Crypto at a Crossroads: Adopting FX Market Structure or Forging its Own Path?

October 02, 2023 - While it is clear that crypto trading would benefit from structural change, it might be over-simplistic to suggest that it should simply adopt exactly the same framework as the FX OTC interdealer market.

The divergence in the approach to regulation between Europe and the US, coupled with the fallout from the collapse of crypto trading platform FTX, has rattled many crypto market participants. Regulatory uncertainty in the US has seen a number of firms shut up shop in the country to focus their business in perhaps more crypto-friendly jurisdictions such as Dubai and Singapore. In March this year, Bittrex closed its US operation with one of the Founders, Richie Lai, saying on X, “Regulatory requirements are often unclear and enforced without appropriate discussion or input, resulting in an uneven competitive landscape. In the end, we made great strides toward accomplishing our goal of maturing the crypto space. However, operating in the U.S, is no longer feasible and Bill, Rami and I will focus on helping Bittrex Global succeed outside the US.” 

According to the IMF, clear policies need to be established to protect investors and prevent abuse. One move that would reduce conflicts of interest is the separation of custody and trading, effectively institutionalising the structure of the crypto market. Traditional financial market infrastructure benefits from the compounding effects of both operational procedures and regulation that have been developed over time in response to market failures. The concept of segregating trading and custody is one of these key features.

On the question of how having a centralised settlement utility would impact on the stability of the crypto market, de Wit observes that there could be pros and cons. “It would enhance efficiency, mitigate counterparty risk, and streamline settlement processes,” he says. “However, it would also pose systemic risk and counterparty dependency.”

Lars Holst from GCEX also sees the benefits of centralised settlement, but also the risks, “The introduction of a centralized settlement utility in the crypto market has the potential to significantly impact its stability, both positively and negatively. If structured correctly it could increase the stability but if we entrust the wrong players, then it could have catastrophic consequences and could erode trust in the market.” 

Another element of FX market structure that crypto could benefit from is replicating the transparency and liquidity analytics accessible within wholesale FX venues. Most crypto venues are anonymous in nature with a lack of information detailing the type of flow and the market participants involved. Statistics such as fill rates and round-trip time - along with more advanced analytics such as pre/post trade mark-outs - are staples within institutional FX.

These all provide clients with greater information on the types of liquidity their firm is dealing against in an anonymous market place and whether it is beneficial flow to them and their franchise. 

“Concepts such as the global code of conduct are another example of an initiative which helps to level the playing field and provide a layer of transparency for how all institutional market participants should interact”
- Tom Flanagan, TP ICAP

“Concepts such as the global code of conduct are another example of an initiative which helps to level the playing field and provide a layer of transparency for how all institutional market participants should interact,” says Tom Flanagan from TP ICAP. “Wider adoption of these practices would help to breed confidence and bring in a wider array of clients.”

Lars Holst shares this view. “As a regulated provider we welcome oversight and transparency. I feel we can only allow regulated players to operate in the market, so we know who we are dealing with to add transparency and reduce counterparty risk. We essentially need to make sure all providers are fit and proper and approved so can trade and operate with confidence. Isn't it time that we ensured all providers are approved, fit, and proper? Is it not the right moment to fill the market with confidence for secure crypto trading? By replicating these elements from the spot FX market infrastructure, the crypto market can attract institutional investors, ultimately fostering a more robust and trustworthy crypto ecosystem.”

In addition, the crypto market is still relatively immature and many regulators have failed to determine what asset class it should be compared with.

Though similarly decentralised and prone to volatility, the crypto ecosystem is highly transparent relative to OTC markets through the constant production of on-chain data. Coupled with crypto’s fast transaction times, it is clear that any attempt to force these markets into a pre-existing mould would only diminish these features and potentially weaken the space.