The Last Look…

The one about technology

So you don’t like digital assets? Probably because you are a profit centre for a firm that hasn’t embraced the new technology.

Innovation rarely announces itself with a neat description of how it’s possible to profit from new opportunities as a free bonus. By the time the majority hears about it, the big bucks plays have largely played out (remember the arrival of electronic broking systems?) and this is true of cryptocurrencies, stablecoins and digital assets more broadly in the context of FX trading. It’s unrealistic to argue that the $7.5 trillion a day market will vanish overnight as blockchain technology takes over, but does that mean there is no money to be made? Probably not.

Let’s consider stablecoins. In the matter of two years these digital tokens have gone from a niche pursuit to a national sport in major financial centres. The US is currently having Crypto Week, which is the cringe name for attempts from lawmakers to pass the Genius and Clarity Acts and make them law. The TL;DR is it’s all about stablecoins. In the UK, the Chancellor is expected to announce a new long-term strategy for digital assets, including a new 10-year roadmap for these markets alongside its Financial Services Growth and Competitiveness Strategy.

Chancellor Reeves is also due to announce on Tuesday that she has given the green light for setting-up a new entity for payments, which will run under the supervision of a reluctant Bank of England, and that will become a strategic national utility platform provider.

In economies such as Australia, the RBA just announced an update to its Project Acacia, trialling 24 use cases for stablecoins and CBDCs, mostly around payments and settlement. An until-recently-reluctant ASIC is on board, giving these projects exemptions. South Korea, Abu Dhabi and Hong Kong are all talking about local-currency stablecoins. Meanwhile, large multinationals with lots of benign FX flow are discovering the joys and benefits of stablecoins in B2B payments and FX hedging, directly translating into a loss of currency business to counterparty banks.

What started as a bridge between fiat and crypto has become a market share thief in payments and now to a much smaller, fledgling degree, FX trading and treasury operations. So-called stablecoin sandwiches, a matter we’ve covered here before, are an increasingly popular way of conducting FX transactions. But here’s the rub: it’s possible to make money from these lunches and some, apparently, do. It appears that a number of HFTs have figured out that monitoring on-chain transactions pays. A stablecoin sandwich is, after all, nothing but flow. The timeframe might have compressed, but if it’s possible to see that a large European corporate is about to do a sizeable FX deal and it’s possible to know the direction, the size of the deal and the time of it happening then…it’s also possible to “prepare” for it, or to use vulgar parlance, to front run these transactions.

What if, someday, suddenly, all that’s left is speculative business, as flow and payments migrate to different rails?

How? Well, let’s say our smart, cutting edge corporate needs to pay a supplier in Mexican peso. Our enterprising treasury can get a dollar-pegged stablecoin for its euros, ping the tokens over to the counterparty who can then off-ramp the Mexican peso from the dollar stable. Let’s also assume that this is all incredibly predictable because it’s possible to see their initial stablecoin purchase due to blockchain technology being annoyingly transparent. If one was a sharp market maker, they might think, well hang on, what price are they using when the stablecoin transfer is made and more crucially, can I do anything about that price? What if I nudge that rate just a bit lower or higher…?

Veterans of the market might recognise this pattern. When electronification (technology, really) hits, it hits differently for those that use the tech compared with those that don’t. Should those that are ahead be punished for seeing an opportunity or should those that are left behind pay the opportunity cost of NOT being at the cutting edge? Or do we need Nanny (insert a financial regulator) to come and sort this out?

Nanny is busy and the business of FX keeps grinding on. Until it doesn’t. For now, automated market makers who can essentially tokenise FX and use smart contracts to execute deals are too small and liquidity in these markets is too shallow for it to present a real and credible threat. But what if, someday, suddenly, all that’s left is speculative business, as flow and payments migrate to different rails? What if algorithm take-up is leapfrogged by smart contracts? What if fretting about liquidity mirages is actually the wrong concern?

If you can’t beat them, join them, the saying goes. Except a lot of the people who know FX have already joined “them.” The question is, where does that leave us?

To find some answers, check out our recent webinar about the intersection of FX and digital assets and ponder the implications of a digital future. Oh, wait, I mean present.

eszalay@thefullfx.com