Copper was pleased to sponsor the HFM Breakfast Briefing alongside our partners AiX Trade, Simmons & Simmons, and Cambrial Capital.
Moderated by HFM Senior Technology Reporter, Victoria Pavlova, the panel kicked off with a discussion around the competing taxonomy of digital assets that regulators are currently trying to establish with.
A natural point for Sarah Crabb, managing associate at Simmons & Simmons to contribute. She notes there is a lack of global harmony among regulators. In the UK, their challenge is in protecting consumers while providing a framework for the market and not stifling tech innovation. The Swiss and Jersey regulators were quick to act in this space, while the UK has thus far only managed a consultation on draft guidance.
The taxonomy we’re looking at effectively breaks digital assets into buckets: exchange tokens, which will be unregulated; security tokens, regulated - if the token operates as a share of equity or debt instrument; and utility tokens, which will be unregulated, but could possibly be considered eMoney. The FCA have provided examples, but there is still no real clarity. Having said that, it looks like BTC will escape regulation as an exchange token.
The conversation then pivoted to the fund side, and David Fauchier, CIO of Cambrial Capital, to get an idea of how this regulatory limbo is effecting the appetite from funds to invest in digital assets.
His view was that currently there are only a small number of funds actively trading crypto in Europe. The bigger volumes are in the US, although they are dealing with their own uncertainty via the SEC and CFTC, with the added complications of the IRS thrown in. The taxonomy and how we bucket assets is one element of the equation, but fundamentally we have to understand that the underlying asset is effectively software, which can be programmed to be anything. And this is being experimented with at the pace software engineers take, not the pace regulatory changes are made. So there is a considerable disconnect and these new economic models are increasingly difficult for regulators to keep up with.
Dmitry Tokarev, Copper’s CEO, provides a salient example with the Proof of Stake blockchain consensus mechanism. With PoS, new blocks are not added following a competition to solve mathematical equations, as is the case with Proof of Work, but rather by staked tokens, which is effectively a voting right and sounds a lot like a security. A token’s purpose might be purely for exchange, but if it can be staked in a PoS blockchain, does it become a security? These are the types of questions the regulators need to understand and answer before any guidance becomes law.
Victoria used this as a good opportunity to discuss whether the perception that institutional investors are more interested in the space now is down to infrastructure improvements and a reduction in volatility.
Jos Evans, CEO of AiX, notes that the security of the asset was the first biggest barrier. Trading out of custody was lacking, but now these elements are being solved and advanced by teams like Copper’s.
Dmitry adds the real drivers behind the adoption of institutional crypto are the LPs. If you can’t explain to investors that their assets are secure then you will never see tickets above $1m USD, which is effectively what 2018 was. Now, on the other hand, with the infrastructure in place, it’s more akin to the hedge fund industry of 20-30 years ago. We’re starting to see good flow as more people understand and are comfortable with how the technology works.
Jos continues, the other missing piece to the puzzle is leverage. Without that capacity there is no market. Crypto to-date has been very capital heavy, which needs to change, and is changing, however gradually.
Dmitry has also noticed that the shift into institutional investment isn’t happening as you might expect. The big traditional asset managers might be dipping their toes in the water, but the real players are very intelligent and successful people from those shops leaving and setting up their own crypto hedge funds. They are porting over the same strategies and applying them to crypto with 3 month outlooks in highly liquid markets (primarily BTC).
David has witnessed the first half of this year being devoted to some big capital raising by very talented asset managers, and speculated the second half of 2019 will look different to any previous period because the quality of the funds trading will be vastly improved. But right now, trading and liquidity is fragmented across roughly 40 exchanges, in as many jurisdictions. It’s 24 hours a day with billions of trading pair permutations. It’s therefore easy for prices to diverge and create inefficient markets. It’s fundamentally different from traditional finance. The new funds are coming into the space with firepower, so the arb opportunities across liquidity pools that exist now because of inefficient markets won’t be there in 6-12 months, which isn’t to say there won’t be opportunities, just the spreads will narrow to something comparable with traditional markets.
Dmitry highlights that it’s the infrastructure advancement that will help the market opportunities expand even as the market becomes more efficient. A prime example being the addition of leverage.
Jos completely agrees, despite inefficiencies, the market is trading huge volume every day. Imagine where it will go with the infrastructure for margining.
However, on the execution side, it’s still messy and risky. For OTC, everything is being done over chat apps and settled manually. AiX has built an engine for autonomously sourcing price from the biggest shops, with the capacity to then send the trade details to a custodian, (Copper, for instance) for instant settlement. A development that will have considerable impact on the strategies available to crypto funds in 2019/20.
The panel then took questions from the audience. With the launch of facebook’s Libra stable coin fresh off the press it was 800lb. gorilla in the room. The panel agreed that while it’s too early for anyone to really predict what the outcome will be, particularly after discussing at length the lack of clarity from regulators, the one certain positive to come out of this is the broad stroke awareness, and de facto legitimacy, facebook will bring to the field.
There is also some speculation that, on the institutional side at least, a stable coin like Libra could be used to facilitate cash management in a fund at zero cost and zero delay, which is an infinite improvement over traditional finance.
For more information you can contact the panelists using the following social accounts:
Victoria Pavlova - Senior Technology Reporter, HFM @HFMWeek Dmitry Tokarev - CEO, Copper @CopperHQ Jos Evans - CEO, AiX Trade @Ai_XChange Sarah Crabb - Managing Associate, Simmons & Simmons @SimmonsLLP David Fachier - CIO, Cambrial Capital @dfauchier
This article is not a direct transcript of the discussion and should only be used for informational purposes.
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