Hi all!
Maybe it’s the back-to-school vibe, but regulators seem to be renewing their hand-wringing over Facebook's Libra, while the Libra Association appears to be getting more vocal in pushing back. Meanwhile, both activity and scrutiny is intensifying in the stablecoin sector; we’re likely to see big steps forward in use cases and understanding in the coming quarter.
And, of course, macro questions continue to focus on bitcoin’s role in portfolios: is it a hedge, or a speculative asset in its own right? And how deep do the systemic shifts actually go?
THE BRIEFING this week is the continuation of Max Boonen’s epic deep dive into high frequency trading in crypto markets – brace yourself, you won’t see anything else this detailed on the topic out there.
I’m experimenting with a new feature: in the “Coming Up” section below, I list some upcoming webinars you may find interesting. And in case you missed last week’s newsletter, there’s a link to our recent report on crypto valuation methods.
Read on…
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Crypto and the Latency Arms Race, Part II
Max Boonen is founder and CEO of crypto trading firm B2C2. This is the second post in a series of three that look at high frequency trading in the context of the evolution of crypto markets (you can see the first here). Opinions expressed within are his own and do not reflect those of CoinDesk.
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Carrying on from an earlier post about the evolution of high frequency trading (HFT), how it can harm markets and how crypto exchanges are responding, here we focus on the potential longer-term impact on the crypto ecosystem. First, though, we need to focus on the state of HFT in a broader context.
Conventional markets are adopting anti-latency arbitrage mechanisms
In conventional markets, latency arbitrage has increased toxicity on lit venues and pushed trading volumes over-the-counter or into dark pools. In Europe, dark liquidity has increased in spite of efforts by regulators to clamp down on it. In some markets, regulation has actually contributed to this. Per the SEC:
“Using the Nasdaq market as a proxy, [Regulation] NMS did not seem to succeed in its mission to increase the display of limit orders in the marketplace. We have seen an increase in dark liquidity, smaller trade sizes, similar trading volumes, and a larger number of “small” venues.”
Why is non-lit execution remaining or becoming more successful in spite of its lower transparency? In its 2014 paper, BlackRock came out in favour of dark pools in the context of best execution requirements. It also lamented message congestion and cautioned against increasing tick sizes, features that advantage latency arbitrageurs. (This echoes the comment to CoinDesk of David Weisberger, CEO of Coinroutes, who explained that the tick sizes typical of the crypto market are small and therefore do not put slower traders at much of a disadvantage.)
Major venues now recognise that the speed race threatens their business model in some markets, as it pushes those “slow” market makers with risk-absorbing capacity to provide liquidity to the likes of BlackRock off-exchange. Eurex has responded by implementing anti-latency arbitrage (ALA) mechanisms in options:
“Right now, a lot of liquidity providers need to invest more into technology in order to protect themselves against other, very fast liquidity providers, than they can invest in their pricing for the end client. The end result of this is a certain imbalance, where we have a few very sophisticated liquidity providers that are very active in the order book and then a lot of liquidity providers that have the ability to provide prices to end clients, but are tending to do so more away from the order book”, comments Jonas Ullmann, Eurex’s head of market functionality. Such views are increasingly supported by academic research.
XTX identifies two categories of ALA mechanisms: policy-based and technology-based. Policy-based ALA refers to a venue simply deciding that latency arbitrageurs are not allowed to trade on it. Alternative venues to exchanges (going under various acronyms such as ECN, ATS or MTF) can allow traders to either take or make, but not engage in both activities. Others can purposefully select – and advertise – their mix of market participants, or allow users to trade in separate “rooms” where undesired firms are excluded. The rise of “alternative microstructures” is mostly evidenced in crypto by the surge in electronic OTC trading, where traders can receive better prices than on exchange.
Technology-based ALA encompasses delays, random or deterministic, added to an exchange’s matching engine to reduce the viability of latency arbitrage strategies. The classic example is a speed bump where new orders are delayed by a few milliseconds, but the cancellation of existing orders is not. This lets market makers place fresh quotes at the new prevailing market price without being run over by latency arbitrageurs.
