Wall Street prepares to take on established crypto companies

Some of the finance industry’s best-known names are building their own digital markets trading platforms, betting that fund managers will prefer familiar and trusted brands to the opaque cryptocurrency exchanges that dominate the sector.

Standard Chartered, Nomura and Charles Schwab are among the traditional financial institutions that are creating or backing new, separate crypto companies, including exchange and custody groups that can handle digital tokens such as bitcoin and ether.

The established companies are wagering that fund managers are still keen on trading crypto, even after prices crashed last year and a string of companies — including crypto exchange FTX and lenders Celsius and Voyager — failed.

For asset managers, the collapses have underscored the risks of putting money into businesses that are largely unregulated and face questions over their transparency. Many are demanding assurances that their money is safe before they start trading crypto.

“The large, pedigreed, traditional institutional investors definitely prefer dealing with counterparties who they know have been in existence for years and have been regulated in the traditional sense,” said Gautam Chhugani, senior analyst of global digital assets at Bernstein.

Crypto’s allure comes after the price of popular coins bitcoin and ether have risen by about 68 per cent and 56 per cent respectively so far this year, compared with an 8.8 per cent rise in the MSCI World Index.

“Lots of institutional players are testing different bits of activity to test the waters, build a bit of experience in the market but also . . . making sure they have an option for further growth avenues,” said Alexandre Birry, chief analytical officer for financial services at S&P Global Ratings.

The newcomers are breaking into a market dominated by companies such as Binance and Coinbase, which have their own institutional customers.

But they are betting that their finance industry expertise and their reputations, unsullied by the wave of crypto scandals and enforcement actions from US regulators, will prove persuasive.

Broker Charles Schwab and market makers Citadel Securities and Virtu Financial are among the groups backing EDX Markets, while UK lender Standard Chartered has supported exchange Zodia Markets and custody house Zodia Custody.

“They wanted to build an exchange they felt comfortable trading on,” said Jamil Nazarali, head of EDX Markets and former Citadel Securities executive.

The infrastructure being built by large institutions is markedly different to the crypto industry’s original structure. Wall Street executives are keen to separate business units such as trading from custody, as a way to reduce risk and potential conflicts of interest.

The collapse of Sam Bankman-Fried’s FTX exchange and trading firm Alameda Research, which were closely entwined, has brought those concerns to the fore.

Custody, where assets are stored securely to protect funds from hacks or theft, has emerged as the most straightforward way for traditional finance groups to grow their crypto presence.

“I don’t want my custody to be run by the same person as my exchange,” said Michael Safai, co-founder of trading firm Dexterity Capital, adding that the extent to which some companies did not separate such functions “isn’t appealing, and it’s even a bit unsettling”.

BNY Mellon and Fidelity already have their own digital asset custody arms and US stock exchange Nasdaq is awaiting approval from US regulators in order to launch its own service.

A survey of 250 asset managers published this month by consultancy EY-Parthenon found that half of them would switch from a crypto-native group to a traditional-backed company that offered the same services. Moreover, 90 per cent said they would trust a traditional financial group to act as custodian of their crypto tokens.

S&P’s Birry said crypto custody was often the first step because “it’s safer and foundational. It’s a low margin activity, you have to do two or three tasks and you have to do it well”.

If Wall Street-backed crypto companies do succeed in enticing institutional asset managers, that may pose a challenge to the dominance of incumbent crypto exchanges like Binance or Coinbase.

Jez Mohideen, chief executive of Laser Digital, a crypto trading and venture capital firm owned by Nomura, said some exchanges were “not providing best execution or best prices” and that further involvement of traditional institutions in crypto would lead to “more transparency and more convergence in pricing”.

However, Bernstein’s Chhugani said that existing crypto exchanges remained a key source of liquidity. “Trading desks source liquidity from those exchanges,” he said, adding that it would take time for new companies to gain market share.

The Wall Street-backed firms are building their infrastructure along more traditional lines. Nazarali said EDX had purposely not built its venue on cloud computing technology, as other crypto exchanges had done. He said the cloud had helped the established crypto exchanges scale “very, very fast”, but that it was too slow and unreliable for professional traders.

“Market makers hate that, that creates a lot of risk for them, they can’t quote as tight prices,” he added.

As the smoke clears, some executives see two markets developing; a shallower, retail-facing one with wide discrepancies between buying and selling prices, and a deep institutional one, where prices are more competitive.

Usman Ahmad, chief executive of Zodia Markets, said that, as the crypto industry developed, it “may lead to a disparity of spreads between institutions and retail [and lead to] institutions paying a tighter spread in a more liquid market”.

“It is going to be a two-tier structure with Binance being the face of retail,” said Chhugani.