But let’s not focus too much on regulatory forces, market dynamics, future expectations or the macro factors around the intrinsic value of crypto-asset for this discussion. That could easily turn into a short novel and would take up this entire print. Rather, let’s focus more on how institutions today can get access to crypto-assets if they wanted to. Would they have to build all new components? Could they overlay crypto on top of their existing system? Are there sufficient technology and service providers out there, both traditional and crypto-native, that can satisfy the needs of existing institutional clients?
The short answer to that last and most relevant question is “yes”.
My response is clearly biased as I am the co-founder and CEO of Omniex, the first institutionally focused investment and trading platform specifically designed and built for crypto-assets. But in working with institutional clients and partners in the last two years, I’ve come to know and really appreciate all the companies that exist today to enable this entire ecosystem. No one company can provide everything a client needs or satisfy all the variations the financial service industry would want to service all its clients. But as a whole, the institutional crypto-asset market is much more mature than many might think it is.
In order to really speak clearly about different institutional client segments and their needs, we need a model that can categorize the industry. I would like to break this down into a four-quadrant model, essentially a two-by-two matrix. On the X-axis, I present the client segment in two broad categories. And on the Y-axis, I present the two primary types of service providers in the current crypto ecosystem. I’ve presented a similarly constructed four-quadrant model (https://www.coindesk.com/four-quadrants-dividing-conquering-crypto-universe) to explain the evolution of the crypto opportunity two years ago. I hope a similar model here can concisely portray market need and showcase current progress as it relates to crypto market maturity.
To begin, let’s break down institutional client segments into two broad categories. One being “Direct Trading”, both active and passive, covering many groups such as asset managers, family offices, quant shops or prop desks, where the firm is broadly accessing liquidity and taking on positions directly for itself. The other category being “Brokering Services”, where the entity is acting as a broker dealer and playing a facilitation role for its clients, for both institutional clients and potentially retail. For those in the FX industry, these two broad categories should look very familiar and generally covers a wide range of parties. This forms the basis of the X-axis in our model below. I will focus on Quadrants 1 and 2 in this write up, essentially covering the “Direct Trading” segment of clients, leaving the complexities of Quadrants 3 and 4, the “Brokering” segment, for a following article due to length. On the Y-axis, I present the two styles of emerging offerings in the crypto ecosystem. Firstly, the “Tech-Stack Offering” should be quite familiar to the reader of this article. Within this issue of e-Forex alone, no doubt you will see many providers offering a technology stack to serve the categories described just above. These are technology companies that offer their services, either hosted or on-premise, to solve various needs of their target clients. The “Financial Offering”, on the other end of the spectrum, perhaps requires more explanation in the context of our new crypto ecosystem. This describes offerings traditionally offered by financial institutions, such as banks and dedicated brokers. Prime brokers, either independent or existing as an entity as part of an investment bank, is probably the best example of this offering’s development path. Since traditional banking institutions have not yet fully entered into this space, this void is taken up by new entrants that use technology and balance sheet to fill that void. This is a further example of how needs are naturally being filled in order for the evolution of a market to continue despite lack of traditional infrastructure.
The diagram on the previous page attempts to describe the relationship and attributes of these four quadrants. As I called out in my previous writeup, this particular explanation of market dynamics, their relationships and attributes, is but one model in the view of one person. By no means is this meant to be complete or final, so please feel to agree or object. Armed with this particular model to base our discussion, let’s start by looking at the various components and services a traditional “Direct-Trading” client of an existing asset class, like FX, would need to satisfy these two broad institutional categories. The below diagram depicts a standard front to back office flow of direct trading clients.
Just a few years ago, I would argue none of these services existed. A crypto fund had to use one of two primary methods to operate in that true wild-wild-west like world. The fund would have to create all or parts of this process flow by themselves, which costs a lot of time and money. Alternatively, they forego an integrated solution altogether and simply connect to each crypto exchange interface separately, perhaps manually via the GUI, then manage the positions via Excel or Google-Sheets.
Fast evolving market
The crypto market has matured in a short period of time. Platforms like Omniex have become available for funds, both passive and active, to operate the way they are used to operate – using an end to end system that provides connectivity, liquidity aggregation, risk management, trade execution & reconciliation, all the way down to OTC trade settlement support. While this did not happen overnight, it did arrive relatively fast in terms of traditional finance speed. Therefore, in terms of needs for Quadrant 1, I would say that the technology stack offering is fully ready to support institutional access.
