Crypto market participants are largely enthusiastic about greater involvement by interdealers and prime brokers but opinion is split on whether the structures of the FX OTC interdealer market should be replicated. Paul Golden investigates.
Interdealers and prime brokers allow institutions to keep their funds at a non-exchange custodian and be capital efficient for routing orders to various venues as well as providing services such as OTC trades, hedging, derivatives, and potentially margin/leverage. For institutions, operational risk is a major barrier to crypto market entry. Many spot exchanges are heavily retail focused and place a lot of risk onto the client – dealers and prime brokers understand and can manage that risk.
“Instead of opening accounts with 10 exchanges, a firm can open an account with one prime broker and get access to all 10 markets..”
Luuk Strijers
The presence of these providers should boost institutional investor appetite as these investors already understand the offering and mechanisms of these market facilitators from other asset classes.
Prime brokers
Luuk Strijers, chief commercial officer at Deribit says there are a number of benefits to having multiple prime brokers on his platform. “Instead of opening accounts with 10 exchanges, a firm can open an account with one prime broker and get access to all 10 markets almost instantaneously at competitive rates,” he says. “Instead of exposure to 10 different platforms, the investment firm now only faces one firm. The presence of reputable or large prime brokers would also ensure stricter adherence to compliance and regulatory standards.”
As long as most of the volume remains retail driven – and the exchanges are the conduit for those real volumes – the pressure on interdealer infrastructure remains low. However, prime brokers would be a welcome addition as credit is a key inhibitor to industry development. That is the view of Thomas Restout, Group CEO at B2C2, who believes that with more interdealers and prime brokers, fluidity in the market will compress margins. “It may also increase adoption and give confidence to large institutional players,” he adds.
Interbank dealers and prime brokers bring a natural market structure to the digital asset ecosystem, facilitating institutional participation through an understood workflow says Ayal Jedeikin, CEO and founder of Cypator.
“Prime brokers introduce efficiencies by reducing counterparty risk while interdealers bring a set-up that is conducive for large participants to frictionlessly face each other,” he adds. “We have seen leading crypto native participants make a shift to this model, wherein counterparty risk is significantly reduced and efficiencies are gained in collateral management.”
Replicating existing structures
According to Bitpanda CEO, Lukas Endersdorfer, replicating structures which are built into existing capital markets infrastructure will be vital to increase crypto asset adoption for traditional banks and financial service institutions. He believes issues such as post-trade settlement instead of pre-funded trading need to be resolved by establishing prime brokerage offerings.
“An increase in interdealers and prime brokers drives adoption and confidence among large institutional players”
Thomas Restout
Meanwhile Patrick Bärtschi, head of business development at Bittrex Global accepts that interdealers and prime brokers are typically highly regulated and well-established institutions with proper risk management and expertise and that embedding this type of infrastructure into crypto trading would reduce counterparty risk and add credibility and legitimacy to the market.
“However, as crypto is still dominated by retail investors the prime broker model may not be the best solution at present for a variety of reasons such as the higher costs involved, and the increased complexity for retail investors in dealing with prime brokers as well as the reduction in control and oversight of associated trades,” he says.
“Prime brokers introduce efficiencies by reducing counterparty risk while interdealers bring a set-up that is conducive for large participants to frictionlessly face each other”
Ayal Jedeikin
“Services need to be offered in a non-conflicting and independent fashion so it will be a natural transition for institutional digital markets to move to an OTC-style of trading model, cleared either bilaterally or through a central clearer,” says Jedeikin.
Convergence with FX
The convergence with FX markets will be strong as the basis of these markets is very similar – fragmented geographically and by exchange numbers and with fungible assets, agrees Restout. “It will be OTC-driven as exchanges become harder to trade on,” he suggests.
“As crypto is still dominated by retail investors the prime broker model may not be the best solution at present for a variety of reasons.”
