Interest in cryptos like Bitcoin and Ethereum has exploded. This has caused crypto exchanges like Coinbase and Binance to see huge jumps in both valuations and earnings.
But how exactly do these cryptocurrency exchanges make so much money?
1. Trading Fees
Trading fees are usually a fraction or a percentage of your total trade value.
Let’s say you buy $100 worth of bitcoin on an exchange that charges 0.1% trading fees; that’s 10 cents extra for trading.
While these fees are usually quite low, often between 0.1% and 0.5% per trade, they can add up, especially if you’re an active trader who buys and sells frequently.
These tiny transaction fees are generating huge profits for crypto exchanges like Binance, with over $76 billion in daily volume.
2. Withdrawal Fees
Withdrawal fees are another important way to make money with decentralized or centralized crypto exchanges.
Whenever you want to transfer your cryptocurrency from a cryptocurrency exchange to your own wallet, there is usually a fee for the withdrawal. And those fees can add up, especially for active traders who are constantly moving assets.
While networks like Bitcoin and Ethereum justify fees by saying they help keep the network secure, exchanges benefit.
For example, imagine you have 1 BTC that you want to withdraw from your Binance account to your Trezor wallet. Binance charges you a network fee of 0.0005 BTC over BTC (Segwit) for this transaction. At the time of writing, that works out to around $13. Do this a few times a day and you’ll see the fees add up.
So the next time you’re frustrated with withdrawal fees, remember that this is how the exchange makes money from you. The house always wins, as they say.
3. Listing Fees for New Cryptocurrencies
Some cryptocurrency exchanges charge high fees for crypto projects to list their tokens for trading on the exchange. Depending on the exchange and the project being listed, these listing fees can run into the millions of dollars.
Being listed on a major exchange means great exposure and legitimacy for a cryptocurrency project. Centralized crypto exchanges like Coinbase and Binance have millions of users, so projects are willing to pay big bucks for access to all these potential buyers and sellers of their cryptos.
Fees also help crypto exchanges offset the cost of integrating a new cryptocurrency. Adding a new token requires development work to make it work properly on the exchange’s platform. There are also compliance costs as exchanges need to review projects to reduce legal risk.
4. Affiliate or Referral Programs
Several cryptocurrency exchanges pay commissions to existing users for referring new customers.
These crypto exchanges hope referral programs will encourage customers to recommend the platform to friends and followers on social media or otherwise. Each referral potentially brings with it a lifetime customer who continually generates crypto exchange fees. To track referrals, links are tagged with a user’s referral code. When a new user signs up using a referral link, the referrer receives credit for any activity or fee generated.
For example, Coinbase offers a referral program that pays $10 in bitcoin for each new user referred. Binance offers a generous multi-level referral program that pays up to 40% in ongoing commissions from referred users’ trading fees.
While referral programs cut into potential revenue, the benefits of customer acquisition outweigh the cost of the exchange. Attracting new, active merchants is critical to generating transaction volume and fees.
5. Crypto Lending
Cryptocurrency exchanges like Binance, Crypto.com, and Nexo offer cryptocurrency-backed loans to retail and institutional borrowers. The loans are secured. This means that the borrower pledges crypto assets that are greater than the loan as collateral. In the event of late payment, the lender can seize the collateral.
Here is an example of taking out a loan on Binance.
You have a bitcoin that you want to hold for the long term, but you need cash. You deposit your one BTC with Binance as collateral and take out a $20,000 six-month loan at 8% interest. You receive the money and still own your bitcoin. If you repay the loan on time, you will get your one BTC security back. If not, Binance will liquidate the bitcoin to recover the $20,000 principal plus the interest owed.
So the next time you leave your cryptocurrency on an exchange, remember that they may lend it out or allow you to borrow for a profit.
6. Initial exchange offers (IEOs)
Initial exchange offerings are similar to initial coin offerings (ICOs), except that the token is not offered directly to the public, but only on a specific exchange platform.
Crypto exchanges like Binance, Huobi, and KuCoin have launched initial exchange offers for hundreds of new cryptocurrencies. They benefit by charging the startup projects listing fees and a percentage of the tokens sold through the IEO.
For example, if a new token performs an IEO on Binance Launchpad, it may pay Binance up to $1 million for the privilege. Binance also receives a certain percentage of all tokens sold through its IEO platform.
Cryptocurrency exchanges market IEOs as a safer alternative to ICOs for investors, while startups holding IEOs tap into the exchange’s existing user base for distribution. It is a win-win situation that generates significant revenue for cryptocurrency exchanges.
IEOs surged in popularity between 2017 and 2019, allowing exchanges to generate millions of dollars in additional revenue during crypto bull markets. However, IEOs declined in 2020 as the hype died down.
7. Premium Services
Some cryptocurrency exchanges have premium subscription plans to diversify their revenue streams and give users access to special features and benefits. They offer paid monthly subscription tiers, which include perks like reduced trading fees, higher earning rates on crypto lending, and increased purchase/withdrawal limits.
For example, Coinbase offers Coinbase One, which charges $29.99 per month for zero trading fees, advanced trading tools, increased staking rewards, and priority support.
These subscription packages are aimed at power users, merchants, and institutions who transact frequently and want to maximize account benefits.
8. Yield farming
Yield farming, which differs from crypto staking, allows cryptocurrency holders to “lock” their assets in exchange for rewards. Exchanges facilitate this by offering yield farming pools that bring lenders and borrowers together.
The exchange allows users to deposit their cryptocurrencies into a pool to earn interest. These pooled assets are then loaned to institutional borrowers, market makers and leveraged traders, who pay interest to borrow the assets. The exchange charges a portion of this interest income as a fee.
For example, if you deposited your ETH into Binance’s ETH 2.0 staking pool, Binance would lend your ETH to earn interest. They give you a portion of the return (received in Binance ETH, which is 1:1 tradable) based on your pool share and keep the remaining return as their profit.
Yields on offer can be quite high, often five to ten percent or more per year. This is much higher than regular crypto savings accounts.
However, yield farming is not without its risks. If the exchange is hacked, the pooled assets are vulnerable. Therefore, it is important to carefully review the exchange’s security practices before depositing your cryptocurrencies into their yield pools.
Cryptocurrency exchanges make a lot of money behind the scenes
From trading fees to withdrawal fees, listing fees, and more, cryptocurrency exchanges rake in tons of money.
Of course, all of these fees can add up for users. So pay attention to the fine print when registering for an exchange. Look around to find one that is reasonably priced.
When you start out with crypto, beware of extortionate fees that could eat up your investment. The goal is to maximize your returns, not line the pockets of a cryptocurrency exchange.
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