Deal To Watch: The Next-Gen Crypto Exchange

Problem

On January 5, 2018, Bitcoin prices peaked at $16,665 a coin, following a Bitcoin craze. While the price per coin has plummeted over 75% and is today worth around $3,500 a coin, the widespread popularization of the concept of blockchain and cryptocurrencies have made a lasting impact on businesses.

 Logistics companies are further exploring how blockchain can better enhance the transparency and reliability of their operations, and companies like Walmart are trying to work on a blockchain-based solution to ensure better quality control for its produce products.

Cryptocurrencies in particular have been a significant point of interest for many investors. Being a fairly new concept, the trading opportunities that digital currencies like Bitcoin have are largely unexplored. Bitcoin options are largely unheard of, and Bitcoin futures are still being planned out on the NASDAQ exchange.

Yet, even with so much interest in trading digital assets, there are few centralized exchanges, and no standardized method for conducting trades. With so many different trading exchanges across so many regions, trading such digital assets are made difficult and inefficient in many ways.

 Because of the large proliferation of digital asset exchanges, supply of digital assets can vary significantly between exchanges. These limited supplies can cause problems, some of which include illiquidity in high-volume trading, or pricing inefficiencies. Since digital asset pricing relies on an exchange’s supply of each asset, the variance in exchanges’ supplies can often influence the digital asset’s price.

Even more, moving digital assets from one exchange to another is difficult and costly, and firms need to offset this increased cost in the form of fees to traders. Traders are therefore better off if they can use multiple exchanges simultaneously so they can take arbitrage on various pricing differences and reduce their costs.  

However, with so many exchanges to choose from, traders may find it difficult to find legitimate and trustworthy vendors thus adding to the inherent risk of trading digital assets.

Solution

Sprocket means to address these issues by creating a global digital asset trading marketplace. They plan on doing this by joining third-party exchanges operating all over the world to create one single marketplace where traders can buy and sell digital assets concurrently on Sprocket’s partner exchanges. By connecting third-party exchanges under one marketplace, Sprocket can effectively neutralize many of the issues that plague the current system.

 Since Sprocket’s platform effectively pools the supplies of digital assets across various exchanges, issues of liquidity are resolved, since when one exchange no longer has enough supply of any given digital asset, Sprocket will be able to connect the exchange with other exchanges quickly, normalizing the procedure for intra-exchange asset moves. Traders who hope to make high-volume trades will no longer be exposed to the added difficulty of exchanges with low supply.

Traders using Sprocket will be able to simultaneously trade on numerous exchanges, which cuts down on time traders would otherwise have to spend on searching different prices on different exchanges. Sprocket can also work as a exchange verifier, so traders do not also need to worry about counterparty risks.

 Most importantly, traders hoping to take arbitrage across different exchanges can effectively help balance out pricing differences, further reducing any pricing inefficiencies in the marketplace.

Business Model

Sprocket plans on achieving this through a couple of independent mechanisms that work together with their own proprietary API which they have designed to be easily scalable.

Their marketplace is intended to join their own exchanges with third-party exchanges with a low latency processing system that can execute a million trades per minute, capable of handling high-volume transfers almost instantaneously.

They also plan to create their own digital asset wallet, which works in a similar fashion to other cryptocurrency wallets. To protect their customers and themselves from theft, they plan on implementing a smart contract based blockchain escrow function to ensure the security of instant settlement trading funds. These smart contracts are public and auditable, so individuals can ensure that their funds aren’t being mismanaged by Sprocket.

The consumer-facing trading interface is designed to be similar to trading platforms by leading stock brokerages, where professional traders can execute complicated trades, chart patterns, apply algorithms and trading bots. This enables quant traders to have a single platform for high-frequency trading.

When a trader executes a trade or transfers digital assets in any way, Sprocket charges a fee. Thus, revenue growth is reliant on two different factors, user-base growth, and trade volume growth.

Sprocket also plans on introducing its own Sprocket EX Token with an issuance value of USD $10. Conceptually, these are the equivalent of preferred stock. Each entitles the holder of the token to a distribution of 10% of the net revenue from Sprocket’s exchange platform.

These “dividends” are distributed by purchasing the ETH equivalent of 10% of net revenue, or issuing SprocketCoin tokens, which are valued at 0.01 ETH.

