The past few years have seen a significant number of senior figures from the FX market transition into the digital asset space. Galen Stops talks to a few of them about where they see the parallels, differences and possible convergences between the two markets.
Galen Stops, editor of Profit & Loss: Where do you see similarities between the crypto and FX markets?
Rob Catalanello, president and CEO of B2C2 USA: FX was always a high volume, low margin business and in a lot of cases this industry really embraced technological change. When I look at the crypto world there’s an unbelievable amount of technology involved and it trades in a similar fashion to FX. Yes, there’s much more volatility, but honestly it’s nothing that we haven’t seen in G10 currencies in the late ‘80s and early ‘90s or in EM currencies during various crisis events.
Dan Torrey, head of institutional sales at Genesis: I would highlight the regulatory angle here. In FX you historically have a world where there is no one single regulator. Regulation has crept in but it’s not one single regulator, it’s a group of central banks attempting to be cohesive, to collaborate and share information to adopt a global code of conduct. But really in FX you still have a world of OTC players that are hopefully acting on an honour system and abiding by this regime that’s been suggested. In crypto, you have true regulatory arbitrage. And while it’s not the same thing, there are similar dynamics in terms of people deciding where it is that they want to operate.
If you look back to what happened with the launch of SEFs in 2013, suddenly the US government was telling NDF traders that if you’re dealing on electronic venues then you’re now subject to the swap rules and need to be reporting your trades. It didn’t do the market any good, it just drove some people offshore. There’s a clear parallel occuring in the crypto space now, we’re seeing more and more firms moving their operations to Bermuda and other domiciles.
Hu Liang, co-founder and CEO of Omniex: I would say that there’s not a single response to this question because I think over time, “crypto” will diverge into two broad markets. One will be very similar to currencies in that it will be a non-regulated market on the cash side and it will behave, feel and look like a currency because it will be used for payments and as a store of value. It will also look like a commodity because it will behave very similar to gold as well. On the other side, as we tokenise more assets onto the blockchain – securities, real estate, private issuance, etc – these assets will behave more like regulated securities and so these types of assets will have to be listed and traded on organised exchanges.
Galen Stops: And on the flip-side, what are the key differences between them?
Dan Torrey: One thing is the massive differential in terms of market size and available liquidity. Let’s just look at global macro funds as an example, which is one of a dozen segments that myself and my peers would traditionally go after in an institutional sales role. Today, these funds can’t truly jump into the crypto space just because of the sheer massive waves they’d make any time they buy or sell these assets. And I’m not just talking about someone the size of Bridgewater or AQR here, I’m also talking about firms that are 1/10th their size.
So that really smart junior kid on the team makes a great internal presentation explaining the negative correlations that are really interesting and that bitcoin is truly digital gold, etc, and then someone asks: “Ok, how do we get in? What’s the minimum position? How do we tactically get in and out of this market?” and then they’re going to realise that they just can’t play in this game yet, the sandbox is too small. However, that said, we are seeing increasing levels of new interest from the bigger institutional players, because they don’t want to miss out on the next bull run.
Nick Carmi, head of financial services at BitGo: The main difference is FX currently settles on a T+1 or a more than T+1 basis, unlike crypto which has instantaneous settlement. Now – in theory – there is no reason why FX can’t settle instantaneously, after all I can walk into a bank right now and exchange dollars for euros instantly. But if I wanted to do the exact same thing online it would take at least 24 hours, why? Because of all the legacy systems in the FX market.
So while the FX industry might want to move to instantaneous settlement, it’s a Herculean task for all the banks, brokers, clients, investors, CLS, clearing brokers, exchanges, etc to all change their systems to go from one day settlement or two day settlement to instantaneous settlement. That is the resistance to making the FX market start to act more like the crypto market.
Now the flip side of that is that to make the crypto market act more like FX, which is more efficient, you need to introduce the concept of prime brokerage, or the extension of credit and fungibility between exchanges. It’s difficult to accept that right now you can’t buy BTC on one exchange and sell it on another one.
If you look at FX in the early nineties when there was no prime brokerage, this was exactly what used to happen. You would buy with one bank, you would sell on an ECN and then you would have to either use your custodian to physically settle between the buy and sell sides or you would simply get out of the position with the same counterparty. And that’s when banks slowly started figuring out the concept of prime brokerage, which is now part of the business and part of the norm.
Ray Kamrath, head of business development at Strike Derivatives: For sure, the crypto market is developing in its own unique way. Unlike FX markets, the development of retail trading has preceded institutional. This is very unusual. While there are 100+ retail venues, brokerages, exchanges in crypto, there are still only a handful of serious market makers that are providing consistent liquidity. In this way, the market reminds me of the time when I started my career in 1993 at JP Morgan. Back then, FX was a “dealer market”. I believe that these market makers will continue to support the retail venues and exchanges but will generally have a preference to establish direct bilateral relationships with institutional clients and counterparties.
