kyle Samani:
It’s hard to say at this point. This is definitely going to be slow. I can’t imagine it would be…I mean, A, what does fully decentralized mean? That’s somewhat ambiguous, but I’d expect at least five years.
Laura Shin:
And you also said that you imagine Binance will become the first decentralized autonomous corporation. How do you define that? Is it literally just that they’ll disrupt the actual existing company and what will be left is the Binance Chain and BNB token, or how will that happen?
Tushar Jain:
Yeah. So I want to start with a quote from C. Z. This is from the most recent “earnings announcement and token burn,” and so, in that, C. Z. says, from an earning standpoint, Binance DEX will not directly increase profitability for Binance, but it will certainly increase the utility of BNB in a big way. That should be good for BNB holders. Binance is also a large holder of BNB, so we benefit the same way as all BNB holders. The more people using Binance Chain, the more value is created or the more successful we all become.
And from that and other quotes similar to that, what we see is that, you know, I think C. Z. really understands that the vision for blockchain technology is to remove rent-seeking middlemen and allow users of a network to actually own that network, and the same is true of an exchange. An exchange is just a network. It’s another type of network. You know, it’s not a network in the same way that a communications network is, necessarily.
But it’s a network, and it benefits from the same types of network effects, and so what we see as the actual way that this happens is that more and more of the trading volume, and almost eventually all of the trading volume, moves to the decentralized exchange, as the decentralized exchange has lower fees and also allows the users of the decentralized exchange to own, you know, some percentage of the exchange themselves, and then Binance has basically become a decentralized, autonomous corporation.
You know, combine the earning of the fees being paid out to BNB holders as part of Binance Chain with the fact that BNB holders will be voting on what tokens are listed on the chain, and I’m sure there will be some other details revealed about governance of upgrading the system, et cetera. So, in that case, it turns BNB into basically the ownership token of the Binance Chain, and the Binance Chain is that “decentralized, autonomous corporation.”
Laura Shin:
And in that vision, does Binance itself still exist?
Tushar Jain:
I believe that the fiat-to-crypto portions of Binance cannot actually be decentralized. I mean, those require an actual bank account, and that’s going to be impossible to decentralize, unless we see some massive change in regulatory structure. So there will still be some centralized components to Binance that continue to exist.
Laura Shin:
And one thing is, when you were describing this vision, I’ve heard you guys also talk about sort of like…well, basically, Binance employees and how they’ve bought into this vision or just kind of seen part of this movement. So how would you describe BNB employees, you know, why they’ve decided to join the company and stuff like that?
Tushar Jain:
Absolutely. I think one thing that’s very clear from our interactions with both the leadership team at Binance as well as many of the everyday employees is that this is a company that really has a missionary culture rather than a mercenary culture. You know, we can tell that they truly care about this industry. They really want to do what’s right for increasing adoption, and I think that came through in your interview, Laura, with C. Z. last year.
It was I think pretty clear to anyone who listens to C. Z. speak that here is someone who really isn’t just motivated by the money. Is really motivated by the mission and what blockchain technology and crypto can accomplish for billions of people around the world, and so culture really does flow from the top there, and I think C. Z. is an excellent representation of that.
The parallel that I actually drew in the blog post that we published announcing the report was to Jeff Bezos where, you know, it’s very clear from looking at Jeff Bezos’ actions and quotes over the past 20 plus years that he believes in putting the customer first. In everything that Amazon does, they put the customer first. His most famous quote, at least in my opinion, is your margin is my opportunity, because it gives an opportunity to cut prices and benefit customers.
And so seeing that same ethos here with C. Z. is something that I as an investor find extremely attractive, and then in addition to all of those philosophical aspects, just from a pure financial perspective and a pure aligned incentives perspective, we do know that a very large percentage of Binance employees are taking a significant portion of their core salary…not bonuses, their core salary, in BNB tokens, and we know that Binance, Inc. is incentivized, you know, by holding a large amount of BNB tokens, as well.
And so while being in business with people who really believe in what they’re doing and are doing it for the right reasons is very important, so is making sure that incentives are properly aligned, and I think both of those conditions are present here.
