Crypto exchanges in the U.S. have been put on notice since the spectacular collapse of FTX and the Securities and Exchange Commission (SEC) recent enforcement actions against two of the biggest industry players, Binance and Coinbase.

While the remaining major centralized exchanges take stock, a pick’n’mix bag of crypto exchanges are emerging ready to seize on their misfortunes with new ideas once dismissed as non-competitive against the incumbents.

"We've only seen exchanges 1.0,” said Franklin Bi, a partner at Pantera Capital. “We're really seeing a wave of the next generation of exchanges that have seen what it takes, know what kind of regulatory landscape they're walking into, but also know what's possible in terms of bridging together a centralized user experience and a pretty rich, vibrant DeFi ecosystem that exists now."

Hybrid exchanges, user-friendly decentralized exchanges and institutional-only marketplaces are all in the mix, with retail-focused centralized exchanges the least desirable at present. Pitches for centralized exchanges are rarely passing the desks of VCs these days, according to multiple investors. And even if they were, it's not a proposal that many want to touch.

“Until there is a simpler pathway towards U.S. registration and deeper volumes to go around, CEX startups are going to be limited in their growth potential, which may dampen VC interest,” said Michael Safai, co-founder of trading firm Dexterity Capital.

For investors and founders with the right risk appetite, though, the landscape for exchanges is the most ripe for disruption than it's been in years, said Thomas Klocanas, general partner and head of venture at BlockTower Capital.

Investing in decentralized exchanges

Since the collapse of FTX, investors and customers have gravitated toward decentralized exchanges (DEXs). Around $144 million across 43 deals has been invested into DEX startups from November 2022, according to data from The Block Research. 

Investors are also looking for new primitives that push the boundaries of what DEXs can do, particularly in terms of attracting institutional players. Gleb Dudka, a principal at venture firm Greenfield, highlighted portfolio company Mangrove, a DEX that is looking to attract market markets who want to operate without locked capital.

The hybrid exchange model that merges CeFi and DeFi is becoming increasingly popular as the long term vision of a decentralized financial system is embraced, Pantera’s Bi said. An example of this is OnDefy, which builds a centralized-like user interface on top of a DEX, Klocanas said.

“It’s no longer enough to just fork Uniswap’s code or push out a basic [automated market maker] model with the twist being that it's supposedly regulatory-friendly,” said Michael Anderson, co-founder of Framework Ventures. “With the alt-L1 narrative waning and the emergence of viable cross-chain solutions, I think established players now have the means to assert their dominance and solidify their leads across any relevant chains.”

Targeting the institutions

Many of the emerging exchanges, such as EDX, Zodia Markets, CrossX, Archax and the controversial Prometheum, are focusing heavily on the institutional market.

“The retail market is reasonably well served,” said Simon Barnby, chief marketing officer at Archax. “I think institutions have always been seen as the ultimate prize, there is that institutional wall of money and when that gets involved that's a real game changer for the space.”

BloxCross, an exchange that started out targeting retail customers in LATAM last year, pivoted to also serving institutional clients for payments, remittances, and digital value transfer following FTX’s impact on retail appetite, said Keith Bliss, global head of markets and strategy at BloxCross.

Some of the exchanges saw the writing on the wall prior to FTX and have been slowly getting their ducks in a row trying to bring TradFi’s market structure to crypto.

Formed two years ago, Zodia Markets, a noncustodial exchange and brokerage catering to institutional clients, has been aiming to launch a solution that would help the market mature through its backing from bank Standard Chartered.

“We saw the gap in the market but it was unintentional from a timing perspective that all these things happened that reaffirmed the business model,” said Usman Ahmad, CEO and co-founder of Zodia Markets.

However, he acknowledged the difficult road ahead. "We saw the opportunity of our heritage being focused on the institutional side, and I think that's where others are seeing the same opportunity. But it's gonna be a tough market for them to crack."

This can be seen in the way the current wave of crypto exchanges have struggled to capture the institutional market. Bullish was launched in July 2021 with an allocated $10 billion of capital, yet its plans to become a public company have been delayed and the company recently laid off some staff. Earlier this month, Crypto.com shut down its institutional arm due to limited demand in the current crypto market.

Challenges of launching a new exchange

For the startups early in their journey, it's a tough market, said Zodia Markets' Ahmad.

“Candidly, unless you have found a specific niche, where you are confident that you can generate [total value locked in the protocol] or volume, you should pivot,” said Julia Zhou, partner at trading group AlphaLab Capital.

 With many leading global exchanges facing issues at home, it opens up the opportunity for regional focused exchanges to take leadership positions, said Pantera’s Bi. However, some pointed to the stiff competition that still exists in the market.

“Traditional banks might be willing to enter the market when you have rules in place, but crypto is already hyper competitive so any new challengers will need a serious point of differentiation,” said Alex Harper, CEO and co-founder of Australian exchange Swyftx, adding that it's the only local exchange to successfully scale in the country in the last four years.

Plus there’s always the current state of the market to consider. Even if bigger exchanges have faced difficulties, that doesn’t mean conditions are any easier.

“There is always room to launch new exchanges, founders just need to be aware that during a bear market product-market fit validation is very hard to find,” said Greenfield’s Dudka. “As on-chain activity continuously decreases and people are more risk-averse just to make it to the next bull run they might refrain from interacting with new protocols.”