Crypto Markets Continue Breakneck Pace of Development

This time last year, digital currency exchanges were considering something they’d never had to do before—implementing circuit breakers to halt volatile price swings on their markets, ones which could wipe out clients trading on margin in nanoseconds.

Fast forward 12 months and the cryptocurrency markets have a derivatives layer, professional-grade tooling and, with the latest announcement from the largest exchange operator in this space, they now arguably have what they need to be considered a bona fide asset class.

Coinbase, the operator of the eponymous retail exchange and the institutional-targeted GDAX venue, announced on its website on May 15 that it would be launching Coinbase Markets, an offering focused primarily at institutional traders, which will introduce custody, prime services, professional-grade technology and research, sales and trading services for this segment.

It’s a remarkable growth spurt for a nascent asset class which, even earlier this year, was regarded as amateur—in terms of technological sophistication—at best. Even in March, the head of a Chicago-based proprietary trading firm, which actively trades bitcoin and other digital currencies, told WatersTechnology that the technical and operational capabilities of these exchanges often leave much to be desired.

“We’ve got some software that connects through [application programming interfaces] to these exchanges, but many of them are run by kids. The best one is Gemini, I think, the biggest is GDAX, but it’s still not the CME or Nasdaq,” they said. “Some of the others, wow. The thing will go down and nobody answers the phone for six hours. That’s a challenge and there are risks in that, but then again, it’s new, and it’s kind of fun that way.”

Despite a new raft of tools and flashy technology permeating crypto markets—not least of all in the form of professional-grade trading software being offered by Trading Technologies and others, and the deployment of sophisticated surveillance software such as Nasdaq Smarts on the Gemini Exchange—there are still several extant problems that require solutions in the market. One of those is the current split between the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) in the US.

“The biggest problem, by far, is [uncertainty in] regulation,” says a Washington DC-based regulatory affairs head for a major market-maker in traditional asset classes. “The CFTC says it can regulate the derivatives but not the spot markets, the SEC says that initial coin offerings look like they pass the Howey test and are securities, but it’s also not addressing just who is responsible for all this. Meanwhile, you have some senior regulators who are saying, you know, let it regulate itself, which seems like the best idea since someone thought about packaging up subprime mortgages and trading them.”

The approach that Coinbase has taken with its suite of institutional offerings demonstrates the scope of its ambition. Coinbase Markets, the company said, will offer on-premise datacenter co-location, low-latency market access and professional-grade settlement and clearing services. Such offerings—in particular, co-location and low-latency access and data feeds—are usually prerequisites for the introduction of high-speed and high-frequency trading strategies.

Coinbase said that its Markets division will be based in Chicago, home of many high-speed trading shops such as DRW, which has been a major participant in crypto markets through its Cumberland subsidiary. Cumberland announced on the same day that it was now trading cryptocurrencies—including bitcoin, ether and roughly 30 other cryptos—across geographical locations on a 24/7 basis.

The core trading system will be built in-house by its Chicago-based team, a spokesperson for Coinbase tells WatersTechnology, with a target of “microsecond-level roundtrip response rates.” 

“Our institutional product offerings are one part of a larger strategy to accelerate the adoption of cryptocurrencies,” the spokesperson says. “We are actively working in parallel on products—for consumers, professionals and institutions—that fall into the ‘investment’ phase. In addition to the investment phase set of products, we’re building ‘utility phase’ products that will accelerate actually using crypto to do things on the decentralized web.”

Coinbase declined to reveal what percentage of its volume is attributable to institutional over retail participation at present, but says “the trend is growing and we are seeing more interest from institutional traders.” It also declined to share a specific timetable for when particular services, such as co-location, will be rolled out.

In addition, the firm announced the launch of Coinbase Prime, which is designed to offer services such as high and low-touch execution, and market data products. Finally, it also announced the Coinbase Institutional Coverage Group, which will provide sales and trading, research, and execution strategy support, which will be based in New York.

“Now this is coming into place, and it feels like we’re sending the plasterers in when the roof isn’t on the building yet. I think everyone needs to slow down first, address the problems we have, resist the pressure from their clients and handle this sensibly. Otherwise, when something goes wrong there’s going to be one hell of an adverse reaction from the regulators.”

Hedge Fund Trader

Mind the Gap

While these are welcome technological upgrades for traders who have previously bemoaned the fact that existing exchanges weren’t built with them in mind, and the target sector of high-speed, technologically-savvy traders are certainly interested in the market, holes in the construction of the wider market structure around cryptocurrencies remain. There are still unresolved questions around the construction of default funds and the commingling of margin for bitcoin trades with wider futures and options products, for instance, not to mention a lack of resolution on the vociferous reaction from the futures commission merchant (FCM) community about self-certification processes at exchanges, which effectively licensed themselves to list and trade these contracts.

Likewise, the degree of volatility to which bitcoin has been subject in the past—although this appears to have been largely stabilized in the short term by the introduction of futures—raises questions over whether real money, such as pension and superannuation funds, should be involved at all.

“I said around the time that the futures contracts came in that this is moving too quickly,” says a trader at a European hedge fund that focuses primarily on cryptocurrency investments. “Now this is coming into place, and it feels like we’re sending the plasterers in when the roof isn’t on the building yet. I think everyone needs to slow down first, address the problems we have, resist the pressure from their clients and handle this sensibly. Otherwise, when something goes wrong there’s going to be one hell of an adverse reaction from the regulators.”

Update, May 17: This story has been updated to include comments from a Coinbase spokesperson.