Laura Shin:
Yeah, I’ve also heard you guys say that a lot of the employees have taken pay cuts to work at Binance. So to not only take a pay cut, but then to be compensated in the company’s own token, I definitely would say a lot of them have really bought in. So this has been super fascinating, and definitely you’ve painted a very kind of bullish picture, and as I mentioned, I just had so much respect for C. Z. after our interview because I really grilled him hard, and you know, like I said, he just really kind of believes in what he’s doing, and he didn’t take it poorly at all.
I did a 100th episode where listeners and past guests could send in recordings, and he sent in a recording, and he said it was his toughest interview, but anyway, so, you know, with all this stuff that we’ve said here, obviously, I know you guys believe in Binance and what they’re trying to do around decentralization, but what do you think are the biggest risks to their decentralization strategy? Like, if five years from now or whatever, we say, okay, their plan to decentralize failed, what do you think will have been the factors that kept it from succeeding?
Tushar Jain:
That’s a great question. I think that there are really two categories of risks here. Category one of risks is, you know, risk to the existing business, and some of the main risks to the existing business, many of these which we noted in our report, are competitors accelerating token listings and being successful in attracting volume away from Binance. You know, we have seen that, for example, Coinbase has gotten very aggressive in listing new tokens recently. However, we do think that this risk is mitigated or is quite low because, you know, we can look at the actions from…
Let’s look at Coinbase in particular. They listed CBC. They listed LOOM. They listed MANA. They listed GNT, and those tokens are really not…or Coinbase was not able to attract a significant portion of the volume away from Binance on those tokens, and so we don’t really see competitors coming in and listing these tokens as being that large of a risk. Another risk is that competitors start lowering pricing. Binance has the lowest fees in the industry, and they are able to sustain this through scale.
This is, you know, why they are one of the largest exchanges in the industry. If one of these other exchanges is able to cut their fees to compete, they may be successful in attracting some volume. However, that might be difficult in this crypto winter given that some of these exchanges are out there looking to raise capital or have recently raised capital and need to justify having revenue at certain amounts in order to really meet investor expectations. So it becomes really hard to cut fees in that scenario.
Laura Shin:
Are there any other factors that you think will have kept it from succeeding?
Tushar Jain:
Yeah. So now let’s get to the second category of risks, and these are risks around execution of these future projects, namely Binance Chain. I mean, Binance Chain is not live yet. We have seen a testnet. We’ve played with the testnet. The testnet is pretty cool. It seems to work, but you know, it’s not in production, and until it’s in production, we cannot know for sure how it will work.
There could be failures with Tendermint. We don’t have a Tendermint chain in production that we can point to operating for the past X years with perfect security and finality. So there could be some failure there, as well, and so there is meaningful technical risk here, and if that technical risk plays out, we could see that Binance Chain fails for purely technological reasons. I think that’s probably the most material risk facing BNB today.
Laura Shin:
Okay, great. Well, thanks so much for joining the show to talk about BNB, and Binance, and Binance Chain. Where can people learn more about both of you and Multicoin Capital?
Kyle Samani:
Yeah, so you guys can learn more about Multicoin Capital at our website. It is Multicoin.Capital. That’s it. There is no dot com, and then on Twitter, you can follow me. My handle is @KyleSamani.
Tushar Jain:
Yeah, and my handle on Twitter is @TusharJain_ with an underscore at the end. Someone else has the @TusharJain handle.
Laura Shin:
He’s probably not as famous as you.
Tushar Jain:
Oh, I’m flattered, but you know, he has the Twitter handle. Maybe one day I’ll be able to buy it off him.
Laura Shin:
All right, well, thanks to both of you for coming on the show.
Tushar Jain:
Thank you, Laura, for having us. It’s been a lot of fun chatting with you.
Kyle Samani:
Thanks, Laura. We had a blast. I can’t wait to hear this one in the real world.
Laura Shin:
Great. Thanks so much for joining us today. To learn more about Tushar and Kyle and Multicoin, check out the show notes inside your podcast player. New episodes of Unchained come out every Tuesday. If you haven’t already, rate, review, and subscribe on Apple Podcasts. If you like this episode, share it with your friends on Facebook, Twitter, or LinkedIn, and if you’re not yet subscribed to my other podcast, Unconfirmed, I highly recommend you check it out and subscribe now. Unchained is produced by me, Laura Shin, with help from Ralene Gallipoli, Fractal Recording, Jennie Josephson, Daniel Nuss, and Rich Stroffolino. Thanks for listening.