Management

While Sprocket’s exchange is still being developed and refined, their management is composed of highly experienced individuals.

Fred Thiel, co-founder/CEO has spent 30 years in building technology-enabled businesses. He sits on the board of various digital asset based companies, like Utimaco GmbH (German provider of cryptographic security solutions), Sequent Software (digital payment tokenization technology developer for mobile wallets, payment card issuers, and banks) and a variety of PE/VC firms.

 Matthew Hetland, co-founder/President, has 20 years of experience in international banking, and is Chairman of the SuitePay International group of companies, which processes payments using a proprietary gateway processing solution.

Why We Like it

 1. Appealing Business Model

 Sprocket’s revenue comes from increases in either its user-base or its trade volume. So, if the company hopes to grow its revenue stream, they must find a way to appeal to traders who are willing to adopt their platform and pay their fees instead of their next best alternative: managing each exchange independently.

 Already, reasons for why traders might prefer Sprocket’s platform emerge. By joining all of its associated exchanges under the same roof, the company is making it significantly easier for traders to check for pricing differences among different exchanges. Ease of pricing inefficiency detection makes traders more likely to catch intraday arbitrage opportunities, which offers a good degree of value for any traders on the fence about using Sprocket’s platform.

 The liquidity provided by Sprocket’s intra-exchange transfer system means that high-frequency trading algorithms and bots can be deployed. This makes Sprocket’s marketplace much more appealing than alternatives for the increasing number of quant traders and quant funds, and is also highly profitable for Sprocket, since high-frequency trading incurs far more fees for the company.

 Other features of Sprocket’s business model detracts from any negatives such a platform might cause. The highly efficient gateway processing platform makes lags in trade executions very unlikely.

2. Strong Management Team

To date, Sprocket is a pre-revenue company, which may deter investors with a low risk profile. However, the company’s top management has a significant amount of experience in related industries.

Sitting on the board of directors for various companies providing digital-asset related solutions, CEO Thiel clearly has a large degree of exposure the industry, which all things considered, is still fairly new. Similarly, his experiences with PE/VC firms demonstrate his familiarity with the practice of rapidly growing companies as well as an understanding of healthy business practices and cost-efficient operations management.President Hetland’s experiences in gateway processing are also sure to be very valuable as Sprocket continues development of its intra-exchange processing system.

Other members of Sprocket’s top management are equally distinguished, bringing expertise from a variety of different fields to Sprocket’s disposal.

Risk Factor: Declining Digital Asset Trading Volumes

As mentioned above, fees are assessed based on trades processed. The appeal of trading digital assets is not just derived from the platform’s effectiveness, but also the general profitability a trader can hope to expect from trading digital assets. So, general trends on digital asset trading volumes can impact Sprocket’s consumer acceptance prospects.  

Since Bitcoin’s peak price late December of 2017, Bitcoin’s average daily trading volume has declined more than 60%, from $15.3Bn to $5.6Bn. Being the most commonly traded cryptocurrency, Bitcoin’s volume is indicative of a larger trend within the industry, where general investor interest is shifting toward other opportunities. This represents a potential issue for Sprocket’s profitability, since lower volume may reflect a lower interest in digital asset trading.

Rating

Sprocket is a Deal to Watch. By establishing a digital asset brokerage capable of efficiently and effectively executing complicated trades, they are opening up a new way to manage digital assets which, despite decreases in trading volumes, are most likely here to stay.

The reason it is not a Top Deal is out of concern that the crypto market is highly volatile and so is follow on investment from VCs in companies like these during tough market downturns. Since we are experiencing a downturn right now there is a concern about being too early to market and not being able to weather short term market challenges.

Additionally, as we think long term there is two major challenges to consider. First off, will Sprocket become the exchange that everyone uses or will there be another entrant that people flock to instead? With limited clarity on where the market will exactly head, it is hard to clearly define if Sprocket is well positioned to win out.

Lastly, with government regulation the crypto-market could experience significant headwinds and an exchange like Sprocket would be at the center of such government oversight.  

Due to these major unknowns, we have to assign a Deal To Watch rating. Regardless, we do feel there is tremendous upside to an organization like Sprocket. If a $50K minimum investment is not too high to prevent the ability to diversify this might be one worth considering, but do consider the heightened risk of this investment.