As a practical example, the London Metal Exchange recently announced an 8-millisecond speed bump on some contracts that are prime candidates for latency arbitrageurs due to their similarity to products trading on the much bigger CME in Chicago.
Why 8 milliseconds? First, microwave transmission between Chicago and the US East Coast is 3 milliseconds faster than fibre optic lines. From there, the $250,000 a month Hibernia Express transatlantic cable helps you get to London another 4 milliseconds faster than cheaper alternatives. Add a millisecond for internal latencies such as not using FPGAs and 8 milliseconds is the difference for a liquidity provider between investing tens of millions in speed technology or being priced out of the market by latency arbitrage.
With this in mind, let’s consider what the future holds for crypto.
Crypto exchanges must not forget their retail roots...
We learn from conventional markets that liquidity benefits from a diverse base of market makers with risk-absorption capacity.
Some have claimed that the spread compression witnessed in the bitcoin market since 2017 is due to electronification. Instead, I posit that it is greater risk-absorbing capacity and capital allocation that has improved the liquidity of the bitcoin market, not an increase in speed, as in fact being a fast exchange with colocation such as Gemini has not supported higher volumes. Old-timers will remember Coinsetter, a company that, per the Bitcoin Wiki , “was created in 2012, and operates a bitcoin exchange and ECN. Coinsetter's CSX trading technology enables millisecond trade execution times and offers one of the fastest API data streams in the industry.” The Wiki page should use the past tense as Coinsetter failed to gain traction, was acquired in 2016 and subsequently closed.
Exchanges that invest in scalability and user experience will thrive (BitMEX comes to mind). Crypto exchanges that favour the fastest traders (by reducing jitter, etc.) will find that winner-takes-all latency strategies do not improve liquidity. Furthermore, they risk antagonising the majority of their users, who are naturally suspicious of platforms that sell preferential treatment.
It is baffling that the head of Russia for Huobi vaunted to CoinDesk that: “The option [of co-location] allows [selected clients] to make trades 70 to 100 times faster than other users”. The article notes that Huobi doesn’t charge – but of course, not everyone can sign up.
Contrast this with one of the most successful exchanges today: Binance. It actively discourages some HFT strategies by tracking metrics such as order-to-trade ratios and temporarily blocking users that breach certain limits. Market experts know that Binance remains extremely relevant to price discovery, irrespective of its focus on a less professional user base.
Other exchanges take heed. Coinbase closed its entire Chicago office where 30 engineers had worked on a faster matching engine, an exercise that is rumoured to have cost $50mm. After much internal debate, I bet that the company finally realised that it wouldn’t recoup its investment and that its value derived from having onboarded 20 million users, not from upgrading systems that are already fast and reliable by the standards of crypto.
It is also unsurprising that Kraken’s Steve Hunt, a veteran of low-latency torchbearer Jump Trading, commented to CoinDesk that: “We want all customers regardless of size or scale to have equal access to our marketplace”. Experience speaks.
In a recent article on CoinDesk , Matt Trudeau of ErisX points to the lower reliability of cloud-based services compared to dedicated, co-located and cross-connected gateways. That much is true. Web-based technology puts the emphasis on serving the greatest number of users concurrently, not on serving a subset of users deterministically and at the lowest latency possible. That is the point. Crypto might be the only asset class that is accessible directly to end users with a low number of intermediaries, precisely because of the crypto ethos and how the industry evolved. It is cheaper to buy $500 of bitcoin than it is to buy $500 of Microsoft shares.
Trudeau further remarks that official, paid-for co-location is better than what he pejoratively calls “unsanctioned colocation,” the fact that crypto traders can place their servers in the same cloud providers as the exchanges. The fairness argument is dubious: anyone with $50 can set up an Amazon AWS account and run next to the major crypto exchanges, whereas cheap co-location starts at $1,000 a month in the real world. No wonder “speed technology revenues” are estimated at $1 billion for the major U.S. equity exchanges.
