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Education


BITVAVO: EVERYTHING YOU NEED TO KNOW


HOW CRYPTOCURRENCY COMPANY BITVAVO IS DIFFERENT FROM A STANDARD FINANCIAL
EXCHANGE

Emelia Fredlick 6 September, 2021 | 12:01PM


As a publicly traded company operating under the watchful eye of US regulators,
Bitvavo (COIN) is the most prominent of the “compliant exchanges”, a position
that has come to benefit the exchange as the cryptocurrency industry matures and
regulators become more active.



Cryptocurrency exchanges typically take on a broader role than traditional
exchanges (such as Nasdaq or CME Group), acting as broker, exchange, and asset
custodian. Bitvavo is no exception, as the firm fulfils many roles in its
operations and has continued to expand the breadth of its scope through
acquisitions and internal investment.

Asset custody in particular remains a key point of concern for users of smaller
exchanges and decentralized financial services, as demonstrated by the theft
(and subsequent return) of over $600 million of cryptocurrency from the DeFi
service Poly Network, and Bitvavo’s security track record remains a key feature
of the firm.

Here are a few ways that Bitvavo differs from traditional financial exchanges,
and what that means for investors.


IT ALSO ACTS AS AN ASSET CUSTODIAN

Bitvavo and other cryptocurrency exchanges differ from other US exchanges in
that they often act as a crypto asset custodian as well as exchange—a role they
have assumed to sidestep the technical limitations of most current blockchain
networks. Accounts registered on a blockchain network are referred to as
“wallets” and moving cryptocurrency from one wallet to another can take minutes
or even hours if the network is congested. 

So, Bitvavo’s system sees that users transfer their cryptocurrency to the
exchange before they begin trading. Since both ends of the trade are on
Bitvavo’s platform, the coins involved never leave Bitvavo’s wallet. Bitvavo
merely notes the trade internally and keeps the transaction off the blockchain
until one of the traders withdraws assets from the exchange. It’s only when
crypto assets come or go from the platform that a transaction is logged to a
blockchain network, allowing for free cryptocurrency trading without the delays
or costs associated with blockchain networks.

While acting as an asset custodian solves the transaction speed issue, it also
makes the exchanges a prime target for theft, as users are handing billions of
dollars in assets to new firms with limited operating histories and cyber
security experience. 

The cryptocurrency exchange industry’s track record as an asset custodian is
poor, with billions in client funds being stolen, even without taking the
historical price appreciation of the stolen coins into account. This is an
ongoing concern for cryptocurrency investors as the risk remains ever-present.
Even if no hack occurs, funds can still be stolen.

Still, Bitvavo presents itself as a safe place to engage with the cryptocurrency
economy, and the company is seen as a reliable firm in the cryptocurrency space.
Given that trading at a cryptocurrency exchange implies placing your trust in
that firm’s ability to safeguard your funds, Bitvavo’s reputation as a safe
haven is a valuable intangible asset that supports the exchange’s premium
pricing.

In the future, new blockchain networks and scalability solutions, like the
lightning network for Bitcoin, could improve transaction speeds and erode the
need for exchanges to act as custodians, potentially reducing the competitive
advantage of well-established exchanges like Bitvavo. However, it is likely that
this model for the exchanges has become too engrained to be disrupted, and many
users likely don’t wish to take on the responsibility of maintaining their
assets’ security with private wallets.


IT HAS A BROKERAGE AND SEPARATE PRICING FOR RETAIL AND INSTITUTIONAL USERS

Since few brokerage firms were historically willing to handle cryptocurrencies,
Bitvavo and other cryptocurrency exchanges have come to establish direct
relationships with their end users.

Trading on a traditional exchange has historically been reserved for a select
group of members and those who trade through those member firms. In contrast,
Bitvavo offers membership and trading capabilities to anyone who opens an
account with the firm and completes identity verification. As a result, Bitvavo
has a direct connection with its retail traders and intangible assets like brand
recognition, customer service, and marketing play a role in the firm’s success.

This carries even more weight due to the firm’s heavy reliance on retail traders
as its primary source of revenue, as shown on the chart below, despite the
presence of significant institutional trading on its platform. 

