Institutional Crypto Faces Prospect of a Nuclear Winter

The coldest temperature in Chicago in over 30 years struck the city on January 30, 2019, when the mercury hit 23 below zero degrees Farenheit. However, that pales in comparison to the industry’s cooling enthusiasm for digital currencies. For financial firms in the Windy City looking to engage with cryptocurrencies, that chill is rapidly becoming an ice age.

The first frosts came with bitcoin’s precipitous fall from grace during 2018, when the price of a single coin plunged from $20,000 to less than $3,200. Then, when most of the world’s derivatives brass were sunning themselves at the Futures Industry Association’s annual conference in Boca Raton, Fla., during March 2019, Cboe Global Markets sounded—almost silently—one of the first warnings of an iceberg, dead ahead, when the exchange quietly announced that it would no longer be listing new contracts for its XBT bitcoin future. The contract, which launched just before the end of the 2017 bitcoin bull run, was the very first of its kind, and many believe its launch helped contribute to the subsequent bear market.

CME Group lists its own bitcoin futures contract, which is similar to Cboe’s design, but is weightier, given that each contract represents five bitcoins, and is ostensibly more popular. Though CME said it had no plans to delist its contract, the damage was already done.

Then came a Wall Street Journal article on April 23, which took the wind out of institutional crypto’s sails even more. Coinbase, the largest and most respected crypto exchange operator, which had previously announced a big push into institutional trading, was canceling plans for radical upgrades to its technology base designed to lure high-frequency traders, the Journal reported. The company subsequently laid off 30 employees from its Chicago office.

Taken individually, these are harsh blows to absorb for a nascent tradable asset. Put them together, and—without dramatic intervention—they could be the first nails in crypto’s coffin.

Peter Pan Syndrome

Part of the problem with the current state of the crypto market is its inability—and in some cases, unwillingness—to embrace its maturation as an asset class. Flaws in market structure, ropey technology, and shoddy practices have characterized the growth of cryptocurrencies overall. Historically, while not ideal, these have been forgivable as the market matures and has been forced to adopt practices it was ill-prepared to handle. Indeed, some segments of the professional market have even (somewhat breathlessly) described these faults as part of crypto’s charm, painting a rose-tinted vision of a frontier asset class where free-spirited cowboys still roam.

But those segments overlook what made the “wild west” wild: claim jumping, cattle rustling, spiraling murder rates, and city streets that doubled as open sewers. In reality, cryptocurrency exchanges have had sufficient time and exposure to institutional practices to get their house in order, but for the most part, have not.

On April 10, the New York Department of Financial Services denied crypto exchange Bittrex a license to operate in the state, releasing a damning letter that claimed traders on the exchange were operating under names such as “Donald Duck,” and “Elvis Presley.” Even more alarmingly, some users appeared to originate from sanctioned nations, such as North Korea.

Bittrex’s problems are the latest in a series of cases that periodically rock cryptocurrency markets, and although many of the more popular exchanges have deployed professional-grade technology from vendors such as Nasdaq, much of the industry remains in a poor state of repair, technology-wise. James Putra, head of product development at broker Tradestation, found this out firsthand when the company decided to build out a crypto brokerage offering tailored toward clients who require institutional tooling and liquidity provision. It approached several exchanges and rapidly discovered that all was not well behind the scenes.

“In those discussions, it gets kind of scary in terms of how immature the crypto market space is or how communication is done,” Putra says. “When you’re looking to figure out how to actually provide access, we’ve even had potential market-makers or exchanges tell us that we can send them orders over Skype—and that’s kind of scary.”

Tradestation ended up partnering with Deltix, a provider of electronic trading platforms for traditional asset classes for its crypto offering, which is due to go live later this year.

It’s not just new entrants to the crypto space that are alarmed by its immaturity: Some of its most ardent supporters among high finance acknowledge this is a problem that continues to hold back institutional involvement.

“I think that the term ‘exchange’ is generous for most of these entities,” said Don Wilson, CEO of market-maker DRW Holdings. “I think that you could call them trading venues, but to call them exchanges is probably a misnomer.”

Wilson’s assessment, delivered at the Synchronize conference, held in New York on April 18, is particularly crushing. He is one of the co-founders of Digital Asset, a pre-eminent blockchain company involved in some of the highest profile projects in the industry. Cumberland, one of the largest market-makers in cryptocurrency trading, was also launched by DRW.

“They generally haven’t, for the most part, operated in a way that’s consistent with the types of exchanges that we’re all used to operating on, and their technology isn’t up to snuff,” Wilson continued. “I think it’s unfair to paint them all with the same brush, but in many cases, they’re not all that concerned about compliance and market manipulation, etc., and they’re just not compatible with the way institutions work.”

ErisX, another company co-founded by DRW, is preparing to launch a regulated exchange and clearinghouse for trading spot crypto and futures later this year. However, previously established regulated exchanges are also finding that the asset class is losing its luster.

Paul Chou, CEO of LedgerX, which was one of the first exchanges regulated by the Commodity Futures Trading Commission (CFTC) to offer bitcoin options, told the New York Times on April 2 that he was “wrong” about institutional money being ready to engage with the market. Likewise, Bakkt, a well-publicized attempt by the Intercontinental Exchange Group to launch a crypto venue, has had several delays to its start date, reportedly due to CFTC concerns around custody mechanisms.

Supporters often paint crypto as an asset class merely going through a difficult birth, much like the emergence of oil as a tradable asset in the 1980s. However, if recent events are anything to go by, it seems that the crypto winter is still in full force, and it may yet be some time before the big dogs of the mainstream financial markets thaw on the concept of cryptocurrencies.