Almost every day, articles such as a recent piece in the FT, describe steps being taken by companies, lobbying groups, and regulators to help the crypto markets to become more mature. While there are quite a few self-serving PR style releases touting products firms are planning to build or how impressive their army of “advisors” is, there are some firms with actual products and industry groups making real progress to improve the markets. I do find it interesting, however, that there are many in the crypto community who are concerned about what maturation will mean in practice.
Frankly, it matters a great deal what one means by maturity, as a future where highly regulated, oligopolistic & regional markets controlled by a handful of multi-billion-dollar firms is not that appealing. In addition to being diametrically opposed to the ethos of crypto, such an outcome would suppress much of the potential benefits of crypto-assets. On the other hand, to realize its potential, crypto requires mass adoption, which, in turn, will need fair, transparent, and liquid markets, that are surveilled against manipulation. Those four concepts are what I mean by “maturity”. The reality, however, is that there is a lot of room for improvement on all four.
Let’s start with fairness. When I say “fair”, my meaning is a market where all players, on the same terms, can access markets in the same way, at the same speed, and with the same data. Fairness does not require that all access and data be free, nor does it require that all participants utilize the same technology. What it requires, however, is that access be on uniform terms to all participants, meaning that no undisclosed deals for preferential market or data access can be allowed. In crypto, however, there are many rumors of deals between participants including special forms of access. At least one exchange blocks the use of their data for documenting best execution or calculating “fair value” pricing without a privately negotiated agreement. This type of behavior is deleterious to properly functioning markets and creates the impression that crypto markets aren’t suitable for investors. It is important to recognize that, if markets were all operated “fairly” by this definition, then private industry solutions (such as CoinRoutes) would swiftly act to level the playing field among investors by providing professional trading platforms, pricing benchmarks, and data feeds.
Transparency is important in multiple areas. Pre-trade price discovery, post-trade reporting, and operational disclosures that help clients evaluate potential conflicts of interest are all vital areas where transparency is required. The NY Attorney General report pointed out many potential conflicts of interest at the crypto exchanges they analyzed. The solution, however, is not to necessarily to “break up” those vertically integrated business models, however. In many cases, the best approach could be to force those companies to be fully transparent about the information flows between business units and hold them accountable for the accuracy of those disclosures. There are many analogous circumstances in other markets, where firms are required to establish and enforce information barriers between businesses, trading desks, etc. Another way to manage some of the conflicts of interest reported is to augment procedural disclosures with robust trade cost analysis (TCA) to show how successfully firms execute trades on behalf of their clients. Such analysis should compare trades to benchmarks such as CoinRoutes RealPrice tm that use consolidated data from all relevant exchanges, in order to ensure that the comparison was meaningful. If such analysis became commonplace, it would go a long way towards ameliorating the concern over some conflicts.
Liquidity refers to the ability to trade at a low cost, which is somewhat dependent on the first two principles, but also requires access to capital and the ability to seamlessly deploy it. At CoinRoutes we have built solutions for trading across exchanges and are working with several firms that are attempting to improve the settlement of crypto-assets across the marketplace. Such efforts are vital to the maturation of the markets, much like equity and derivative prime brokerage helped improve the liquidity and volume traded in equity markets. To be clear, liquid markets require participation by many types of investors and traders. Today’s crypto exchange markets are dominated by retail traders and crypto early adopters, while the Over the Counter (OTC) markets are the method of choice for large asset owners. A mature market would see more participation in displayed markets by all participants, while OTC trading would be utilized by clients who require immediate liquidity or more liquidity than the market has to offer. For this to happen, however, tools such as CoinRoutes smart order router and data feeds would need to become ubiquitous, as they have in equity markets
Lastly, my version of maturation would mean bringing manipulation in crypto markets under control. As a recent story in the WSJ asserts, (“Bots are Manipulating Price of Bitcoin in “Wild West of Crypto’”) manipulation in the market is rampant. This type of behavior is very destructive to investor confidence and is a major factor suppressing institutional adoption. It is important to understand, however, that this is not a problem that can be fixed solely by regulation. While regulatory oversight can be invaluable in preventing fraudulent “pump” groups and in prosecuting schemes where exchanges conspire with key clients, there is also a need for private industry solutions. The efforts of firms such as Eventus Systems, Nasdaq SMARTS and Trillium that are building/deploying anti-manipulation surveillance tools are quite important. In addition, the increased use of trading technology such as CoinRoutes SOR can also discourage firms from placing orders to create impact without a real intent to trade. (That is the definition of spoofing) Buyers or sellers can use our smart order router to accumulate or sell large amounts of coin almost instantaneously at costs lower than the average OTC broker. To illustrate this, I just ran an example in the CoinRoutes Cost Calculator that shows that 1500 Bitcoin could be sold in an instant using our SOR at a net cost of less than 1%.
In this example, using the CoinRoutes SOR would sell 1500 BTC (worth over $9.7 million) at a price, inclusive of exchange fees of 6482.94. Despite this trade only requiring the sending of 8 orders (one to each of the exchanges that trade BTC-USD that accept US based clients), it results in 857 executions due to the high number of individual orders posted on the exchanges. If in retrospect, it turns out that some of the coins sold were from bids that a firm placed to “spoof” the market higher, then the spoofer would likely lose a lot of money when they are forced to cover that position. This type of natural competitive discouragement is a very effective means to stop such behavior from occurring.
Thus, if one defines the maturation of the crypto market as meaning that it will become more fair, liquid and transparent and less susceptible to manipulation, I think we can all agree that would be desirable The good news is that the process to maturity is gradually gaining traction. Continued progress is a matter of all the major players in the crypto markets adopting these key principals. Industry acceptance, along with the promotion of self-regulation and principles based regulatory initiatives should be welcomed by the industry, as should private industry efforts to move crypto in the right direction.