Cryptocurrency’s complex quest toward building institutional infrastructure
If the normalisation of Bitcoin and crypto-at-large is to be achieved, there are fundamental challenges that this ‘non-analogue’ asset will be faced with. During Citi’s Digital Money Symposium, panellists of the ‘Institutional Infrastructure for Crypto’ session explored the obstacles crypto firms have faced while trying to carve out a footing within the institutional ecosystem.
Timing, definitional uncertainties, market sentiment and regulatory hurdles are a handful of the factors raised by the panel as influencing the industry’s journey over the last decade.
What is unique about the cryptocurrency journey?
Providing a background of the crypto market, Michael Moro, CEO, Genesis noted that cryptocurrency was initially an industry that started at the retail level – serving individuals with institutional infrastructure not appearing until 2016 or 2017.
“It’s really night and day when looking at 2013 to 2021, but it’s still a work in progress. We have a lot of holes to fill, processes to perfect, but we’re headed in the right direction.”
Moderator Shobhit Maini, director, market & securities services transformation, Citi, noted that while the market has been talking about the deployment of institutional capital into cryptocurrency since 2016 or 2017, it wasn’t until 2020 that we saw reputable investors begin to allocate money into the asset.
When asked whether infrastructural changes had occurred to generate the attention cryptocurrency saw during 2020, Brett Teipaul, head of institutional sales, trading, custody and prime services at Coinbase explained that as recently as June 2018 he believed that the necessary infrastructure simply wasn’t there.
At the time, Teipaul was working at Barclays and was considering whether the bank should open an OTC crypto trading desk. He said: “Infrastructure certainly wasn’t there to operate in the heavily regulated environment in which I was familiar with, which is a pretty remarkable statement as I’m now going to spend the next five years of my life or forever in this industry.”
Laying the foundations for the crypto asset class
Teipaul noted that there were three core factors which allowed for the formation of the asset class including the emergence of qualified custodians, prime brokerage services along with enhanced trading tools, and third, lending and credit intermediation.
Another factor which contributed to institutional interest in cryptocurrency, Teipaul added, is the emergence and recognition of reputable venues that conduct sufficient KYC AML procedures, with some of these larger players having satisfied the diligence levels of even the largest financial institutions. Coinbase currently recognises at least seven of these reputable venues: “effective and robust security continues to be highly relevant to institutional uptake.”
While perhaps unique to Coinbase, Teipaul also commented that the firm’s B2B infrastructure allows financial institutions without native capabilities to use Coinbase as a sub-custodian.
Agreeing on a crypto definition
When it comes to approaching cryptocurrency as a new concept, Itay Tuchman, global head of foreign exchange, Citi, explained that while traditional markets tend to “put it in a box that we are already comfortable with, we have to admit that this is a new asset class emerging.”
He noted that trying to make it feel like an analogue product like a precious metal or trying to make it feel like pure foreign exchange is a bridge too far.
There are similarities however between crypto and FX, Tuchman observed, such as the fragmented liquidity landscape (both geographically and technologically) and its high frequency. “I’m always impressed that Bitcoins tick frequencies at four times as many Euro-dollars frequencies. It’s a huge endorsement of the amount of interest, liquidity, activity, in the crypto asset space and FX probably has the highest trading volumes in that way as an analogue.”
The way in which crypto has evolved is also fundamentally different from the way FX trading took its current form. Tuchman explained that the retail asset classes in things like foreign exchange evolved from an institutional landscape around 15 years ago – making it an institutionally oriented marketplace.
“Margin related retail FX exploded onto the scene and had to conform to an already existing and latent FX ecosystem. It is the exact opposite with crypto. Crypto has grown on the back of a retail ecosystem. Now we’re trying to fit institutional mindsets to it […] you can’t help but be impressed by how much has been developed in the last couple of years.”
Listening to market forces to guide evolution
Providing context to Genesis’ success, Maini explained that the firm started out as an OTC broker dealer, added lending capabilities, followed by the addition of custody derivatives and capital introduction. “You’re beginning to look more and more like a bank – what were the market forces that drove Genesis toward adding these capabilities?”
“It was about connecting the crypto world to the institutional investor community,” responded Moro.
This became focused on making the experience of working with Genesis very similar to what you might get with a prime platform in equities or FX, Moro furthered. He explained that Genesis worked to remove friction to smooth the user experience and remove any speed bumps that might appear on the way.
The firm also had to pay close attention to timing, as the introduction of a full prime broker in 2013 would have been seven or eight years too early. Most of the necessary plumbing and infrastructure did not exist at that stage and Moro observed that the client demand would not have been sufficiently robust either.
Genesis also had to pay close attention to the sentiment of the marketplace and investors. “For the first five years of our business all we did was OTC trading. It was always about just getting crypto into the hands of kind of the early institutional guys, as well as general partners of these institutional guys in their personal accounts. We wanted to expand the network clientele and frankly, to spread the message around Bitcoin.”
Navigating regulatory divergence across jurisdictions
Moro observed that the evolution Genesis has experience has taken a piece-by-piece approach as the market conditions allowed for growth.
In 2018 Genesis added its lending business, in 2020 it acquired the custodian and began offering options and “now, the challenge is that in a traditional world you can do all or most of our activities through a broker dealer […] In crypto you cannot do everything through a broker dealer, and capital is a huge constraint to broker dealers and banks being the full-service prime broker.”
This means that crypto firms wanting to carry out these activities need to create different entities and apply for different licenses to operate in different jurisdictions servicing different customers.
“You’re basically piecemealing together all of the services you want ‘under the hood’ and doing everything in a jurisdictionally-legally-totally-compliant way, but you need the client to not notice any of it. I think that ultimately the challenge for cryptos is that regulation is still at the state-by-state level. We really have to keep in mind what state is implementing what rule.”
He concluded that much of the rulemaking and regulation around crypto is still developing around the world. Genesis has clients around the world and trying to be mindful and keeping up with every local jurisdiction is an incredible challenge while pioneering an asset class, Moro notes.
“But that’s also part of the fun too.”