Report Highlights “Growing Legitimation” of Bitcoin

A new report published by Arcane Research says that bitcoin is becoming increasingly legitimised through the growing market and infrastructure, and continues to attract the attention of both retail and institutional investors as an emerging asset class.

The report, The Bitcoin Trading Ecosystem and the Emerging Institutional Infrastructure, was based upon a survey of over 200 institutional market participants conducted by LMAX Digital with the aim of better understanding their needs in the crypto space and identifying infrastructure gaps. It also lays out the current market structure in crypto markets, looking at different players in different sectors of the market.

The report further states, “From billionaire hedge fund managers such as Paul Tudor Jones, to US banks given the green light to hold customers’ digital assets, a remarkable shift in attitudes towards cryptocurrencies is evident.”

It further argues, there are “fundamental” differences between the current period and the last time bitcoin topped out in late 2017, namely that while the latter was characterised by speculation in ICOs and all about the profits being made, the most recent action has been supported by public companies acquiring bitcoin.

While it does appear to be a little disingenuous to suggest the attention on bitcoin gains is lower this year, there was an absolute frenzy as it approached and hit $60,000 (it was at $40,000 at the time of writing the report), it is harder to argue with the report’s suggestion that the macro-economic backdrop of extremely loose monetary policy, combined with more focus on institutional market structure and the general digitisation of finance, is proving attractive to investors.

The report uses data from LMAX Digital and CME Group to assess the growth in institutional trading, observing that the spot product on LMAX Digital and the bitcoin futures on CME are only open to institutional investors and shows “explosive demand for bitcoin exposure from this investor group”.

Findings

As part of the survey, market participants were asked about the three most important factors they considered when selecting a cryptocurrency trading venue. The clear number one to feature was the reliability of technology (i.e. 100% uptime), with just short of 70% citing that; followed by depth of liquidity, cited by just short of 60% and low latency and certainty of execution, at just over 40%.

Competitive commissions came in next at just over 30%, which suggests a retail influence in the survey, however at just under 30%, regulation and the reputation and safety of coins, is very much a concern of institutions.

Reliability of technology, depth of liquidity and certainty of execution are considered the three most important factors when selecting a crypto trading venue

To reinforce that, the survey asked about the custody solutions used by respondents. Around 45% use standard wallet-based custody services offered by the execution venue, while around 20% use an offline solution, however there is evidence of the growing offering from traditional custodians in the finding that around 15% use a solution offered by “traditional custody specialist”.

In terms of infrastructure gaps, the nature of the respondents very much played a role in the findings. Access to banking was the most significant gap seen, especially by brokers at almost 60%, while prop trading firms found access to credit the biggest gap at just over 50%. Corporate concern was the lack of global regulation with just under 50% citing that – the most pressing concern, interestingly, for banks was also access to credit. Funds and asset managers’ biggest gap was access to banking at around 37%.

The survey also found that 70% of respondents expect asset managers and funds to dominate crypto trading, followed by 40% expecting banks to do so. Retail clients are not forgotten, with around 30% seeing that sector as dominating growth, slightly more than saw corporates doing so, which suggests respondents do not see too many corporations following the Tesla lead.

Numbers

The report also supplies data from Genesis, showing the firm did $31.5 billion in spot in Q1, an increase of 287% from Q4 2020. Before Q1 2021, hedge funds and passive funds were the largest clients at Genesis by OTC volume, however, as corporate clients began buying bitcoin for their treasuries in Q1, this shifted. “The entrance of companies like Tesla, MicroStrategy, and Square led to a wave of interest from corporates, and corporates accounted for 25% of the OTC volume in Q1 for Genesis,” the report states. “This is an increase from only 0.5% in Q4 2020.”

The above data could, of course, be a one-off, and as noted, corporates are not expected by too many respondents to drive further growth, but if institutional funds do enter the market the overall volume data is likely to at least be sustained.

Opening pandora’s box of 100x leverage to novice traders is a recipe for disaster

Another interesting data point in the report is average trade size, which, viewed through the lens of traditional market data, is anything but institutional. LMAX Digital has by far the largest average trade size at around $11,000 per trade, followed by Bitstamp under $5,000. The report cites Binance US as having average trade size of under $1,000, which is intriguing because elsewhere in the report it cites the Binance $10 million bid-offer spread. If there are indeed $10 million trades going through the exchange, that suggests a huge amount of trades even further under $1,000.

Binance is actually cited as the dominant platform in crypto derivatives, which is interesting given the recent headlines involving the exchange and its serial problem with regulators around the world. The report notes that offshore, unregulated markets are the most influential in terms of price discovery and see volumes “far above” those of the spot venues, but also recognises the associated risks in this structure, by stating, “Opening pandora’s box of 100x leverage to novice traders is a recipe for disaster.”

The tone of the report is, unsurprisingly, positive throughout, although there is no mention of the looming role of central bank digital currencies as that was not part of the original survey, which was taken before the latest round of statements from central bankers seemingly promoting those products.

The entry of custodian banks and reports that other banks are at least looking at providing market access for customers to access crypto products are seen as the main drivers of institutional adoption. Indeed the report concludes, “We believe the recent developments in the ecosystem will lead the asset class to mature. Regulators will increase their pressures and venue requirements to protect retail consumers. These regulations will also contribute to making bitcoin an asset well suited for institutional investors. Over time, we believe that the increased institutional presence will lead to a more substantial part of the price discovery in bitcoin to occur on regulated institutional trading venues.”