FX: Cryptocurrency trading venues snowball

By:
Paul Golden
Published on:

The emergence of new trading venues marks a notable advance in the development of cryptocurrencies, such as Bitcoin, although exchanges vary in their product offerings.

Interest in cryptocurrencies has been boosted recently by a sharp increase in the value of blockchain platform Ethereum and there are a number of platforms keen to exploit demand for trading of digital currencies.

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Brad Bailey, Celent

Cryptocurrency exchanges have been trying to evolve to something that would make a wider swath of investor types more comfortable, says Brad Bailey, research director for Celent’s securities and investments practice.

Some trading venues operate more like a retailer for Bitcoin, where they allow users to accept payments in Bitcoin and convert them immediately to the base currency, observes Dan Anderson, founder of LEOcoin.

"Coinbase is a good example of one of these venues," he says. "Others – like Kraken – operate purely as an exchange, allowing consumers to buy and sell digital currencies against other currency pairs."

Trading venues also require different verification levels.

"On our exchange there are several verification steps, meaning that users do not have to provide all of their information immediately," says Anderson.

Verification

Tier 1 verification, for example, allows users to immediately start trading, just by entering their email address.

"Other trading venues have fewer tiers," he adds. " Coinbase only has two, with the first step requiring users to provide their email, phone verification and bank verification before they can start trading.

"Some venues also allow people to buy and sell different digital currencies."

On LEOcoin’s LEOxChange, people can trade with LEOcoin, Bitcoin and other digital/cryptocurrencies.

Jesse Powell, CEO of Kraken, observes that some exchanges have zero fees on trading and instead charge for deposits or withdrawals.

He also suggests not all platforms pay the same amount of attention to the law and licensing requirements around the services and products they offer.

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Paul Chou, LedgerX

Paul Chou, CEO of LedgerX, agrees there is often little difference between exchanges in terms of fee models, adding: "Most trading venues employ a typical per-trade fee model with standard variations around maker/taker fees."

These venues vary primarily by what products are offered – cash settled versus physically delivered, spot, futures, swaps, options – and in what geographies they are legally able to operate, adds Chou, who is keen to highlight the benefits of cleared options contracts.

"The vast majority of trades for Bitcoin are done bilaterally over the counter between trusted counterparties," he explains. "However, there is always a risk in bilateral transactions that counterparties will default – if your counterparty is not in great financial health, you may have to discount the value of the swap because there is less of a chance that they will actually come through with the trade.

"Reviewing and valuing bilateral swaps can be a very messy process, since you have to make a lot of assumptions about your counterparty’s credit worthiness."

Clearing house

LedgerX’s approach is to have a clearing house attached to the exchange, which acts as the central counterparty to all transactions. Every trade is novated and the clearing house guarantees those trades.

Chou suggests cleared options contracts increase the size of the potential liquidity.

"In a bilateral trade, institutions are unwilling to transact with smaller players because they can’t trust their credit," he says. "But with contracts cleared by exchanges, both large and small players can participate because the credit issue is mitigated."

LEOcoin’s Anderson says the cryptocurrency exchange market is a long way from any legitimate concerns around saturation, while, according to Kraken’s Powell, there will eventually be many trading venues that are trading derivatives.

"As far as spot, deliverable cryptocurrency is concerned, I see at least two venues per major market being viable," he says.

When asked how many cryptocurrency trading venues the market could sustain in the long term, Celent’s Bailey says the answer is linked to how many cryptocurrencies are likely to exist.

"The number of cryptocurrency trading venues will be a function of the changing regulatory environment globally, the number of successful coins and the nature of the investors who are looking for liquidity in those cryptocurrencies," he concludes.

"A development that would radically alter the future trading landscape would be a central bank offering a fiat currency in crypto form, such as a crypto-dollar."