Even though Kraken is based in the US and facilitates exchanges between a number of different cryptocurrencies, its customer base is decidedly euro-driven.
In fact, according to BitcoinAverage, Kraken has over 50% of the EUR/BTC market. That makes it the largest player in that trading pair.
Due to regulatory issues in the US (which has 50 different states with 50 different ideas about money transmission), Kraken leans on its European banking partnership with Germany-based Fidor.
Even with that geographic bent, being San Francisco-based has had benefits for Kraken, and, in March, the company closed a $5m Series A funding round from Hummingbird Ventures.
CoinDesk sat down with Kraken CEO Jesse Powell to talk about the challenges of running a cryptocurrency exchange in terms of banking, regulation and how decisions are made for adding altcoins.
Impact of Mt. Gox
While some may associate the name Kraken with spiced rum or perhaps its monstrous fictional namesake, Powell says that he had owned the domain Kraken.com for years, having designs on using the name for something. However, he didn’t know exactly what it would be.
In the beginning, Kraken’s parent company, Payward, was planning to provide a bitcoin wallet service, like Coinbase.
“We’ll probably never get back to doing the Payward wallet,” he said. “[We’ll] probably just focus on Kraken. We’re trying to rebrand everything to just Kraken.”
Do one thing and do it well has become the strategy for Kraken, said Powell:
“We’d prefer just to be laser focused on being the best exchange and let other people deal with payments between people.”
FinCEN and Kraken’s focus
Powell’s trip to Tokyo in order to help Mt. Gox bounce back from security intrusion that severely affected bitcoin influenced Kraken’s move to into the exchange business. Since the company was initially formed in 2011, though, regulatory issues have shifted. According to Powell:
“We when started, it wasn’t clear that it would be a problem to operate in the United States. We didn’t think exchanging was money transmission, until the FinCEN guidance in March 2013.”
Kraken’s exchange platform debuted in early 2013. For many months, users could only trade with ‘play’ money. But the strategy helped the company work out bugs in the system early on. By the time of its official launch last September, Kraken had better knowledge about running a robust exchange:
“We wanted to find the problems before losing real money. It was important to us to have a really lengthy test phase.”
Kraken currently makes all of its money on exchange fees, which means it is dependent on the price and volume of coins traded in order to profit.
Powell said, though, that the startup is looking at other ways to make money, adding:
“We’re exploring some other ideas for revenue. Obviously we’re serving a dual purpose for many users, people are using us like a bank. A lot of people just put their money in and leave it there.”
Kraken’s focus on European markets is based on problematic regulatory compliance issues within the US.
The exchange only does business in a handful of US states because of the different compliance requirements from state to state. “People in some states may miss out on an opportunity to get into bitcoin,” if something isn’t done to ease the rules, said Powell.
At this point, there haven’t been any issues that have cropped up against exchanges or wallets in the United States. “There’s been no enforcement action yet, whatsoever, as far as I’m aware, against any of the exchanges,” he explained.
However, that could change if states take action against an exchange or a wallet provider:
“The laws are consumer protection laws. But until [people start complaining,] they just don’t care.”
The biggest problem, however, comes in the form of banking for startups that want to get involved in bitcoin.
“Even if you are not getting enforced against by the regulators or even if you have your licences, it does not guarantee you a bank account. The banks are the biggest hurdles for these businesses,” said Powell, adding.
“Our approach really has been really to do whatever it takes to get the bank comfortable with giving us an account. First part is to get bank accounts; second part is to actually service customers.”
Bitcoin and banks
While at the beginning of 2014 there was some promising news with Wells Fargo and Bank of America both publicly looking at bitcoin, Powell said that Mt. Gox’s disintegration has dealt a serious blow to the US cryptocurrency market, with banks now causing bitcoin-related companies difficulty in obtaining accounts.
This environment shows how much banking really has control over the business climate, he explained:
“It’s crazy that in the United States you don’t have a right to a bank account, but you can’t really operate a business without a bank account.”
It’s impossible to run a business with just paper money these days, a scenario that Powell has trouble trying to envision as feasible in 2014. The idea of running a business by mailing around what he described as “100% stacks of cash” is not really possible.
Legitimate businesses have to use banks – something that, if given a choice, the feds would rather prefer over a purely cash economy:
“I think that the government would say that actually: ‘we’d prefer that you have a bank account’.”
Kraken now trades bitcoin, litecoin, dogecoin, namecoin, ven and ripple’s XRP. Powell says that Kraken is interested in adding peercoin at some point, as well.
It takes careful study of the cryptocurrency’s volume and differentiating aspects to decide if an altcoin has long-term potential for addition to Kraken, Powell explained, adding:
“Peercoin is one that we would like to do, if we get the time for it. We do namecoin. If there’s something interesting about it, like namecoin, we might do it.”
Many people don’t realize that adding an altcoin to the exchange takes effort. Therefore, for Kraken, new coins have to be scrutinized, according to Powell:
“Some of these are just pump and dumps, and it costs a lot of dev time to put these coins in [to the exchange]. And I think it says something to people, that we start trading it. So we want to be careful what we put our name on.”
The problem for exchanges that support altcoins is that the bandwagon can often leave a coin (and thus users) behind rather quickly. For an exchange doing its best to follow regulatory and banking standards to the point of even providing public audits, scams are a problem.
It’s something that Powell, and Kraken as a company, is ultimately concerned about for the community’s sake:
“There’s this [altcoin] hype in the beginning. And all the mining effort will go to [a coin], and there is all this support. A week later, after the pump, you get the dump. Everyone’s out and you’re on to the next coin,” he said.
Kraken logo via Bitcoinx