The Last Look…

Exactly what are institutional attitudes to cryptocurrency markets? As a subject, crypto, largely headlined by the price of bitcoin it has to be said, is an emotive one – one hand we have those who jump on every positive scrap of news to pump up the crypto tyres, on the other negative headlines are often given an importance they are not due.

Generally speaking, you can identify the crypto fan from the sceptic pretty easily by their reaction to news – for example China reiterating its ban on its citizens holding and trading crypto. The sceptic sees this as hugely damaging, the fan as something to be shrugged off (and given China doesn’t allow its citizens to trade in a large number of offshore fiat markets one could argue they are right).

One thing is for sure, the digital assets industry has attracted some serious talent away from FX, no doubt helped, if the talent is in the trading arena, by a much more fun market in which to play! So what is the attitude?

I would generalise the feedback I get from my conversations with people by saying that few believe there is no case for the technology, especially in the FX workflow, but what is a very high percentage drops dramatically when asked if the crypto market boom is sustainable. There are, of course, those who see current price levels as just a staging post to stratospheric highs in coming years, but there is, I sense, a caution around what could be called the “Yazz” theory (check it out kids, a decidedly average 1988 hit entitled The Only Way is Up!)

A sub-theme I found interesting was how a growing number of people in what I would the institutional space believe, as I happen to, that what will emerge as the popular solution in the institutional space will not be bitcoin. I have mentioned several times before that I feel bitcoin faces an “ESG problem” when it comes to real institutional investor adoption – if other, cleaner, solutions continue to emerge; one of them, possibly Ethereum, will come to the fore.

While ESG is a growing (whisper it, trendy) topic in finance, another challenge facing bitcoin adoption is market behaviour – put simply, it is still seen as something that can be manipulated way too easily. From celebrity tweets to trading firms playing games, there is a suspicion about market activity. One investment professional told me they thought that hedge funds were increasingly interested in crypto because the market can “be pushed around much easier than fiat”, adding “they see easy money”.

Certainly, if a market participant throws enough volume at any market it will move, but it does seem that crypto needs to get over the impression that it lacks depth. There are some really good pockets of liquidity out there, however, and in reality, the 10-15% moves (down) we have seen recently are manageable, depending upon the platform you are trading on.

It’s funny to observe traders complaining about some LPs going missing from the market or widening out the second it moves – anyone would think they have a right to tight, deep pricing whenever they want! More seriously, this suggests to me that crypto is still too heavily dominated by retail traders – they do tend to moan the loudest – and again, this is seen as an obstacle by institutional players.

I wonder if the crypto world needs delineation between retail and institutional as exists (admittedly it’s blurred) in FX? Looking back a few years the challenges to institutional adoption were custody (which has very much been solved); trading technology that institutions are familiar and comfortable with (ditto) and robust liquidity (jury is out). It was interesting to note a couple of crypto aggregation products coming on the market in recent weeks, this is an attempt, no doubt, to build liquidity further. Whether it will work is something else, because as most markets can demonstrate, what actually counts is the number of “real” LPs, i.e. those who don’t run away the second things get tricky. You can aggregate dozens of liquidity sources, but if they include recyclers what value is it? Institutions at least, will go into the crypto space well aware of the downsides of fragmentation and liquidity recycling, thanks to their experience in what is a much deeper market in FX.

Going back to recent conversations, another asset manager source expressed the opinion that the presence of so many firms born out of the high frequency space is a negative for the market because institutional investment firms will want to do “size”.

Interestingly, this manager saw the future of crypto as a conflict between equity and FX-sourced market structures – in the former the smaller trading firms dominate liquidity, in the latter it’s banks. That is probably an observation that I could align with, and overall, having had these discussions, I am rapidly coming to the conclusion that what crypto really needs to become “institutionalised” is the banks being their core service providers, the way they are in fiat – and (again whisper it) decent regulation. Along the way, the banks will have to adopt the technologies associated with cryptocurrencies and that is no bad thing, because the result will be another asset class available to trade for all, one that is closely linked with FX, and one which is, to repeat myself, fun to trade (how long for though, who knows?)

colin@thefullFX.com

@colinlambertFX