The Last Look…

In the past I have received a fair amount of blowback over my position that total transparency in markets is a bad thing, well, at the end of May we saw another event that I think reinforces my case – and into the bargain raises potential questions for some of the market makers in those sectors.

I should stress that when I talk about total transparency, I am referring to the actual trading marketplace – I continue to believe, as promoted largely by the FX Global Code, that transparency of action is vital – hence why I worry about stablecoins and what is too often a lack of transparency over exactly what assets are held to back them, exactly where they are held, and who exactly “independently” audits them.

The latest lesson in transparency also comes from the crypto world, where on May 29 a trader was was long bitcoin – who isn’t? – and looking good, until a news item, inevitably involving Don II, saw the cryptocurrency reverse. The position was apparently shaky, but not too bad, however the problem was everyone could see it on a generally available tool that provides data on positions etc.

Other traders, seeing this, sold bitcoin further apparently, squeezing said trader out of their position and, along the way, relieving them of about $100 million.

Traders losing money is an irrelevance – it happens – but it was how this appears to have happened that is key, because other traders took advantage of public information to trigger what was effectively a liquidation event as they like to call it, or a stop-loss to normal people (Ok, normal-ish!).

This is not the first time we have seen such things, they happened quite regularly a few years ago in equity markets (Game Stop anyone?), when the retail army got together on chat rooms and took the short-sellers out, so why do people continue to push for total transparency?

The obvious answer is vested interest. Some firms are predicated upon the speed at which they analyse order and trade data, and the more transparent the market is, the better. Obviously there are venues who like it because it’s their model – that’s fine, there is a place for a transparent, all-to-all venue(s), but what some don’t realise is there is a bigger space for more discrete markets.

I wrote recently about how more and more people in equity markets are waking up to the benefits of private liquidity pools, it seems fairly clear that the people pushing back against this are the majority of non-bank markets in these markets (who require transparency to exercise their speed advantage) and the exchange, who risk seeing business divert to new venues, thus undermining their data business and, in an extreme circumstance, their entire value proposition.

Crypto, it seems, is also waking up to this, although it should be noted there has been a healthy OTC market pretty much since hedge funds started getting interested. Following the taking out of the trader in bitcoin on May 29, Changpeng Zhao, founder of Binance, itself an exchange of course, questioned out loud why there wasn’t a dark pool in crypto, adding “now might be a good time for someone [to launch one]”.

Exchanges will always have an important place in markets, but I wonder if we are starting to see the roots of change in other markets, a shift that could see them look more like FX markets in the future (although, I should add, with a greater share for exchanges than in FX)? If this does happen, there will be an interesting side issue – how do the major market makers in these sectors react?

If you look at FX, another frequent opinion of mine that attracts opprobrium is that non-bank firms have, in the big picture, failed to have the impact they expected. With the exception of XTX Markets, which operates a subtly different model, they have failed to attract non-ECN business (which is the vast majority of FX volume), and have found themselves playing largely with each other on those venues (and of course, the odd bank clearing the internalisation exhaust). So what happens if the cash cows of so many non-bank firms, equities and crypto, undergo significant market structure change?

Personally I think these firms have the ability to make the right adjustments to succeed in FX, the big question is do they want to? It involves investing in a different business model and changing how they view one piece of their business – is it worth the hassle when they are making so much elsewhere?

I suspect that we will see these firms continue to be in FX, they will continue to sit at top of book in most ECNs, and they will continue to make money – but will it be enough for them? The pot of gold at the end of the FX rainbow largely comes via direct connectivity, these firms are not showing the desire to travel that road.

So while these firms may end up merely as another trader in FX, existing in a shark tank that demands constant investment, there could be a bigger challenge emerging in their core markets. If equities and crypto both start showing more FX-like qualities – and I think once the (non-scalping) consumers see the benefits they will flock to the model – do these firms need to react?

To reiterate, these markets are not exiting the exchange model, but growth could come elsewhere, in an OTC-like structure, and that is a problem for these firms if the huge return on technology and models that need total transparency is to be maintained. And when traders vote with their feet, I wonder what the regulators’ position will be? Interesting times…

colin@thefullfx.com