Patrick Bärtschi
Crypto and FX markets have a similar base of trading 24/7 and therefore it is not surprising we have seen a similar client-based crypto OTC offering emerge in the last few years according to Danny Bailey, senior institutional sales lead at Bitstamp. “As more institutions trade crypto there will be more of an interdealer appetite, although this will take time and require a robust risk management and regulatory framework,” he says.
But there is also a view that brokers are anathema to crypto natives who understand the value of self-custody and control and that the infrastructure used to run these systems will be crypto native and much more efficient and stable than what exists in traditional financial markets.
There is no question that crypto markets would benefit from both legal and regulatory definitions. However, so much of the ecosystem’s overall structure is derived from functionality that is baked into the core programming of its flagship networks. For instance, Bitcoin and Ethereum provided a blueprint and a launch pad respectively for the vast majority of projects that came to populate the ecosystem.
In turn, the development of automated market maker technology has accelerated the use of decentralised exchanges that connect participants directly without third party intermediaries, a phenomenon unique to the crypto space. Unlike securities, which derive their value from being either a portion of theoretical profit or tangible debt, cryptocurrencies are generated a priori and operate with unique tokenomic properties.
“Though similarly decentralised and prone to volatility, the crypto ecosystem is conversely highly transparent relative to OTC markets through the constant production of on-chain data,” says Rich Evans, CEO CEX.IO Markets UK. “Coupled with crypto’s fast transaction times, it becomes clear that any attempt to force these markets into a pre-existing mould would only diminish these features and potentially weaken the space.”
“As more institutions trade crypto there will be more of an interdealer appetite, although this will take time.”
Danny Bailey
These distinctions help explain why the crypto ecosystem is not beholden to the same constraints as an OTC market. In fact, there is an argument to be made that crypto markets present a technologically advanced alternative to these established systems. “FX OTC is typically traded away from centralised markets,” concludes Strijers. “However, we believe in the potential of centralised liquid order books where large size can be traded and that some size is too large for regular order books.”
Interbank dealers and prime brokers help to bring market structure
Crypto market participants are largely enthusiastic about greater involvement by interdealers and prime brokers but opinion is split on whether the structures of the FX OTC interdealer market should be replicated. Paul Golden investigates.
Interdealers and prime brokers allow institutions to keep their funds at a non-exchange custodian and be capital efficient for routing orders to various venues as well as providing services such as OTC trades, hedging, derivatives, and potentially margin/leverage. For institutions, operational risk is a major barrier to crypto market entry. Many spot exchanges are heavily retail focused and place a lot of risk onto the client – dealers and prime brokers understand and can manage that risk.
“Instead of opening accounts with 10 exchanges, a firm can open an account with one prime broker and get access to all 10 markets..”
Luuk Strijers
The presence of these providers should boost institutional investor appetite as these investors already understand the offering and mechanisms of these market facilitators from other asset classes.
Prime brokers
Luuk Strijers, chief commercial officer at Deribit says there are a number of benefits to having multiple prime brokers on his platform. “Instead of opening accounts with 10 exchanges, a firm can open an account with one prime broker and get access to all 10 markets almost instantaneously at competitive rates,” he says. “Instead of exposure to 10 different platforms, the investment firm now only faces one firm. The presence of reputable or large prime brokers would also ensure stricter adherence to compliance and regulatory standards.”
As long as most of the volume remains retail driven – and the exchanges are the conduit for those real volumes – the pressure on interdealer infrastructure remains low. However, prime brokers would be a welcome addition as credit is a key inhibitor to industry development. That is the view of Thomas Restout, Group CEO at B2C2, who believes that with more interdealers and prime brokers, fluidity in the market will compress margins. “It may also increase adoption and give confidence to large institutional players,” he adds.
Interbank dealers and prime brokers bring a natural market structure to the digital asset ecosystem, facilitating institutional participation through an understood workflow says Ayal Jedeikin, CEO and founder of Cypator.
