P&L Talk Series with Integral’s Harpal Sandhu

Harpal Sandhu, CEO of Integral, talks to Profit & Loss about the launch of his new cryptocurrency exchange, and how he sees the crypto markets evolving in the future.

Profit & Loss: What was the genesis of Mint Exchange?

Harpal Sandhu: A lot of people don’t realise that the derivatives markets in cryptoassets is actually quite a lot larger than the physical market. Because of this, we were speaking to a lot of FX brokers, people who were trading large amounts of crypto and CFDs, and they were having problems trying to hedge those positions because, unlike FX they can’t go to prime brokers or prime-of-primes in order to access liquidity, so there’s very few places that these firms can go in order to hedge their crypto exposures.

We had some very direct conversations with these firms who were asking us if we can deploy our FX technology and infrastructure that they already use in FX on the crypto side. Our initial reaction was: ‘Absolutely, we can do that. We’ll just deploy it in the exact same way’, but as we dug a bit deeper, we realised that the infrastructure doesn’t actually exist in the crypto markets that would allow us to provide services at just a technology level to help these firms solve their hedging needs.

That’s why we decided to set up a separate, independently capitalised entity that was designed as what we would call in the fiat world a typical exchange – meaning that it’s not just a matching engine but also aggregates up all liquidity pools in the crypto markets. The exchange uses Integral technology to link up the liquidity of about 22 major crypto exchanges (although I consider many of them to be brokers rather than ‘exchanges’ in the traditional sense of the word) with market makers who can add liquidity and brokers’ own resting orders from their warehouses to create a single, consolidated liquidity pool and then provide modern infrastructure enabling firms to access that pool.

Underlying the whole exchange is a clearing solution, so firms open an account with this new clearing house and then trade against the exchange on an aggregated basis. The whole set up is designed to offer FX quality infrastructure to the crypto market, it’s in a whole different league compared to the REST APIs, Javascript and Python that are available in the market right now.

P&L: When exactly did Mint Exchange launch?

HS: We’ve been working on it since September of 2017. We launched it in beta in August 2018 and then the first customers went live in September. The exchange itself handles the top five cryptocurrencies today – so bitcoin, bitcoin cash, litecoin, ethereum and XRP – as physicals with physical delivery.

P&L: Obviously in the year between when you started working on the exchange and its launch, the price of cryptocurrencies plummeted dramatically. Has this impacted enthusiasm from your clients for this asset class and subsequently your platform?

HS: Maybe if we’d started in September 2017 we’d have felt more of a change, but starting where we did, in September 2018, things have actually gotten better and better each month. Because we were able to take the existing technology and infrastructure from an existing FX firm, we have been able to keep our costs significantly lower than other exchanges and therefore we have extremely low transactions fees. By comparison, some of the other firms in the market expanded too quickly in 2017 and early 2018 and are having to deal with a lot of restructuring issues as a result, while others are having to play catch up to build the required institutional level of infrastructure.

P&L: Long term, do you see cryptocurrencies and the traditional FX markets remaining distinct and separate, or do you think eventually it will all trade in one place?

HS: It’s hard to know. I would say that for regulatory reasons, I think that they will stay separate for quite some time. In fact, that was another reason why we had to roll out Mint Exchange as a separate entity, because it is subject to a number of different regulatory regimes that Integral, as a pure technology platform, is not.

P&L: Having previously built out an OTC FX platform, were there significant differences when you were putting together this crypto exchange?

HS: Oh yes, it was very different than FX. Although we were able to use the underlying Integral platform, we had to make some very specific extensions in order to support crypto trading. Everything from increased precision to settlement mechanisms to the microstructures of what works and doesn’t work is different – and the expectations and service levels in crypto are totally different to FX.

In existing crypto markets, you might send an order and never get an answer back from your counterpart. Ever. Then you try to call the back office of that counterpart but there’s no telephone number. So, you send an email, but to whom? There’s just a generic support@exchange.com email and then literally four days after you send the email someone responds saying that, yes, the deal got done. They explain that the message didn’t go through and it didn’t appear on the website because they were having some problems with their systems that day.

What I’m saying is that you have to build resilience into every single bilateral relationship in the crypto market, whereas in FX this isn’t required because there is a service level expectation that doesn’t exist yet in crypto. I would say that crypto is where FX was in 1993, before the Internet.

P&L: Given these similarities, do you expect this market to evolve in a similar way to FX then?

HS: Yes, but much faster.  What took FX 25 years of natural organic growth might take only three to five years in crypto, and here’s why I think we’re well placed to capitalise on this.

If you look at the FX market today, it’s a predominantly OTC market that is largely dominated by the banks. These banks have their own proprietary customer networks, but not many of the major exchange platforms really have such a network of bespoke connections in place, instead they just have a central limit order book.

