Long term readers and listeners to our In the FICC of It podcast will know that I am sceptic when it comes to some of the claims made about crypto markets – especially that they are something new and innovative.
My scepticism was reinforced this week when I received some research from crypto liquidity provider B2C2 which took a look at relative performance of market mechanisms during the bitcoin rout of mid-March, for what I was reading could have been lifted from the FX market, such were the similarities being observed. Not only that but it was lifted from Profit & Loss in 2000 because it’s basically “OTC vs the Exchange”!
Being the dutiful and diligent journalist I am, it needs to be pointed out that the key aim of the research appears to be to promote B2C2’s business, which is fair enough I suppose, and in an ideal world we would know the identity of the three “major, high volume spot exchanges” that it uses for comparative purposes, but overall the findings feel genuine and will look familiar to FX market watchers.
Taking the spreads shown to a “representative B2C2 client” and comparing them to the exchanges, the firm claims that in BTC 25 it showed a tighter spread than any of the exchanges 75% of the time and it was tighter 80% of the time in BTC 100. Taking the tightest spread of the three unknown exchanges it was tighter on average by around 20 basis points, but that did rise to 100 at certain times.
In other words, when the smelly stuff hits the fan, it is generally better, if you are a liquidity consumer, to go direct to the source – the LP. The amounts on offer are normally larger and the spreads tighter, because guess what? People are more willing to price a name. For the consumer, well we all want to be able to trade in our desired size where possible, especially – as was the case during mid-March, when crypto markets were going horribly pear-shaped and any bid was a good bid (I am less sure if crypto traders understand the FX market lingo but hopefully they get the drift).
For the LPs, if they cannot internalise, they will go to the exchanges (ECNs) but rare are the days, if ever, when the primary venues in FX transacted more than the platforms of the major dealers – the same appears to be the case in crypto. In other words, as is the case in FX, the direct, bilateral channel often works best in times of stress – and this paper could be sending that message to the crypto market participants.
There is one other FX market trait I saw in the B2C2 paper – one where the relationship becomes important. At face value this looks like an oxy-moron – after all, the blockchain is meant to be “trust-less” and crypto is meant to be about doing what you want, anonymously and without consequences. How can that be the case if the counterparty knows who you are? The paper obliquely refers to other market makers switching off streams and stresses how the firm stayed in – this is again a mantra from certain houses in FX and I most certainly think it is important that people know who they can trust and who they can’t when things go wrong.
But this in turn begs another question that is relevant to both crypto and FX markets – the answer to which will be interesting. What happens when markets settle down and the flaky liquidity providers return? Will all be forgiven, or have they damaged their business model for good?
The answer may be different in the two markets, but I doubt it – for all the talk, I still see this as just another tradeable instrument and one that trades very much like FX.