“Prime brokers introduce efficiencies by reducing counterparty risk while interdealers bring a set-up that is conducive for large participants to frictionlessly face each other,” he adds. “We have seen leading crypto native participants make a shift to this model, wherein counterparty risk is significantly reduced and efficiencies are gained in collateral management.”
Replicating existing structures
According to Bitpanda CEO, Lukas Endersdorfer, replicating structures which are built into existing capital markets infrastructure will be vital to increase crypto asset adoption for traditional banks and financial service institutions. He believes issues such as post-trade settlement instead of pre-funded trading need to be resolved by establishing prime brokerage offerings.
“An increase in interdealers and prime brokers drives adoption and confidence among large institutional players”
Thomas Restout
Meanwhile Patrick Bärtschi, head of business development at Bittrex Global accepts that interdealers and prime brokers are typically highly regulated and well-established institutions with proper risk management and expertise and that embedding this type of infrastructure into crypto trading would reduce counterparty risk and add credibility and legitimacy to the market.
“However, as crypto is still dominated by retail investors the prime broker model may not be the best solution at present for a variety of reasons such as the higher costs involved, and the increased complexity for retail investors in dealing with prime brokers as well as the reduction in control and oversight of associated trades,” he says.
“Prime brokers introduce efficiencies by reducing counterparty risk while interdealers bring a set-up that is conducive for large participants to frictionlessly face each other”
Ayal Jedeikin
“Services need to be offered in a non-conflicting and independent fashion so it will be a natural transition for institutional digital markets to move to an OTC-style of trading model, cleared either bilaterally or through a central clearer,” says Jedeikin.
Convergence with FX
The convergence with FX markets will be strong as the basis of these markets is very similar – fragmented geographically and by exchange numbers and with fungible assets, agrees Restout. “It will be OTC-driven as exchanges become harder to trade on,” he suggests.
“As crypto is still dominated by retail investors the prime broker model may not be the best solution at present for a variety of reasons.”
Patrick Bärtschi
Crypto and FX markets have a similar base of trading 24/7 and therefore it is not surprising we have seen a similar client-based crypto OTC offering emerge in the last few years according to Danny Bailey, senior institutional sales lead at Bitstamp. “As more institutions trade crypto there will be more of an interdealer appetite, although this will take time and require a robust risk management and regulatory framework,” he says.
But there is also a view that brokers are anathema to crypto natives who understand the value of self-custody and control and that the infrastructure used to run these systems will be crypto native and much more efficient and stable than what exists in traditional financial markets.
There is no question that crypto markets would benefit from both legal and regulatory definitions. However, so much of the ecosystem’s overall structure is derived from functionality that is baked into the core programming of its flagship networks. For instance, Bitcoin and Ethereum provided a blueprint and a launch pad respectively for the vast majority of projects that came to populate the ecosystem.
In turn, the development of automated market maker technology has accelerated the use of decentralised exchanges that connect participants directly without third party intermediaries, a phenomenon unique to the crypto space. Unlike securities, which derive their value from being either a portion of theoretical profit or tangible debt, cryptocurrencies are generated a priori and operate with unique tokenomic properties.
“Though similarly decentralised and prone to volatility, the crypto ecosystem is conversely highly transparent relative to OTC markets through the constant production of on-chain data,” says Rich Evans, CEO CEX.IO Markets UK. “Coupled with crypto’s fast transaction times, it becomes clear that any attempt to force these markets into a pre-existing mould would only diminish these features and potentially weaken the space.”
“As more institutions trade crypto there will be more of an interdealer appetite, although this will take time.”
Danny Bailey
These distinctions help explain why the crypto ecosystem is not beholden to the same constraints as an OTC market. In fact, there is an argument to be made that crypto markets present a technologically advanced alternative to these established systems. “FX OTC is typically traded away from centralised markets,” concludes Strijers. “However, we believe in the potential of centralised liquid order books where large size can be traded and that some size is too large for regular order books.”