Rob Catalanello: The actual trading is very similar, what’s really missing is the whole sales support that goes along with it and the customer service aspect of how to actually build a business, how to make sure that your clients are not only happy with your service but also that you’re adding some sort of value to them, as opposed to just showing a really tight price I still think that is the main difference.
When you go to a lot of these crypto events people are trying to market solutions based on traditional finance, but these solutions are often based on problems that don’t necessarily exist in crypto. So while a lot of work has gone into coming up with these technological solutions, people haven’t spent enough time figuring out a way to keep clients happy and informed and just provide them with excellent service beyond this technology.
Galen Stops: Do you see FX providing a road map for how the crypto markets will develop?
Ray Kamrath: I believe crypto is a dealers market and dealers will prefer a direct OTC business model that is lower cost and provides more flexibility and control than a regulated futures market. Preference does not mean that they will not support various models but at this early stage of development, market makers will decide where the liquidity is. This will change over time as the clients assert more influence. This is very similar to how FX evolved. In 1995, the idea of FXall was pretty laughable but as the market developed with prime brokerage, CLS, and other infrastructure that supported more trading, the end users began to dictate the terms of trade and we got FXall, EBS open to clients, Currenex, and so on.
Hu Liang: To some degree, yes. I think the similarity is in the price discovery and execution. In the FX world we have market makers, whether that’s bank or high-frequency hedge funds streaming two-way prices, you see the price and you execute and you strike a deal. But on the post-trade settlement side it’s very different. You have ISDA agreements, you have CLS, non-CLS pairs and then there’s clearing in the traditional financial world, and that’s very different in the crypto space, none of that infrastructure exists.
There the questions are: do you settle it on a blockchain? Do you have an escrow agent somehow in the middle? Do you work with a crypto custodian like Bitgo or Fidelity? All of that infrastructure is quite different from FX right now. Would it eventually become more like FX if someone like a Goldman Sachs or a Citi or a State Street stepped in? Perhaps. But if other infrastructures emerge they could look very different on that post-trade settlement side.
Galen Stops: Do you see a convergence happening between these two markets?
Nick Carmi: Yes, I really do. Most of the institutions that are active in the crypto space are the same from FX – the same person trading USD/JPY on Fenics or on 360T is trading USD/BTC on Coinbase and Gemini. Why can’t they just trade it all on one exchange?
In addition, clients play the triangulation between gold/euros, dollar/euros, and yen/euros. Add crypto into the mix and it becomes more complicated and far more interesting. There is no reason one strategy cannot be used across all of this, it’s just a functional and operational issue.
Rob Catalanello: Yes, I think we will, but what’s going to be key is that the crypto industry is going to have to figure out how to talk to real money accounts. When you talk to some of the big asset managers they are very accustomed to dealing with their banking partners and their capital markets partners in a very specific sort of way and I don’t think that they’re going to change in this regard for crypto, crypto will have to change for them. So there’s going to have to be a much greater focus on customer service as opposed to showing ridiculously tight prices.
Look at what happened in FX – in the early 2000s people were still sending splits via spreadsheets for big block trades and manually booking them. But in the past 10 years it’s become remarkably automated and crypto sets itself up nicely for that, it just really needs more focus on understanding what support institutional accounts need from a middle and back office perspective. I think the firms that can figure this out will be the ones with the advantage going forward.
Galen Stops: Could the crypto markets ultimately prove to be a threat to traditional FX?
Dan Torrey: I would argue it won’t, just because of the additive effect on the other side. I really believe that as this institutional crypto trading space grows, a lot of the winners in the crypto e-trading environment will be the firms that have succeeded, and to a certain extent still succeed, today in FX. It just enables them to either tack on some crypto pairs to what they’re already doing or launch a new crypto platform or, if they wanted, to transform into an all-out crypto player.
Nick Carmi: No, if anything it will benefit FX. A lot of the institutions from traditional financial markets are not in the crypto space because the barriers to entry make it difficult for them. BitGo is changing this paradigm by building the market infrastructure for institutions to feel confident investing in digital assets.These firms are looking for another asset and therefore cryptos could become like NDFs. In the FX market, NDF trading is very profitable for the good players because the spreads are very healthy. So if you look at NDF volumes compared to the rest of the FX market they’re very small, less than 5% of the market, but the revenues from trading these products are huge. In this manner, the crypto market transforms itself.