Markets
Cryptocurrency exchanges targeting prime brokers are a step backward for market efficiency, traders say
As the world’s largest cryptocurrency exchanges crack down on brokerages that have been pooling their clients to profit from lower trading fees, some market participants are warning the move could hurt markets.
Exchanges say they are taking these steps to promote a level playing field for their users while ensuring transparency about the identity of prime brokers’ clients. Others see it as a step backward, at least from the perspective of creating more efficient markets.
Cryptocurrency markets were designed primarily for retail clients, which is why they differ so much from traditional finance. In mature markets, prime brokers offer institutions the equivalent of a simple bank account, behind which an army of intermediaries securely store cash and assets and facilitate lightning-fast trades across a range of platforms. Prime brokers also provide credit, allowing traders to mix and match positions, with everything cleared and settled a day or two later.
Cryptocurrencies’ ability to disintermediate and provide real-time settlement via blockchain means that large participants with multiple simultaneous trades must fund all of their positions in advance across a group of large, vertically integrated exchanges. Prime brokers solve this funding problem through their lending and funding component, points out George Zarya, CEO of gapinga top-rated brokerage firm that provides services to crypto clients.
By reducing brokers’ access to lower fees, exchanges could – perhaps inadvertently, perhaps not – make the cryptocurrency market less attractive to them.
“The exchanges have decided that intermediaries are not needed. They can also provide loans, right?” Zarya said in an interview. “But they can only provide loans for positions based on their exchange. They can’t provide portfolio margin, which includes your positions across the entire market. So we’re essentially moving toward less capital-efficient markets.”
Large cryptocurrency exchanges tend to focus on “liquidity capture,” said Brendan Callan, CEO of Tradu, a recently launched cryptocurrency exchange owned by investment banking group Jeffries. In other words, they create a captive audience model, where trading volume increases because a user must continually enter and exit positions on that exchange.
According to Callan, this results in a divergence in bid prices on very popular and liquid pairs like BTC/USDT across exchanges. The spreads between exchanges can seem “insane” to a conventional currency trader, he said, because liquidity providers are all getting reimbursed behind the scenes by a prime brokerage account so they can make markets on any other exchange.
“That means there’s no friction between the counterparty risk thresholds across all of these exchanges. But the crypto exchanges themselves are pushing for that because they want that capture,” Callan said in an interview. “They want you to have to enter and exit positions on their exchange because it increases their volume, but it comes at the expense of the quality of their liquidity. There’s not as much depth in the market behind each quote and it’s very sporadic.”