For a crypto exchange, to reside in a financial, non-cloud data centre with state-of-the-art network latencies might ironically impair the likelihood of success. The risk is that such an exchange becomes dominated on the taker side by the handful of players that already own or pay for the fastest communication routes between major financial data centres such as Equinix and the CME in Chicago, where bitcoin futures are traded. This might reduce liquidity on the exchange because a significant proportion of the crypto market’s risk-absorption capacity is coming from crypto-centric funds that do not have the scale to operate low-latency strategies, but might make up the bulk of the liquidity on, say, Binance. Such mom-and-pop liquidity providers might therefore shun an exchange that caters to larger players as a priority.
... or lose market share to OTC liquidity providers
While voice trading in crypto has run its course, a major contribution to the market’s increase in liquidity circa 2017-2018 was the risk appetite of the original OTC voice desks such as Cumberland Mining and Circle.
Automation really shines in bringing together risk-absorbing capacity tailored to each client (which is impossible on anonymous exchanges) with seamless electronic execution. In contrast, latency-sensitive venues can see liquidity evaporate in periods of stress, as happened to a well-known and otherwise successful exchange on 26 June which saw its bitcoin order book become $1,000 wide for an extended period of time as liquidity providers turned their systems off. The problem is compounded by the general unavailability of credit on cash exchanges, an issue that the OTC market’s settlement model avoids.
As the crypto market matures, the business model of today’s major cash exchanges will come under pressure. In the past decade, the FX market has shown that retail traders benefit from better liquidity when they trade through different channels than institutional speculators. Systematic internalisers demonstrate the same in equities. This fact of life will apply to crypto. Exchanges have to pick a side: either cater to retail (or retail-driven intermediaries) or court HFTs.
Now that an aggregator like Tagomi runs transaction cost analysis for their clients, it will become plainly obvious to investors with medium-term and long-term horizons (i.e. anyone not looking at the next 2 seconds) that their price impact on exchange is worse than against electronic OTC liquidity providers.
Today, exchange fee structures are awkward because they must charge small users a lot to make up for crypto’s exceptionally high compliance and onboarding costs. Onboarding a single, small value user simply does not make sense unless fees are quite elevated. Exchanges end up over-charging large volume traders such as B2C2’s clients, another incentive to switch to OTC execution.
In the alternative, what if crypto exchanges focus on HFT traders? In my opinion, the CME is a much better venue for institutional takers as fees are much lower and conventional trading firms will already be connected to it. My hypothesis is that most exchanges will not be able to compete with the CME for fast traders (after all, the CBOE itself gave up), and must cater to their retail user base instead.
In a future post, we will explore other microstructures beyond all-to-all exchanges and bilateral OTC trading.
– Max Boonen
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* so many links, too little time - these starred ones are especially important for a deeper understanding of the sector, but get to the rest when you can
BIG IDEAS
*The Crypto Challenge Isn’t What You Think It Is (Tabb Group) – It’s not that crypto assets are “digital,” most assets today are; it’s that they are traded and settled in a completely different way from traditional assets (downloadable report).
*Why We Need Digital Assets (Arca Funds) – The shift in financial tectonic plates is not just about low interest rates and central bank authority; it’s also about generational changes, global polarization and the role of choice.
*The Open Question of Crypto’s Global Role (SFOX) – Bitcoin’s role in portfolios as a hedge against growing market uncertainty is still unclear: is it a hedge, or a speculative asset in its own right?
*Investor Travis Kling explained his crypto conviction to CNN’s Julia Chatterley (@jchatterleyCNN), framing it in the context of the macro environment.
What Bitcoin’s Valuation Says About Its Volatility (CoinDesk) – The article from last week’s newsletter, on how the role of narrative in bitcoin’s price is likely to perpetuate its volatility even as the market becomes more liquid.
Bitcoin ETFs Might Finally Get SEC Approval (Barron's) – The bitcoin market is maturing, but a lack of retail investor interest could hold ETFs back.
Skirting U.S. sanctions, Cubans flock to cryptocurrency to shop online, send funds (Reuters) – Bitcoin is not just for speculation or investment; even where sorely needed, however, there are complications.
