Obstacles to institutional crypto trading remain slow to clear

The volume of cryptocurrency traded by institutions remains small compared to other asset classes. That was one of the key findings of the GreySpark Partners report Charting the growth of cryptocurrencies, which noted that growth in new crypto hedge funds has slowed. By the end of this year, these will still only represent about 2% of the number of funds trading on other asset classes globally.

GreySpark research analyst and the report’s co-author, Meri Paterson, acknowledges that there are several obstacles to trading, including regulatory uncertainty, high levels of volatility and a lack of custody options that professional investors would deem reliable. But she suggests that, as crypto exchanges and other market makers become more established, liquidity will stabilise and no longer contribute to violent price swings.

Many institutional investors are accessing cryptocurrency on an over-the-counter basis in an effort to offset the risks associated with trade execution and transaction settlement. This approach also provides an opportunity to access bespoke lines of credit in the form of prime brokerage-like services from established leverage providers willing to service demand for risk associated with exotic or new asset classes or instruments types.

Another major factor holding back the market is the absence of trusted custody solutions, with participants waiting for big houses such as State Street and Northern Trust to take on this role. Finding capital-efficient instruments for short or hedge positions is also an issue.

There are at least signs of progress on the provision of cryptocurrency-centric custody offerings from established providers, with solutions under development by existing infrastructure providers such as SIX and Intercontinental Exchange, as well as startups.

“There will be a period of fragmented practice as market participants figure out what the best model is, but custody will cease in the near future to be the deal breaker that it is currently,” says Paterson.

When asked to outline the factors that will persuade the large custodians to offer cryptocurrency custody solutions, she refers to the scale of the investment required to develop solutions for cryptocurrency custody, including building the IT infrastructure and hiring specialists.

“While there is no clarity on the regulatory position, custodians are understandably hesitant to make such a commitment,” says Paterson. “In addition, some scepticism still remains about the ability of cryptocurrencies to hold the interest of market participants for long enough to make wading in worth their while.”

It is difficult to specify the developments required to create regulatory clarity around crypto assets, given that most regulatory bodies seem to be in observation mode. Paterson observes that regulators are known to react swiftly under two circumstances: when there is a public scandal or when the state is missing out on significant revenue from either taxes or fines.

“We should all hope the first circumstance doesn’t come to pass,” she says. “The second set of circumstances could be triggered if real money investors decided to take some risks and started trading in earnest. However, it is a ‘chicken and egg ‘situation, which is why I think a big name should bite the bullet and open for business.”

Wani Yosepa, fintech team lead at GreySpark, explains that market makers are working closely with initial coin offering (ICO) project managers to stabilise coins, using a number of techniques including traditional market maker and issuer relationships, which include requirements to maintain two-way prices, especially in circumstances where news is being released into the market that can impact price.

“Price floors perform a similar function where threshold prices are agreed between ICO project managers and market makers to defend the price from outside market participants aiming to artificially deflate the price,” he adds.

Such price floors can be either hard or dynamic, in line with the issuer’s needs for the firmness of the threshold as well as the resources available to defend that price.

Yosepa suggests the ICO market is on the downslope from ‘inflated expectations’ to what Gartner’s hype cycle calls the ‘trough of disillusionment’. “This could mean that new coins will find it hard over the next 12 to 18 months to attract buyers and that the landscape will contract,” he concludes.