Crypto is big news – and while it’s not all that everyone’s talking about at TradeTech FX, there’s definitely a buzz around digital assets that’s impossible to ignore. Not everyone is on the same page with regards to adoption rate – some feel institutions are being left behind, while others advocate caution until we see which way the wind is blowing. But after the crypto winter we saw in recent months, one thing seems for certain – the sun is once again coming out. The industry consensus is that crypto is here to stay, and if you’re not yet on board, you might have missed the boat.
“There will be a new crypto summer, and everyone should be getting ready for that,” stated David Mercer, CEO of LMAX Group, in his keynote crypto interview. “There’s going to be a convergence, it’s inevitable.”
“There will be a new crypto summer, and everyone should be getting ready for that.”
Mercer believes there is no doubt that crypto assets will eventually pervade traditional assets – the only question is how long it will take. “The two things holding it back are the lack of regulatory determinism, and the lack of conventional credit mechanisms,” he said.
But the growth of the asset class is undeniable. “This year we expect our activity to be around 80/20 FX to crypto, which is about where it should be. But don’t forget that the eighth biggest currency pair last year was BTC/USD. It’s already a traded asset class. You can trade Bitcoin against most other assets on the Street already – and in five years from now we’ll be trading against even more – from BTC/S&P, BTC/gold, and much more.”
However, there are still some barriers to institutional adoption.
“In traditional finance you have an ecosystem, you have traditional customers, bank intermediaries, brokers, exchanges, prime brokers, custodians,” explained Mercer. “Not all of that exists yet in the conventional space.”
Elodie de Marchi, head of operations and corporate strategy at digital assets data provider Kaiko, agrees. In a panel discussing ‘Crypto for institutions: how will the new crypto wave impact FX markets and what are the barriers that need to be overcome to ensure mainstream institutional adoption,’ she stressed that: “We urgently need to see more maturity in the infrastructure space. We also need to improve access to data and education. If you don’t have high quality data, you simply can’t operate.
“We urgently need to see more maturity in the infrastructure space. We also need to improve access to data and education.
“Crypto is a highly fragmented system – you have centralised exchanges like Coinbase, alongside decentralised ones like Uniswap – and these are now seeing around 50/50 in terms of activity. Only looking at centralised exchanges is like only looking at the tip of the iceberg. You need data for rebalancing, for risk management – and you need specific solutions for crypto. We do see institutional adoption, but big banks and largescale projects really need better infrastructure and better data to really drive real adoption.”
Panellists also emphasised the need to learn from what’s been done in the traditional finance sectors in order to see a convergence.
“We need to look at how can we take the benefits of traditional finance and overlay that into the innovation occurring in the crypto space. For example, there was probably an over-extension of credit in the crypto space in the summer, and we could perhaps benefit from the checks and balances of traditional finance,” said Nicola White, CEO of digital asset liquidity provider B2C2.
“There was probably an over-extension of credit in the crypto space in the summer, and we could perhaps benefit from the checks and balances of traditional finance.”
“Crypto exploded spectacularly this year, creating a messy credit event,” agreed Edd Carlton, institutional digital asset trader at Flow Traders. “It highlighted the importance of counterparty risk – who is on the other end of your trade? We work to create what I call the path of least resistance –we try to make the pre- and post-trade set up as similar as possible to what people are used to.”
One thing is for certain – the market is rapidly evolving, and the pace of growth is by no means slowing. “Eight years ago, crypto trading was very hi-touch, very voice-driven, based around RFQs,” explained Carlton. “Now, I’d say 90% is done electronically. The evolution in terms of market structure has been very rapid – in fact, it’s been a carbon copy of the evolution in the FX space, just over a much shorter time span.”
Everything is now moving forward – and new issues are coming to the fore. “We’re also focusing right now on what crypto can bring to the traditional finance space,” said White. “For example, settlement. In traditional finance you’re looking at a day, maybe two, before you exchange on the back of a trade. In crypto, we settle 70% of trades within 15 minutes and 99% within 45 minutes. If you think of the events in June this year, you’re substantially reducing that credit risk in a very short period of time.”
Luke Brereton, senior VP at State Street Global Advisors, went further: “We need to get rid of settlement risk – it’s not fit for purpose for the crypto market. It traditionally consumes a huge amount of capital because of intra-day cost of funding. We want to achieve atomic settlement at the point of trade. That’s what we need in order to achieve institutional involvement.”
“We want to achieve atomic settlement at the point of trade. That’s what we need in order to achieve institutional involvement.”
Another option is to extend outwards from crypto and flip technology back to the more classic analogue asset classes. For example, last year State Street Global Advisors did an FX forward, traded on the blockchain as a smart contract – with micro processes embedded in the contract enabling them to review it automatically every few minutes. “Here’s a way of using blockchain to take on traditional markets and make them more efficient,” stressed Brereton. “That’s the way that we’re going to see broad institutional adoption of this trend – not just by trading crypto, which realistically is just another risky asset class.”
But when it does come to trading institutional crypto, where next?
“Now that we’ve moved through the credit issue, the trend is in execution,” predicted White. “We’re bringing algos into the crypto space – how do I vwap, how do I twap?”
“We starting to talk about issues like liquidity management, pricing, latency, cross-connects,” added Carlton. “These conversations are bread and butter in the FX world, and they’re now starting to happen in crypto as well.”
Another trend is, unsurprisingly, derivatives – particularly crypto futures, and perhaps it is here that the true potential lies.
“Treasury groups in June were sitting on massive positions in Bitcoin, in Ether, and hadn’t hedged it – they hadn’t thought about the chance that the asset class would go down,” noted White. “Now, the conversations are all about options, about hedging. There are more and more institutions finding themselves involved.”
“It’s going to be interesting to see the derivatives space grow, and whether it grows faster than spot,” agreed de Marchi.
For now, the mood is one of cautious optimism.
“We believe crypto adds value to a portfolio, but there are reasons to take it with a pinch of salt,” said Sven Schubert, head of FX strategy at Vontobel Asset Management. “The added value will change over time, just as it did for gold once the gold standard changed. In five to 10 years, we will have a very different perspective as to whether it adds value to a portfolio or not.”
But don’t get too excited, there’s still some way to go.
“Participating in a crypto risk trade is not a top priority for most of our clients right now,” admitted Brereton. “There are people looking at it, they’re interested, it has potential, but it’s not happening quite yet.”