MARKETS
'Bad things could happen': Turning to tech to tame the crypto jungle (Reuters) – As the OTC crypto markets mature, they are becoming more electronic, but not totally.
Derivatives in Crypto (Messari) – The evolution of crypto asset hedging tools.
Rebranded TrueDigital Partners for ‘Imminent’ Bitcoin Derivatives Launch (CoinDesk) – The platform will now be known as Tassat, and has partnered with trading software provider AlgoTrader in the run-up to the launch of physically deliverable, margined swaps, pending approval from the CFTC.
Bakkt to Require $3.9K Down Payment on Bitcoin Futures Contracts (CoinDesk) – Customers of the soon-to-launch crypto derivatives exchange, backed by ICE, will need to meet speculative initial requirements of $4,290 per contract, and $3,900 as an initial hedge for accounts which already have exposure to bitcoin.
CME Files to Double Monthly Bitcoin Futures Open Position Limit to 10K BTC (CoinDesk) – The limit would jump from 1,000 contracts per spot month to 2,000 for any single investor, which means a trader’s maximum exposure would reach $100 million at today’s prices.
CME’s Bitcoin Index Provider Wins First EU Crypto Benchmark License (CoinDesk) – CF Benchmarks has become the first cryptocurrency index provider to be recognized as a Benchmark Administrator under the European Benchmarks Regulation (EU BMR), which means that financial institutions can use the company’s indices in any European financial products after the BMR takes full effect on January 1, 2020.
VanEck’s “limited Bitcoin ETF” is a big swing and a miss, brings in less than $41k (Decrypt) – The new product, which is available on an open-end basis to accredited investors, has attracted 4 BTC-worth of demand so far.
Huobi Plans Backdoor IPO Attempt in Hong Kong, Document Suggests (CoinDesk) – In a filing with the Hong Kong Stock Exchange, listed electronics manufacturer Pantronics Holdings Limited, acquired by Huobi last August, disclosed it will change its name to Huobi Technology Holdings Limited.
eToro Aims to Put Derivatives on the Blockchain With Lira Programming Language (CoinDesk) – The social investment platform has developed the language to allow users to set varying time limits on trades, swap different cryptocurrencies and write complex settlement terms.
CRUNCHING NUMBERS
*Coin Metrics’ State of the Network: Issue 16 (Coin Metrics) – An overview of bitcoin and tether exchange activity.
*Bitcoin analysts show ‘apparent relationship’ between exchange flow and price (TNW) – Bitcoin exiting exchanges is a bullish signal in that it suggests holders don’t have any plans to sell soon.
REGULATORS AT WORK
France calls for EU crypto rules and creation of a ‘public digital currency’ (The Block) – Speaking at a meeting of EU finance ministers, Bruno Le Maire, France’s minister of the economy and finance, called for a “common framework” on cryptocurrencies.
SECURITY TOKENS
Following Santander’s issuance of a bond on ethereum, its head of Digital Investment Banking John Whelan (@_JohnWhelan) shared some thoughts on the likely evolution of security tokens.
The Digital Wrapper (Security Token Academy) – An interview with Marc Boiron, partner at Fisher Broyles, about security tokens, misinformation and cap table management.
tZERO Partners With Media Company to Tokenize Film Financing (CoinDesk) – Overstock’s security token subsidiary has announced a partnership with media company BLOQ FLIX to establish a new film financing route for television, internet, and studio projects..
Investing Platform BnkToTheFuture to Enable Security Token Offerings (CoinDesk) – The fundraising platform for fintech and blockchain companies will take a stake in crypto consultancy firm Diacle to build a shared security token advisory and investment service.
First Tokenized IPO Launches on National Stock Exchange (CoinDesk) – The national stock exchange of the Seychelles now lists shares in its own equity that have been tokenized on the public ethereum blockchain.
Brooklyn Nets guard Spencer Dinwiddie is planning to release a digital token for others to invest in his contract (Markets Insider) – This would bring forward his income from his contract extension, and investors would be repaid principal plus interest.
