Crypto trading fees aren’t compressing yet, but here’s how exchanges are preparing for when they do

The brokerage world was rocked earlier this week after industry giant Charles Schwab announced it would drop its commission fees for stock trading to zero. 

It was a watershed moment for the discount brokerage space, which can trace its roots to the 1990s as a cheaper, internet-based approach to the traditional high-touch brokerage stock trading model. Soon after Schwab's announcement, competitor TDAmeritrade announced it would also drop its commissions to zero. The news followed a similar announcement by Interactive Brokers, which last month announced a new product for zero-commission stock trades. E*Trade said it would eliminate commissions on Monday.

Still, the Schwab news had the biggest impact on the market, sending it and its rivals into a tailspin. TDAmeritrade and Schwab have seen their respective stock price tumble by double digits since Sept. 30. 

Money for nothing, trades for free

To be clear, fee compression isn't new in the discount brokerage world. Fees have been coming down for decades, catalyzed in part by millennial-aimed startups like Robinhood — which has offered zero-commission stock trading since day one.

Previously, Schwab charged $6.94 on average per trade. In 2001, the firm charged, on average, $34.50, according to data compiled by the Wall Street Journal. It will officially drop its fees on Oct. 7.

Investors have good reason to be concerned about broker fee compression, as TDAmeritrade and Schwab make a sizable portion of their revenues from stock trading. As per Bloomberg, Schwab could lose as much as $400 million — a figure that would only be offset by $20 billion in additional deposits. TDAmeritrade is in an even more uncomfortable position. TDAmeritrade makes 28% of its revenue from stock trading fees, compared to Schwab's 8%. As such, the companies are looking to cut costs. Schwab said last month it would cut its workforce by 3%. 

These developments raise interesting questions for the budding cryptocurrency broker and exchange space, which is known for its high trading fees. In late February, The Block wrote that a price war was heating up in the crypto market as newer entrants came online with cheaper fee schedules for crypto trading. Then, market commentators said such a move would trigger compression in the market — much like what we've seen in U.S. equities. Exchanges such as Seed CX and LMAX Digital had also recently come online, with pricing that undercut exchanges like Coinbase by nearly half. 

Crypto retail fees on the rise

Looking at the data, however, paints a more complicated picture. 

For the most part, trading fees on both the taker and maker side have stayed the same at the biggest profile exchanges over the past two quarters. In fact, a number of exchanges — including Coinbase, Poloniex, and Bitstamp — have actually increased their fees.

Coinbase raised its fees for certain traders, per an update out Thursday. 

"This latest update will slightly increase fees for lower-volume customers and reduce fees for high-volume customers — any customer transacting above $50,000 a month will either see a reduction in their trading fees, or no change at all," the firm said. "The update also introduces three new tiers below $100,000 a month."

A Coinbase spokesperson said fees wouldn't increase for most customers. 

On the other hand, HitBTC and Gemini have lowered their fees. To be clear, Gemini at one point was charging fees many market participants told The Block were exorbitant, perhaps most colorfully described as "ripping people's face off." Today, its fees are more in line with rivals like Bittrex and Bitstamp. As for HitBTC, there have been some concerns about the legitimacy of its volumes.

Yet market participants are convinced that fee compression is on the horizon for the crypto world. Joe McCann, a former trader at hedge fund Passport Capital, said earlier this week that "crypto exchanges operators" should "take note" of the broker fee compression developments. 

"This is absolutely coming to crypto faster than you think," he added. According to McCann, all it takes is one big player to come in and lower fees dramatically — akin to what played out following Schwab's announcement

To be sure, comparing the business models of cryptocurrency "exchanges" with those of discount brokers is an imperfect comparison inasmuch as most cryptocurrency exchanges function as a custodian, exchange, and discount broker under one roof. Still, people familiar with the situation at several major cryptocurrency exchanges note the majority of their revenues come from trading fees. One executive said his exchange, which is one of the largest in the market, makes approximately 90% of its revenues from trading fees. The same person estimated it was likely even higher at other exchanges.

Still, the same executive noted: "Everyone else is just trading ... even those deposit and withdrawal fees probably not contributing too much to bottom line," alluding to the fees exchanges charge to clients to get funds on and off a platform. 

A spokesperson for Coinbase, the largest cryptocurrency exchange in the U.S. by volumes, declined to comment on its revenue breakdown. Hunter Merghart, Head of Bitstamp US, also declined to comment on the firm's revenue breakdown.

Mo business, less problems

With this backdrop in mind, if McCann is right and fees do compress to near zero, a lot of exchanges are going to be in trouble. 

"Their business models don't work," one market observer told The Block. McCann agrees, noting that exchanges will ultimately have to move into ancillary services like custody, prime brokerage, lending, and media to survive. 

In fact, last year Coinbase specifically said it was looking to diversify its revenue stream to better insulate itself from market vicissitudes.

The dependence on purely transactional revenues raises a lot of potential issues for cryptocurrency exchanges. For one, it ties their revenues to market forces — which are largely unpredictable. If fees compress, those problems compound. 

"You need to smooth out your forms of revenue by adding additional services to the business," McCann said, pointing to Coinbase. 

"They launched an interest-bearing account, signals and indicators for traders — they're not charging for that, but you can see they are spreading their tentacles for when things go to zero," he added. 

Elsewhere, other exchanges have rolled out new derivatives trading platforms and over-the-counter trading offerings, and many have lengthy tenures in the custody business (another area that is quickly moving toward zero-fees.)

In U.S. stock trading, many brokers also operate sizable wealth management units. Thirty-two percent of Charles Schwab's revenues come from asset-based fees. TDAmeritrade, Schwab, and E*Trade all make some money from selling order flow to high-frequency trading firms. These businesses are all on the table for cryptocurrency exchanges, but the development of cryptocurrency exchanges won't exactly mimic the discount broker space, experts say. 

• Lending and margin: One way exchanges can bring in additional revenues in a low-fee environment is by charging clients to trade on margin. Robinhood, the broker known for its pioneering zero-commission stock trading, makes money via its Robinhood Gold offering, which increases a trader's buying power. A few cryptocurrency exchanges offer margin, including Bitfinex, Binance, and Kraken. Coinbase and Gemini, on the other hand, do not. 
• Selling their data: In U.S. equities trading, exchanges are often criticized by their broker clients for the fees they charge. In many cases market data — the lifeblood of trading – brings in more revenues than trading itself. In total, annual revenue from market data services for the three biggest exchanges increased to 45% of total revenue by 2017, according to the Wall Street Journal.  The Securities and Exchange Commission's recent push for exchanges to better justify increases to their market data fees is aiming to make the process more transparent, as reported by Reuters. In crypto, the market structure isn't necessarily built up yet for exchanges to start charging for data, but the proliferation of algorithmic trading and low-latency trading could make such a business more viable, market experts say. McCann is of the opinion that exchanges could sell data to projects as well. "The data of its users + something like Coinbase Earn can be a huge boon for new projects looking to gain access to a ton of users. So customer acquisition as a service is another capability."
• Prime broker services: Cryptocurrency exchanges could also break into the prime broker market. Prime brokers help larger traders trade across various markets, extending them leverage and helping them route orders to the market where they will get the best price. It was a business that Coinbase was looking to build out at one point but ultimately shuttered following the exit of key members of its institutional team.