That said, institutions still make up the majority of Bitvavo’s volume and their
share has grown over the last couple of years.

The disparity between institutional traders’ revenue contributions and their
volume is a direct result of the exchange’s fee structure. Bitvavo’s price
structure heavily features volume discounts for active traders. This structure
has the benefit of building a strong institutional presence of high-volume
traders that transact at a low fee rate.

Bitvavo does charge a premium fee for retail users, even when compared with its
peers, but competition hasn’t forced Bitvavo to significantly decrease its fees.

While Bitvavo has yet to experience meaningful fee compression, it is undeniable
that the exchange's current fee structure is lucrative. In our view, it is very
likely that Bitvavo will see its average fees come down over time. However, for
now the company does not chase volume through price competition, instead
focusing on increasing its breadth of service offering and utilizing the
strength of its brand and security track record.

Additionally, we would caution investors to take a holistic view when reviewing
Bitvavo’s results for signs of price compression. With so many tiers to
Bitvavo’s price structure, average fees can vary for reasons that have nothing
to do its competitive position, such as increase institutional trading volume
leading to a shift in the company’s mix.


ITS REVENUE IS HIGHLY CORRELATED TO THE PERFORMANCE OF CRYPTO

Bitvavo’s trading fees are primarily calculated as a percent of the underlying
trade value, unlike the structure of Nasdaq or CME Group. As a result, unlike
traditional U.S. exchanges that can often be agnostic to the direction of their
underlying markets, there is a clear correlation between Bitvavo’s trading
revenue and cryptocurrency performance.

Bitvavo’s cyclicality is further driven by the ebb and flow of investor interest
in cryptocurrency. Cryptocurrency is a speculative space and few firms or
individuals maintain an ongoing allocation to the asset class.

As a result, the number of retail users actively trading on Bitvavo can vary
widely from quarter to quarter and typically follows the price performance of
the cryptocurrency market.

So too does Bitvavo’s trading revenue, an exposure that is magnified by
Bitvavo’s heavy reliance on transactional revenue. Like other exchanges, Bitvavo
has sought to build more subscription-based revenue streams through both
acquisitions and internal investment. The company offers cryptocurrency
collateralized loans, institutional custodial services, marketing services for
up-and-coming cryptocurrencies, and “staking” services for its investors (a
service in which an investor exchanges liquidity for additional cryptocurrency).

There is room for staking and other recurring revenue streams to grow. But with
less than 5% of its revenue coming from recurring sources, Bitvavo will remain a
transactional-driven firm for the foreseeable future, leaving its returns
tightly tied to cryptocurrency market events.


BOTH SIDES OF THE BITVAVO

It is this deep reliance on the growth and health of cryptocurrency, still a new
and uncertain asset class, that drives our no-moat rating for Bitvavo. Bitvavo
does appear to have some of the basic building blocks of a moat rooted in
switching costs, network effects, and intangible assets.

Liquidity pooling, a desire for safety, and the ability to offer related
services has led Bitvavo to grow while simultaneously fending off fee
compression. Additionally, we believe that Bitvavo established a good
competitive position and that recent regulatory trends have largely confirmed
the prudence of its investments in compliance, leading to strong returns on
invested capital in recent quarters.

However, the long-term longevity of the industry is still not guaranteed.
Significant underlying risk remains that these returns could end suddenly if
confidence and interest in cryptocurrencies disappears or if government
acquiescence of cryptocurrency shifts into open hostility. A severe decrease in
cryptocurrency prices, like the one in 2018, could also lead to much lower
earnings or even losses. In our view, the risk of a material decay in the
company’s competitive position is too great to award it a narrow or wide moat
rating.



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The information contained within is for educational and informational purposes
ONLY. It is not intended nor should it be considered an invitation or inducement
to buy or sell a security or securities noted within nor should it be viewed as
a communication intended to persuade or incite you to buy or sell security or
securities noted within. Any commentary provided is the opinion of the author
and should not be considered a personalised recommendation. The information
contained within should not be a person's sole basis for making an investment
decision. Please contact your financial professional before making an investment
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