The Last Look…
Posted by Colin Lambert. Last updated: June 21, 2022
I had a very interesting conversation with someone in the crypto world last week during which we agreed that the industry could be on the verge of market structure change – but not necessarily in the way many people want.
There is a lot of sometimes over-emotional chatter about a crypto “winter”, but to give the issue some perspective, Bitcoin, the poster child for crypto, is some $10,000 per coin lower than it was this time last year. That is 33% of course and significantly worse that the S&P which is down some 11% over the same period, but what is more damaging is how badly the industry has coped with sustained decline. “Banks” are going bankrupt, firms are switching client accounts to “HODL Mode”, which as I said recently is laughable, and, most importantly, retail traders are getting badly burned.
My conversant pointed out, quite correctly, that crypto still has a trend, it’s just in a direction that most retail accounts struggle to express because they can’t borrow the crypto to short the market, even if someone was lending. This would suggest that the market is now operating in a fashion that TradFi institutions would recognise, but will it make them more confident about entering the space?
The short answer appears to be no, because there is still uncertainty about too many issues in the crypto market structure, not least regulation. I have often argued that crypto is just another asset class to trade and one aspect of the current situation that reflects that view is how the number one concern of people I speak to in the institutional space about crypto is exactly the same as it is in TradFi markets – liquidity.
Look at any industry survey in any asset class and liquidity always ranks in the top two, if not the very top of concerns – “if I get into this position, can I get out?” In crypto at the moment, the answer seems to be “maybe” depending upon where you trade and process. There is liquidity there, of course, but accessing it is not as easy as it once was, with OTC players – who largely service the institutional space – taking a bigger role in the market. As an aside, and one more data point, in spite of the spike in activity and the latest decline in crypto prices, liquidity is still clearly tricky because two institutional venues, LMAX Digital and CME Group are registering volumes broadly in line with last month, which means they are significantly down year-on-year.
The sense is that if crypto is going to become mainstream, this is a pivotal moment in its history. The retail-driven boom years are likely behind it, the introduction of two-way risk has come as something of a shock to too many retail punters (many of whom are new to the trading game) and will make them more cautious going forward.
This leaves the market in limbo, with the traditional giants seeing declining volumes from their retail client base, and the myriad of arguments for Bitcoin being dismantled one-by-one – the latest that it is a natural inflation hedge. So, what is the solution for (re)building confidence?
It probably lies in the institutional space, but will take some time because it is hard to discern what those players actually want. Many cite the need for regulation so they understand the world they are thinking of entering, but anecdotally regulation has not improved liquidity, so is that really the answer? More probable is the emergence of a leadership group – from the TradFi space – that gives the institutions a market structure they recognise, and more importantly, service from firms they recognise. Too many (not all, it should be stressed) native crypto firms have proven to be insufficiently robust to give the institutions confidence, so what is needed are recognised names, with a deep history in TradFi, to lead the way.
The crypto industry is between a rock and a hard place because market structure change appears inevitable as the retail influence wanes, but there will not – in the foreseeable future at least – be anyone to fill that void
This inevitably leads us to the banks (and by banks I mean established household names, not the latest Panamanian “bank” no-one has ever heard of) and their collective willingness to offer these products. Goldman Sachs is already there, of course, in derivatives, but more is probably needed.
The establishment of a regulatory framework would help banks provide these services, of course, and, importantly, it could lead to a degree of principal risk being held, which would deepen liquidity – and as we all know, liquidity begets liquidity. The trouble is, and to go full circle here, the banks are very unlikely to allocate capital to principal risk as long as the Basel Committee is intent on levying punitive capital charges for doing so.
This leaves the crypto industry between a rock and a hard place because market structure change appears inevitable as the retail influence wanes, but there will not – in the foreseeable future at least – be anyone to fill that void. Certainly the pace of growth we have seen in crypto will reverse sharply and the second, and most impactful, phase of a “winter” will cut in – firms cutting services and jobs. Coinbase has already started this, of course, rescinding 300-400 job offers and then announcing over 1,000 job cuts, and it is unlikely to be the last (others may do it in a more discrete fashion however).
I fully expect a healthy OTC market in crypto, probably in the NDF and futures space, for years to come, however this comes at a price for the retail community in the form of two-way risk and the end of HODLing. People can still argue there is a finite number on the amount of Bitcoins that can be mined, but they forget this is technology – a newer, shinier crypto could be developed (maybe already has been) to take up the slack. The fact is the theories for using Bitcoin have, as noted, been debunked one-by-one, leaving it where, to my mind, it has always been – a number that represents something to trade.
The sense is, for prices and some firms at least, the “winter” has further to go – this means more pain for investors in crypto and, potentially for some employees who will find themselves on the street at the worst possible time for their employment prospects. Salvation will be at hand in the form of a few strong firms likely to emerge from the downturn provided they are backed up by new entrants from the TradFi world. The problem is, that salvation is some time off still – the intervening period could get very messy.