Cryptocurrencies are digital currencies where transactions are verified and records maintained by a decentralized system using cryptography, rather than by a centralised authority. Unlike fiat currencies, which are backed by central governments, cryptocurrencies do not exist in a physical form and their value is not dependent on trust in a central bank. Since they have no intrinsic value, cryptocurrencies can only function if sufficient market acceptance, and belief in their value, is present.
With interest in cryptocurrencies gathering momentum, central banks are increasingly exploring the possibilities of developing their own digital currencies. A number of factors are driving global interest in Central Bank Digital Currencies (CBDCs) including a general decline in the use of cash and the ease with which cross-border payments can be made using digital, rather than fiat, currencies.
Ahead of the pack is China, which began work on its Digital Currency, Electronic Payment (DCEP) project back in 2014. According to the People’s Bank of China (PBOC), the aim of developing the Digital Chinese Yuan (DCNY) was to protect China’s monetary sovereignty after the popularity of privately-issued cryptocurrencies posed a threat to the country’s capital account management and, by extension, to its financial stability. Other reasons for developing a CBDC, the PBOC said, were to enhance the efficiency of payments systems and to promote financial inclusion, expanding digital payment opportunities to the elderly and people without smartphones.
While critics argue that the aims of the DCNY are more sinister, citing increased government surveillance and the potential subversion of the US dollar’s position as the global reserve currency, there is no doubt that Asian central banks are more progressive on CBDCs than their western counterparts. Similarly, with institutional interest in crypto trading gathering momentum across the globe, Asia is leading the way. According to a recent survey by Fidelity Digital Assets, the adoption rate in the region is 71% compared to 56% in Europe and 33% in the US.
The Technology Challenge
The rise of institutional crypto trading is leading to a keen interest in the technology available to ensure that trades can be executed efficiently and securely. Given the speed at which the crypto industry is developing, the most important characteristic of a successful technology implementation is that it has the agility and flexibility to adapt to each emerging workflow and set-up.
Like an eFX platform, a crypto tech stack consists of a connectivity layer, an aggregation and smart Order Router (SOR) module and a post-trade/settlement integration layer. However,
unlike FX, which is traded over the counter (OTC) through direct bilateral connection, crypto is traded in a hybrid manner either on exchanges or OTC. The industry has yet to adopt a common communication language so the connectors have to normalise various protocols before these are sent to the aggregator.
Crypto exchange feeds differ from direct OTC liquidity provision in that trading is organised in a disclosed or non-disclosed Central Limit Order Book (CLOB), exposing varying degrees of market depth depending on the cryptocurrency/instruments and the markets. These dual liquidity sources require the aggregator itself to make subtle adjustments in order to combine both OTC and CLOB feeds in a meaningful way. Here multi-asset expertise on the part of the technology provider is essential: the exchange trading model largely mimics the equities space whilst the OTC feeds follow the FX model.
In the crypto world, where market innovation is fast and furious, only larger vendors with prior experience connecting to a large and diversified set of liquidity pools have the tools and means to keep pace.
The SOR, with its de facto low latency nature, needs to be able to disseminate orders across multiple pools, taking into account parameters such as wallet compatibility, credit availability and cost. Adding an advanced analytic platform to the combination of aggregator and SOR allows tweaks to the rules to be analysed and adapted on the fly.
The UI too needs to reflect the dual nature of the trading pools available in terms of data and trading tools, blending an Execution Management System (EMS) ‘securities’ look and feel with that of an institutional FX trading station.
Finally, once trades have been executed, settling them will be near instantaneous (crypto is driving us towards an trading world where everything is in real time) so tight integration of the post-trade and settlement channels into the wallet providers needs to be implemented.
Is there money to be made in crypto as there is in FX?
With the increased number of crypto market makers, comparable to FX LPs, in the market as well as other speculators, it is certainly possible, with the right technology, to trade crypto as profitably as FX. Many market makers and high-frequency trading firms have both FX and crypto trading desks and bring their knowledge and expertise of FX to the new and innovative crypto market. Crypto offers attractive possibilities for these market participants, and not only because it is a 24/7 asset class. The volatility of crypto markets leads to greater arbitrage opportunities while the size of the retail market is advantageous for market makers. The biggest difference between the two asset classes currently is the lack of ‘real economy’ flow from corporates and asset managers – but the market is maturing quickly and opportunities to make money will only increase as more buy-side firms become involved.
Making the right choice
Even more than with other asset classes, robust and reliable technology is one of the most important considerations for institutions wanting to enter the crypto trading arena.
Mainstream adoption of crypto trading is only a matter of time. To ensure success, institutions wishing to trade crypto should look not to the proliferation of new dedicated solutions, but rather to a partner with a proven track record in other asset classes.
At smartTrade all of the functionality of our LiquidityFX solution such as pricing engines, price distribution, auto-pricing and auto-hedging, order management, hosting and colocation as well as analytics and TCA, is available for cryptocurrencies. Our proven solution accommodates the new trading model and allows our clients to access the digital asset ecosystem and trade crypto assets alongside traditional asset classes. smartTrade’s technology is scalable and highly flexible, allowing for an agile response to a market which is still in the process of institutionalising and maturing.