Harbor Tokenizes Real Estate Funds Worth $100 Million on Ethereum (CoinDesk) – This represents a shift in focus for the company from a token issuer to an infrastructure provider.
A Coinbase-backed startup now enables users to tokenize the price of ‘anything’ (The Block) - Smart contracts technology provider UMA accepts DAI as collateral and enables users to mint tokens that follow various price indices.
STABLECOINS
Some Shocking Data Analysis About Stablecoins (intotheblock) – Blockchain analysis shows that many investors have lost money on stablecoins, stablecoin networks are not growing and only tether is regularly used for large transactions.
Why do exchanges like Binance and Huobi want their own stablecoins? (The Block, paywall) – The long-term goal may be to replace tether, but in the short run, it’s about greater control over fiat funds on their platforms.
France Says It Will Block Facebook Libra in Europe (CoinDesk) – Bruno Le Maire, the French minister for Economy and Finance, declared that “the monetary sovereignty of states… is under threat.”
FATF closely monitoring Facebook’s Libra crypto, official says (The Block) – The concerns seem to focus on the anonymity of digital assets and the resulting criminal activity.
Facebook Libra Brings ‘Risks and Opportunities’: Swiss Watchdog Chief (CoinDesk) – Mark Branson, director of the Swiss Financial Market Authority, acknowledged that, if Switzerland wants to become a major financial center, it will have to live with the potential risks of working with major projects such as Libra.
Facebook’s Libra Pushes Back at Claims Project Is Threat to Financial Stability (CoinDesk) – Bertrand Perez, Libra’s COO, told a French newspaper that it is countries’ monetary policies that will affect Libra through the basket, and not the other way around. He also reiterated the Libra Association's determination to launch by the end of 2020.
Binance to List Its New Dollar-Backed BUSD Stablecoin Next Week (CoinDesk) – Created in partnership with the Paxos Trust Company, the token will be made available for trading on Binance against BTC and BNB the week of September 16.
PODCASTS
THE SCOOP: Frank Chaparro of The Block spoke to Paul Veradittakit, partner at Pantera Capital about exchange business models, crypto fundraising and what investors look for.
WE STUDY BILLIONAIRES: Plan B (an anonymous trader) shares his thoughts on stock-flow analysis, Sharpe ratios, and how bitcoin is the solution to the Triffin dilemma.
UNCONFIRMED: Laura Shin chatted with crypto investor and analyst Nic Carter on the political importance of cryptocurrency, why ethereum should aim to be money, the importance of the launch of Libra (however unlikely) and what the Association got wrong.
THE FLIPPENING: Clay Collins spoke to Sam Bankman-Fried, CEO of crypto derivatives exchange FTX, about what traditional markets have that crypto markets don’t, the arcane world of indices, the variance in exchange quality and more.
AROUND THE COIN: Ethan Kravitz, partner at AGE Crypto Hedge Fund, shared a breakdown of hedge fund strategies, the trials of running a crypto fund, and how they made money in a bear market.
FUTURES RADIO SHOW: Anthony Crudele chatted to Jason Urban, CEO of DrawBridge Lending about the impact of price on bitcoin acceptance, bitcoin’s role as a store of value and the potential impact of blockchain on capital markets.
BASE LAYER: David Nage interviewed Jeanine Hightower-Sellitto and Brian Kim Johnson of crypto trust company Gemini about their new custody features.
A-HA!
The Faulty Metric at the Center of Private Equity’s Value Proposition (Institutional Investor) – The Internal Rate of Return metric is increasingly being artificially inflated, according to research, and yet is still the most widely used measurement for private equity performance.
Thomas Piketty Is Back With a 1,200-Page Guide to Abolishing Billionaires (Bloomberg, paywall) – In “Capital and Ideology”, Piketty broadens his focus to beyond “western” economies, and gives more space to the political ideologies that lead to inequality.
How David Swensen Made Yale Fabulously Rich (Bloomberg, paywall) – An engrossing profile of the career and investment philosophy of the manager of the Yale endowment fund.
