Missing the Bus? FX Traders and Crypto
Posted by Colin Lambert. Last updated: May 1, 2024
There is a strange thing happening in foreign exchange, according to Eva Szalay: it’s possible to get people to passionately argue that the same thing is either the unavoidable future or the worst of the worst.
The trigger words are tokenisation and crypto. While even long-term bitcoin naysayer Jamie Dimon gave his blessing to tokenising assets, the mention of crypto brings out the “terrorists and prostitutes” speech from many FX stalwarts. Ultimately, however, one can’t be without the other, so in other words it’s really “potato” or “potato”.
Of course, digital assets are highly divisive and it’s possible to split a room in two with a casual mention of blockchain, but given that foreign exchange traders were largely the first into bitcoin as a tradable asset, it’s strange that the space benefitted so little from the huge growth in crypto trading in the past decade and a half.
Despite the spectacular busts in crypto, it has fostered a whole new industry, that some, such as prop trading firms like Jane Street and Virtu, are making a handsome dime from as authorised trading participants for the recently-launched spot bitcoin ETFs. CME Group is also emerging as a key player while LMAX Digital is in the top rankings of crypto exchanges according to data providers.
But by and large, the FX industry seems to have missed out on the crypto gravy train and for some reason it has been unable to benefit from the digital currencies space more generally. This is odd because initially crypto was the closest to FX, but with the launch of spot bitcoin ETFs this year the market structure has moved towards equities.
“From a market structure perspective, FX is the only market that’s set-up to handle 24/7 trading, it’s a natural fit and my view is that the crypto business will end up with FX desks down the line,” says David Mercer, the CEO of LMAX Group which runs both an FX venue and a crypto exchange.
For now though, there is a natural reluctance to embrace innovation in the currencies trading space, Mercer adds, partly because “FX guys are contrarian short-termists.”
It’s not just that, albeit Mercer might have a point. The lack of bank participation in crypto trading has been a big hurdle to more linkages between FX and digital currencies, according to one senior employee at a trading firm. Until they get involved in trading in spot markets, there will be little interaction between the two markets, this person says. While prop shops and HFTs can make money from crypto trading, their involvement causes little interplay.
The lack of banking services for crypto companies is also holding back the growth of the two markets, allowing stablecoins to take the role of the dollar, displacing the greenback from its base currency role. According to crypto data provider Kaiko, stablecoins (pegged to the dollar or to a smaller extent, euros) are on one side of 82% of all crypto trades, while fiat currencies hold just 18% market share, declining from above 30% two years ago.
And yet, from a trading perspective, crypto should be attractive to FX traders: spreads are wide, volatility is high and markets are open even more than currencies. As Mercer puts it, crypto is like FX was in the 1980s.
Where is the innovation in foreign exchange today? It’s crypto
The institutionalisation of crypto markets is also happening, at least according to the IMF. Since the approval of spot bitcoin ETFs linkages between traditional markets and crypto have likely strengthened. The IMF recently noted in a paper about cross-border flows in bitcoin that the launch of the ETFs “indicates that bitcoin may increasingly be used – even if indirectly – by more mainstream financial operators,” which is a development that could see bitcoin cross-border flows become more similar to the way traditional funds move because of a convergence in average user base.
At the same time, foreign exchange is due some technology upgrades: at The Full FX Scandinavia conference last week, panellists talked about how fax machines are still part of the market, much like paper cheques. Cross-border payments are painfully slow, the corresponding banking system opaque and expensive and the big debate for the industry this year is whether settlement can move off T+2.
“Where is the innovation in foreign exchange today? It’s crypto. Crypto is the innovation and on a 10-to-20 year horizon, it’s a natural extension of foreign exchange,” Mercer says. “Whether you call it crypto or tokenisation, that’s where innovation is in FX, that’s a fact.”
Fax me your objections.