It might be an exaggeration to suggest that cryptocurrency traders are going through an existential crisis, but there is no doubt that they have been shaken by the collapse of FTX and subsequent discussion of potential weaknesses in the structure of the crypto market.
One of the most lively debates has been on the extent to which elements of spot FX market infrastructure could be usefully replicated in this environment. There are already a number of similarities between the crypto and FX markets, such as the decentralized nature of trading.
With increased institutional adoption, it will be important for service providers to separate offerings such as liquidity provisioning, prime brokerage, lending-borrowing, custody and exchange services, says Ayal Jedeikin, CEO and founder of execution-only non-custodial trading platform Cypator.
It will be a natural transition for the institutional digital markets to move to an OTC-style of trading model, cleared either bilaterally or through a central clearer
Ayal Jedeikin, Cypator
“These need to be offered in a non-conflicting and independent fashion so it will be a natural transition for the institutional digital markets to move to an OTC-style of trading model, cleared either bilaterally or through a central clearer,” he adds. “Leading centralized exchanges are already spinning off OTC desks to cater to institutional clients. This is non-custodial in nature and settled post-trade, reducing counterparty risk significantly.”
According to Tom Flanagan, digital assets head of platform trading at liquidity provider TP ICAP, one element of the FX market structure that crypto would benefit from is the transparency and liquidity analytics accessible within wholesale FX venues.
“Most crypto venues are anonymous in nature with a lack of information detailing the type of flow and the market participants involved,” he says. “Statistics such as fill rates and round-trip time – along with more advanced analytics such as pre- and post-trade mark-outs – are staples of institutional FX.”
This data provides clients with more information on the types of liquidity their firm is dealing against in an anonymous marketplace – and whether it is beneficial flow to them and their franchise.
Structural issues
In November it was reported that the US securities regulator was investigating FTX’s handling of customer funds and specifically whether it was following securities laws related to segregation of customer assets and trading against customers.
There is an expectation that crypto will use capital market models for addressing structural issues, such as separating custody from market-making and capital allocation services. But the infrastructure used to run these systems should be more efficient and stable than in traditional financial markets, which rely on dated technology.
The crypto ecosystem is also not beholden to the same constraints as an OTC market, suggests Rich Evans, managing director institutional sales, prime liquidity at exchange CEX.IO.
“As such, it would behoove institutional entities to consider how they can best accommodate the environmental conditions of digital asset investing,” he says. “In fact, there is an argument to be made that crypto markets present a technologically advanced alternative to these established systems.”
While using a third-party custodial solution requires a degree of trust, there are benefits in terms of convenience, and for many traders it would be more secure, acknowledges Christo de Wit, South Africa country manager at cryptocurrency platform Luno.
It has also been suggested that having a centralized settlement utility would improve the stability of the crypto market, although de Wit reckons this would not come without some downsides.
“A centralized settlement utility in the crypto market would enhance efficiency, mitigate counterparty risk, and streamline settlement processes,” he says. “However, it would also pose systemic risk and introduce counterparty dependency.”
When it comes to the future of crypto trading, it is clear that regulated trading venues are needed. Replicating structures that are built into the existing capital markets infrastructure will also be crucial to increasing crypto asset adoption for traditional banks and financial services institutions.
That is the view of Lukas Enzersdorfer-Konrad, deputy CEO of trading platform provider Bitpanda, who reckons issues such as post-trade settlement instead of pre-funded trading need to be resolved by establishing prime brokerage offerings.
But Patrick Bärtschi, head of business development at crypto exchange Bittrex Global, suggests that greater regulatory clarity is required to determine which structures are most suitable.
“The crypto market is still relatively young and many regulators have yet to determine what asset class it should be compared with,” he concludes. “The outcome depends on whether crypto is considered a security or a commodity, or whether it will be regulated as a whole new asset class.”