Crypto is an extreme version of an OTC market and so one of the reasons why FX technology hasn’t been coming into this market effectively is because the major exchanges don’t have technology that works in OTC markets and the banks won’t go into crypto for regulatory reasons. There are very few firms that currently have the right OTC technology that can move over from FX to crypto, and Integral is one of them.

P&L: One key difference between FX and crypto that you’ve highlighted are the market participants involved. You’ve said the banks won’t come in yet for regulatory reasons, so who do you see driving growth in this market?

HS: Yes, the banks won’t risk their existing franchises until there’s some regulatory clarity and there’s no evidence that there will be any time soon. That’s another reason why we had to create Mint Exchange as a separate entity – because we needed to add all the other layers that the banks were unwilling to provide. That’s why, for example, we had to build a clearing house instead of using a bank prime broker.

But let’s remember something: the banks were never really the customers themselves in FX, banks were the intermediaries between the customers. Then the real question is: which of the banks’ customers will start using cryptocurrencies?

I think the answer is: lots of them. I think corporations will use crypto to facilitate fiat payments because it’s cheaper than using the banking network, I think asset managers will start investing in crypto as a store of value and as an investment, and I think speculators will be investing in crypto as the retail guys have already been doing. So then if I’ve got retail speculators and I’ve got asset managers and I’ve got corporations, well, who else was ever investing in FX?

It’s the same three players, except in FX you had banks that were acting as intermediaries amongst those customers. In crypto, it’s going to be fintech companies that have OTC technology and credit and clearing intermediation entities in place who will play the same role that banks did in the OTC FX market.

P&L: One of the consequences of FX being an OTC market is that it remains highly fragmented. You mentioned crypto being an extreme OTC market and we’ve certainly seen a huge fragmentation of liquidity already. But, as a consequence of the crypto bear market, do you see a thinning of the crowd in terms of the platforms and service providers out there? Is this leading towards liquidity consolidation?

HS: That’s a very interesting question, but I would actually take a slightly deeper view on this. Looking back a couple of years ago when crypto had massively high margins, everybody wanted to get into it. These margins funded the entry of hundreds, potentially even thousands, of people who wanted to play some level of intermediation. Now the initial role that they wanted to play was as a broker, but since there was nowhere to offset their risk, they started deploying internal order books themselves to offset risk amongst their customers.

That is what has led to the massive fragmentation of the liquidity. Individual users needed somewhere to trade so they would go to their local broker, the local broker had nowhere else to go so they created their own order books, and then there was a very, very loose knit of connectivity amongst those books by the prop trading firms who are trying to trade against them. The brokers themselves never really wanted to be exchanges, they just wanted to service their customers and so they ended up becoming mini exchanges themselves.

We think that as platforms like Mint Exchange start to emerge, those brokers will get out of the business of running small order books and just connect into these centralised markets, just as they do now in equities and every other market. That’s because by accessing this liquidity, the brokers significantly reduce their costs, they reduce their risks and they get a higher level of service so that they can in turn better serve their customers.

So yes, I think in the next phase of development in the crypto market we’ll see a concentration of better liquidity. But there will also be a proliferation of brokers because now they will be able to open up much more easily as they just have to deal with their customers and can offset all their risk on the exchanges. Then there will be a third phase where there has to be some rationalisation and shake-out, but right now this market is still so rich, so fragmented, so big and so under-served. We’re still in the early phases of development.

P&L: You mentioned your clearing house before, how is that capitalised?

HS: It’s capitalised primarily by investors. Integral put in capital and investors put in capital, so the clearing house functions like a traditional exchange and is in the process of being mutualised out to the primary customers. Again, this is good for the brokers because it gives them a utility whereby they can put capital in the centralised exchange and then offset risk with each other.

P&L: Custody has been a sticking point for many firms in the crypto space. Can you talk about how customer funds will be held at Mint?

HS: Right now, our custody solution is evolving. For the time being we have bundled custody into the exchange service itself for these major institutions. While the accounts themselves are segregated, the customers do face off against Mint Exchange. We’ve kept the solution very simple. We don’t offer margining; everything is fully funded.

P&L: Are you targeting existing FX clients with this platform or is the focus more on crypto-specific firms?

HS:Our initial intent was to just service our existing FX customers, that’s why we tailored the whole platform to them. Having done that quite well, other firms in the crypto market have started knocking on our door, so my guess based on the feedback that we’re getting is that it will eventually become a lot more balanced. Right now we’re keeping our resources and our focus on existing customers, but over time the market will migrate to where the friction is lower, and we think that by providing better technology at lower costs with access to more liquidity means that more and more crypto-focused firms will start to move over.

Galen Stops

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