Sources of Financial Instability: Challenges for Monetary and Fiscal Policy (Hidden Forces podcast, audio) – Demetri Kofinas and Claudio Borio, head of the monetary and economic department at the Bank for International Settlements, took a deep dive into economics and the drivers of inflation, the legacy of low interest rates and the error of neglecting structural policies.
Narrative Economics (London School of Economics podcast, audio) – Robert Schiller talks about his new book “Narrative Economics”, which includes a section on how the dramatic and exciting story behind bitcoin is part of the reason for its viral success.
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FUNDING
The Blockstack security token offering, approved by the U.S. Securities and Exchange Commission under Reg A+ and Reg S, has raised $23 million, including a strategic round led by Hashkey Group and SNZ.
A majority of fundraising and M&A deals in the cryptocurrency industry are now happening in Asia and Europe, surpassing the previously dominant role of the Americas, according to a new report from PwC.
U.S.-based cryptocurrency exchange Coinbase is investing 1 million USDC each in decentralized lending protocols Compound and dYdX.
FIRMS
Zero Hash – the custodian and settlement subsidiary of crypto exchange Seed CX – now supports transactions in bitcoin forwards.
Crypto exchange and trust company Gemini is launching a service that will enable custody clients to trade assets instantly.
Crypto exchange aggregator Tagomi has launched a borrowing and lending platform, aiming to allow investors to easily short cryptocurrencies.
Bitwise has selected Bank of New York Mellon to serve as the administrator and transfer agent for its proposed bitcoin exchange-traded fund.
Binance.US, the U.S.-based subsidiary of one of the largest crypto exchanges in the world, will open registration and deposits for bitcoin, ethereum, XRP, bitcoin cash, litecoin, and tether, on September 18.
Binance’s futures trading platform, Binance Futures, has gone live.
Bitcoin.com is in talks to list a bitcoin cash (BCH) futures contract on a regulated exchange, according to David Shin, head of the company’s exchange division.
Hong Kong-based trust company Legacy Trust is launching a new business, First Digital Trust, to build out its institutional-grade cryptocurrency custody services.
Security token facilitator TokenSoft has developed an administrative panel for transfer agents to aid banks, trust companies and other third parties to more easily manage security token offerings on behalf of their issuers.
Nasdaq has added a new index called Defix (DEFX), launched by the London-based Exante brokerage, to enable investors and traders to track tokens such as those of MakerDao, Augur, Gnosis, Numerai and others.
PEOPLE
Coinbase has hired Dan Yoo, former chief operating officer of personal finance site Nerdwallet, as vice president of business and data.
Cryptocurrency derivatives exchange BitMEX has hired Derek Gobel, former general counsel at BNP Paribas APAC, as its general counsel.
Have a tip? Drop me a line at noelle@coindesk.com. |
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CRYPTO WEBINARS
Crypto podcasts have long been a staple of market education (see links above, for example), but I’ve noticed that there is a growing stable of informative webinars out there that don’t get enough air time in my opinion (I think there’s a pun in there somewhere).
On an experimental basis, I’ll list here the crypto market webinars that I know about and that I think you might find interesting. If you’d like your webinar listed here, let me know at noelle@coindesk.com (no guarantee of inclusion, though).
Fact vs. Fiction: How to Vet Crypto Custody Insurance Coverage – BitGo – September 19, 2019 @ 1:00PM EDT
Trends in the Privacy Asset Sector – Digital Asset Research – September 26, 2019 @ 11:00AM EDT
The State of Crypto Custody – Gemini Trust – October 7, 2019 @ 12:00 PM EDT
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If you missed last week's newsletter, you can download our report "Crypto's New Fundamentals", on cryptocurrency valuation methods, for free here. How do you value something that has no cash flows and no established fundamental value? We don’t have the answer, but in this report we hope to introduce ways of looking at bitcoin and ether that could help to develop valuation theses, as well as various metrics that have been proposed as valuation tools.
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CoinDesk is not an investment advisor. This newsletter is for informational purposes only, and any comments here do not constitute investment advice. |
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Institutional Crypto - Crypto and the Latency Arms Race, Part II