From mining to physical trading to futures, speakers at this spring’s FIX Trading Community Americas Briefing made it clear: cryptocurrencies—and the consequences they augur—are top of mind, with planning around them now on tap even at financial services’ most staid and steadfast firms.
The briefing, hosted last week by Goldman Sachs in New York, narrowed in on a range of ongoing topics for FIX members—from fixed income electronification to better pre-trade transaction cost analysis (TCA) and an assessment of MiFID II’s infamous onset in January. But the session on cryptocurrencies attracted special attention. The digital assets having grown in stature from sideshow curiosity to piqued interest after the December 2017 explosion in Bitcoin’s price (BTC), and its subsequent softening since.
Perhaps the most remarkable takeaway was the widening variety of touchpoints that investment banks, asset managers and technology providers have begun to assess—whether offering BTC futures (already available) and exchange-traded funds (in the works, or under appeal with the SEC); building out institutional-grade venues and robust infrastructure to facilitate physical trading; efforts at influencing the evolution of mining and walleting of coins; or more seamless integration for crypto holdings into investors’ portfolio management. All of this also came without much mention of blockchain—the darling distributed ledger technology underpinning cryptocurrencies—other than to reassure that interest in BTC investing does not require blockchain expertise. Quite a change, indeed.
Still, caution carries the day. When polled, 73 percent of the audience admitted they either owned no crypto, or were still looking for the right opportunity. The panelists were similarly mixed with some heavily invested, others recently selling theirs, and one jokingly adhering to the acronym ‘HODL’—or hold, as it is known in Silicon Valley.
So, why the disparity? The panel—with participants ranging from Fidelity and Goldman to CBOE to startups—first pointed to a key missing driver: an affirmative stance from US regulators. That is particularly true compared to the legitimacy crypto has been given in Asian jurisdictions like Japan and South Korea, they said. Pulling in more investors starts with clarifying with which regulator among the Securities and Exchange Commission (SEC) and Commodities Futures Trading Commission (CFTC) should take the lead—and perhaps accepting that it is neither a cleanly-defined security nor a commodity—and building a regulatory framework from there. That would further ward off associations with North Korea and initial coin offering (ICO) fraudulence, too.
Institutions also require stronger confidence in the crypto trading landscape. As one speaker said, the fear is that institutional activities—BTC market-makers’ hedging, for instance—can’t be properly completed when access to the physical temporarily goes dark. “We sometimes lose sight of the fact that this is the first asset class ever that really began with retail, and as a result, the venues are really just simple central limit order books, not full-fledged exchanges,” said another. “As we saw in December with volumes running wild, those venues fall down when put under stress. That experience has helped refocus the industry back to walking first, before running.”
A third, related area causing nervousness is custody of the digital assets. Among the unanswered questions here: Where and how to properly store the keys for crypto-wallets; what should the custodial structure look like, how to segregate custody effectively from execution, and achieve compliance with the ‘40 Advisers Act? And, of course, how to bake in know-your-customer (KYC) checks, to identify trading counterparties and avoid illicit players.
Of course, these problems may seem ancillary to established markets, but they’re essential questions about how to facilitate trading, and the advice was to approach the area with rigor and healthy skepticism. “Independence of the custody functions is crucial,” one contributor argued. “You must avoid the possibility of a Madoff situation; you also don’t want a venue to know your entire position. If someone comes to you with a comprehensive ‘full’ solution, you should question that.”
Though many problems remain unsolved for, that doesn’t mean firms are shying away; in fact, “dive in” was repeatedly the call to the audience—whether on the tech side, product development, or legal. That partly explains the “overwhelming institutional demand”, one panelist explained, for mining hubs and crypto infrastructure in the first months of 2018. Many, he guessed, are focused on two areas: process governance around the mechanics of crypto, and testing network stability of chosen coins or venues. The reason why is simple, he said: “They all want to be a player, and have a vote in how things play out.”
Some progress is also just a matter of timing. For instance, the BTC futures market remains mostly saturated with retail activity. But this was down to futures commissions merchants (FCMs) treading carefully with their clearing commitments, as the release of the futures coincided with the price spike. “Those products launched at the height of the mania,” one panelist said, “and that caused FCMs to be more cautious. Once some of that flushes out of the market, we’ll see them loosen a little and make it more available to a wider audience.”
Getting easy wins done around messaging is underway, as well, as mainstay crypto venues like Coinbase and Gemini are already eying FIX versions for release, and collaboration is increasingly between crypto trading startups and investment banking. (For that matter, cross-pollination is on the rise, too, as new ventures are increasingly being built up by veterans of institutional fintech). “To use the standardization and infrastructure around what we already have in place is a no-brainer,” as one panelist said. “FIX already has most of the nuts and bolts required to handle crypto.”
It could also prove a competitive differentiator for new entrants, another pointed out. “We evaluated a few platforms already whose protocols are not even close to familiar; it’s not even a language we speak,” he said. “Having a standard in place we already use every day is of huge utility to us.” A representative of FIX Trading Community confirmed that a crypto-specific update for the protocol will be available later this year, following the work of its committee focused on the space.
It may still seem like early days as firms dip their toes in, and organize teams to spin up small implementation projects to gain crypto familiarity. But there’s something different this time, the panel concluded. It’s often been assumed that crypto enthusiasm would crest and trough with BTC’s price—and yet, even as the price has cratered this spring, interest remains decidedly on the upswing. After years of living in blockchain’s shadow and with no small amount of stigma, crypto seems to be gaining fresh confidence as a strategic priority.
“Part of the reason why,” one speaker said, “is that we don’t want to be completely dependent on startups to shape how we do this. It’s a philosophical view: this could be the securities infrastructure of the future, where securities are digitally native on the blockchain. We’re concerned about how that shift is expedited, and we see this as ‘we have to be able to deploy in our technology divisions first.’” Agreeing, another added that whether you believe in Bitcoin or not, “some form of tokenized fiat will exist in the future. Having the intellectual property and technology to support that is important to the future of our firm, and recognizing this as an early institutional adapter, embracing that—we now see it as required.”
Once the session finished, another poll asked the audience for their biggest concern going forward about crypto coming to the markets. Given the chance, only ten percent of the room chose the most extreme: “It’s a scam.”
As one panelist summed it up, “That number was a lot higher six months ago.”
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