How do Chinese exchanges with zero transaction fees make profits?

     Why do Chinese Bitcoin exchanges charge no fees for spot trading? Whenever asked this question, the three major exchanges (OKCoin, Huobi and BTCC) will reassure everyone that they have no problem making profits. Here, I will do a mind experiment on how spot exchanges that do not charge transaction fees make money. Of course, other than logical reasoning, I have no particularly effective evidence to support these statements.

     China's bitcoin trading accounts for the vast majority of global bitcoin trading, so the exchanges have a lot of customer deposits. I think Chinese exchanges exist in the form of shadow banking. They borrow money from customers and use it to buy Chinese bond-like financial products.

     When a product is free, you are the product. Chinese exchanges use the deposited RMB funds to trade Bitcoin to earn interest income. How much money does it cost to maintain the operation of these exchanges? I don't have direct data, but the three major exchanges have about 150 employees. Assuming the average salary is 10,000 yuan per month, and the bank savings interest rate is between 3% and 5%, bank savings is the lowest risk lending method because the money can be redeemed at any time to meet the withdrawal needs. (Based on the assumption, an exchange) The annual salary expenditure is 18 million yuan. Assuming a lending rate of 5%, the exchange needs 360 million RMB or 56 million US dollars of stable customer funds to make this money. And if the trading volume announced by the exchanges is true, then the three major exchanges have no problem with having this amount of funds.

     But that's barely enough to pay salaries. To make a profit, Chinese exchanges need to take on more risk. Based on China's restrictions on private companies borrowing from banks, Chinese banks began selling high-interest wealth management products to small businesses more than a decade ago. Banks' wealth management products are backed by the company's assets and don't usually appear on the bank's balance sheet. Depending on the redemption period, the products offer annual returns of 10% to 20%. Investors often trust, even if the banks don't say so, that their funds are safe, based on the belief that if these wealth management products fail to deliver, the consequences will be so disastrous that the government will not sit idly by. In fact, when the borrowing companies fail to repay when they are due, the banks usually use their own money to fill the hole.

     Just like banks, Chinese exchanges also need to keep a certain amount of funds to ensure liquidity, so they cannot invest all their money in wealth management products. The following is a list assuming that the bank interest rate is 5% and the wealth management product provides 20% interest. NIM stands for net interest profit. In the case that the exchange pays zero interest to users, the net interest profit is equal to the total interest earned by the exchange's investment.

     As the above chart shows, the more loans you make, the longer the term, the greater the risk, and the more money you make. Since the exchange has no regulatory measures on the use of user funds, company management can make any investment projects they think are profitable; even CEOs can trade A-shares in their spare time.

     Bitcoin trading is secondary. These entrepreneurs have created a very profitable quasi-banking system. Because they have a lot of cash from their users, they can invest it in any asset they find profitable. The Chinese Bitcoin exchange model will be widely replicated in emerging market countries where loan intermediation is broken and nominal interest rates are very high. If I were to open an exchange in India today, I would definitely adopt this model because private lending is difficult to obtain there and nominal interest rates are very high.