The Last Look…

My antenna was tweaked a week or so ago by a report that at least two HFT-type firms were supposedly pulling out of the crypto market in the US. At face value the rather aggressive approach taken by the SEC in particular is likely responsible for the action, but is there more to it?

The moves, first reported by Bloomberg News, apparently involve Jump pulling back in the US but continuing with plans outside that centre, and Jane Street pulling out of the US and scaling back growth plans elsewhere. Now call me a cynic, but I suspect if there was enough money to be made in the business, there would be no question of a pullback – after all, both firms operate very successfully in other markets in the US, where the regulatory oversight is just as keen (but in fairness better nuanced).

The source of the trouble is, as seems to be the case more generally, the collapse of FTX and its trading offshoot Alameda, but given how that firm was built on an illusion, should the impact be this significant? What does it say about the depth of the market structure when a firm built on a lie can have such a major influence?

HFT-type firms rely upon volume to make money and volumes have gone down since FTX imploded, looking at the volume data published by LMAX Digital the monthly average for Bitcoins traded dropped from 645,000 in the six months before FTX, to around 507,000 in the following six months to April 2023. A drop, most certainly, but not dramatic. Equally, the share of “large non-banks/HFTs” on LMAX Digital has barely changed – it was 43.5% of Bitcoin volume in the six months before FTX disappeared, it has been 43% since.

If two major market makers are disappearing from the US at least, liquidity will inevitably struggle, especially given the banks’ collective reluctance to really get involved. This could mean that moves, when they happen, will revert to 2020-21 in their character, in other words, be more violent. This, in turn, makes crypto a tough sell to institutional investors who remain, after several years, the promised land for much of the crypto industry.

As was the case in FX, did the sheer number of non-bank firms chasing the same relatively small amount of business, mean not everyone was going to make enough money?

Probably the biggest impact from this story, however, is on another evolution in the crypto world, the shift from exchange-traded to OTC. This is seen as the final piece in the jigsaw that will attract institutions, but if OTC liquidity in particular suffers, does this slow the asset class’ growth?

While this can be seen as a negative for the future of crypto, there is another way of looking at it, however, perhaps the market structure is evolving to a degree where the HFT model no longer works? It happened in FX where the more valuable client flow went to disclosed OTC venues where both the LP and the customer had more visibility (thanks to the third-party analytics firms that grew up around the time) over how it impacted the market and was handled. This move squeezed out some HFT-type players from the market and forced others to change their business model – is the same happening in crypto, which would be a sign of the market’s maturing, rather than its fragility?

To go back to being a cynic, though, there is probably one other factor above all else, connected with something I have already noted. Could it just be, as was the case in FX, that the sheer number of non-bank firms chasing the same relatively small amount of business, meant not everyone was going to make enough money? A few firms that are thriving in other markets failed in FX, is the same happening in crypto?

After all, the volumes remain, in the big scheme of things, pretty minor league, so there is only so much business to go round – did Jane Street and Jump merely decide the investment necessary was unlikely to be worth the return? They wouldn’t have been the first, nor will they be the last.

colin@thefullfx.com