Much of the reason for that has been the tremendous number of traditional finance personnel moving into this fast-growing crypto space. This influx of talent, or brain-drain if looked upon from the other perspective, brought people with years of traditional finance experience, both business and technical, into a field ripe for maturation. These people are highly necessary in creating an ecosystem fit for institutional adoption of crypto-assets. Many recent startups are a great combination of capable startup technologists and those with traditional finance experience, coming together to tackle this challenge.
Despite the recent talks about institutional crypto funds, there are also a number of the “Direct-Trading” firms, however, that are at relatively small scale as they push into the new crypto asset class. For these firms, sometimes the complexity of the crypto ecosystem could be overwhelming. Activities such as opening multiple exchange accounts and setting up multiple OTC counterparty relationships could be daunting. Coupled with the fact many core-long thesis-based clients do not look at best-execution the same way as a mature FX fund managing retirement or endowment money would, the industry could better serve these clients, in the near term, to provide a more vertically integrated, simpler solution.
This is essentially my depiction of Quadrant 2 clients. A vertically integrated stack of technology, credit, counterparty relationship and custody are traditionally the roles of a prime broker. Therefore, while this role is necessary, the ability for startups and technology firms to serve this role in the long run is questionable. While technology is infinitely scalable, if designed and implemented correctly, credit is not. Therefore, as the ecosystem scales and market size increases, the role of the prime broker most likely belong in a traditional financial service firm with a large balance sheet. Its capabilities and workflow, however, can still be integrated into a technology company that provides a scalable software implementation as in many traditional asset classes. In fact, I see the role of PMS, OMS, EMS, and trade matching or netting platforms remaining similar as today.
Benefits of new platforms
There is however, a big benefit of having new technology platforms that are designed and implemented specifically from the ground up to serve this new digital asset class as opposed to just building on top of existing platforms. That not so small benefit is the ability for a purpose-built technology stack to easily change and scale with the new digitalized world of finance with its cleaner implementation, without decades of technology debt.
As one of the earliest members of Currenex, a company that revolutionized the eFX industry in the early 2000s, I can speak at length to the need for new platforms as an industry is scaling at tremendous speed. One of Currenex’s main successes was its purpose-built platform that was able to handle the exponential growth of the active FX market when prime brokers augmented their service into FXPB in the mid 2000s. That movement spawned a large number of new platforms specifically designed to handle the volume, speed and settlement needs of FX. While we are not yet at that scale, we are marching towards that inflection point. Any successful financial platform today is around 15 to 20 years-old, at minimum. Continuing to build on top of these platforms with the added complexities of the blockchain and other crypto idiosyncrasies is nearsightedness that must be avoided. Therefore, beware of systems that simply added crypto functionalities on top overnight. Crypto is going to be a long-term phenomenon, make sure the platform you choose can match that expectation.
We will turn our attentions to the “Brokering” firms in a following article. The needs of this client segment to be different and perhaps more complex than those of the “Direct-Trading” firms, and therefore needs specific focus. In short, brokering firms come in many styles. While they are themselves an institution, they can serve other institutions or consumer markets. They could be market making with principle funds or applying an agency model or some combination of both. They could be high-touch, communicating over the phone, providing research and other services, or they could be providing a branded GUI screen directly to the clients to provide fast and simple trading capabilities. Given these differences in operations and complexity, the providers of a full technology-oriented broker stack are going to take a little time to fully materialize. I’ll simply leave you a little sneak peek of a “Brokering” service workflow below to get the imaginative juices flowing.
In conclusion, with all the great progress in the past two years since the great crypto bubble, the institutional financial industry does have the means to access crypto in a way that looks and feels familiar to existing institutional investors. Undoubtedly, there are still a lot of work to make crypto truly streamlined and embedded seamlessly into the existing workflows.
With regulatory questions still to be answered and long-term fundamental values to be analyzed, as an industry we still have much work to do. But as confirmed by numerous reports, such as those produced by Fidelity, Morgan Stanley and Tabbs Group, crypto as an institutional asset class is here to stay. And if we turn our attention to the even more numerous startup companies rationalizing crypto from a consumer’s perspective, the wave of retail demand will no doubt converge with the mounting institutional force to create a truly digitalized future many of us envision it will be. It is an exciting time to be a technologist and a financial professional. I, for one, am grateful to be part of this transformation.