The Last Look…
Posted by Colin Lambert. Last updated: November 17, 2021
Crypto valuations…discuss. A truism of all competitive markets is that the cost of trading generally gets crushed – it happened at various times in FX, and, as I wrote about last week, it’s happening again. Crypto markets haven’t got there yet, but I think we can all agree that it’s a very competitive space and there are a lot of providers, so what does this say about valuations in the sector?
I raise this because three weeks ago, crypto exchange FTX raised $420 million, a round that valued the company at $25 billion. In its third quarter update last week it revealed its average daily trading volumes were $360 million. FTX recently bought LedgerX and seems to be a provider on the up, so the valuation may well prove to be accurate, but if FX and crypto market structures are converging – which is something we will talk about at our joint virtual event with TABB Group on December 1, what does this mean for crypto providers?
FTX is just one of many in this space with huge valuations, so rather than study one firm, let’s look at a typical crypto trading technology provider, valued at $20 billion, with average daily volumes of $400 million.
Brokerage at the moment is still huge in crypto markets, a lot of it is size-related, but let’s assume, ahead of the institutions really piling in, that it’s 0.15% on average. That’s a business bringing in just over $400 million per year for trading (assuming it is charging the makers, which, quite rightly, it is not over a certain amount). There are, inevitably, other fees related to deposits and withdrawals, but even data is unlikely to be a rich seam, as it is in FX, because of developments like the Pyth Network, which have a large, and growing number of trading firms and venues sharing their data.
To go back to the brokerage example, compare that with a typical FX platform that is handling, say $40 billion per day in spot, with a brokerage fee of $5 per million, or 0.005%. That is bringing in $200,000 per day at around $50 million per year in brokerage revenue (I am assuming a 250-day trading year for FX and 365 for crypto).
I don’t see many FX trading platforms valued at $20 billion.
I get that one is a mature business and one is on the rise, but I wonder if there is a warning to the crypto world from FX? Both markets have a large number of providers targeting different areas of the client base, both rely upon market makers to ensure they have adequate liquidity, and both have blurred lines between retail and institutional.
It should be noted that FX platform valuations, such as they are, have not really dropped, but they were never in the billions of dollars in the first place.
The sense is banks are realising the folly of backing so many venues over the first decade of this century, will they repeat the mistake in crypto?
It really will depend upon how the crypto world evolves – is the wider industry, especially the institutions, going to be happy with a very fragmented market? At the moment, hedge funds and HFT market makers are very happy with it because arbitrage opportunities abound, but history and market efficiency theory tells us arbs are normally short-lived. The crucial factor will be the attitude of real money – this is where the big flows will come from that will truly grow the market. Will these firms want to connect to dozens of platforms? Will they want to engage in what will no doubt be another growing subset of this industry, aggregation providers?
More pertinently perhaps, will the banks be willing to offer the type of market access in crypto that they are in FX? The sense is banks are realising the folly of backing so many venues over the first decade of this century, will they repeat the mistake in crypto? Of course, people will say the HFT market makers will step in, but are they going to be offering deep enough liquidity and a good trading environment for larger flows? It would have to be observed that few of them can in FX – will crypto be any different?
Another area of potential interest is spreads and volatility. Spread compression is already a feature of life in crypto of course, and yield remains good in spite of it, but you do wonder at what stage they cross over? As I noted last week, too many FX platforms are barely covering an LP’s average yield, while this won’t happen for a while in crypto, I feel confident in saying it probably will unless the market congregates around fewer venues. If that happens, then whether the valuation is realistic or not will depend upon whether the venue is a winner.
Can an FX platform, worth perhaps $800 million, suddenly attracts a $10 billion valuation through the addition of few extra assets to trade?
Volatility is probably the area of least concern, although things have calmed down over the past year or two, I note in B2C2’s weekly review of crypto markets that vols remain around the 100%+ mark, that should be good enough for any trader. Inevitably these will also go lower I suspect, not least because I am unsure whether some institutions will commit heavily to a market with such volatility (especially when the move is to the downside).
I suspect that many investors in crypto are trying to cover all bases in the hope that one winner will more than make up for several losers in the end game. I also retain what I would term a professional interest in the crypto industry – as I used to tell my erstwhile colleague on the P&L podcast, to me crypto was something to trade rather than a real game changer, however I do accept the technology will play a big role in the FX industry at some stage in the near future.
What would be really interesting – and I think this is something we will find out in the near future – is what will happen to FX platform valuations when they do add cryptocurrencies to their offering? Many are tied up in exchange groups of course, so judging it will be difficult, but it will probably be an acid test of how over-exuberant investors in crypto platforms are getting, if an FX platform, worth perhaps $800 million, suddenly attracts a $10 billion valuation through the addition of few extra assets to trade?
Then we would know the bubble is real.