A new initiative seeks to help digital currencies shed their dodgy, Wild West origins and become acceptable to institutional investors. And in doing so, it could also facilitate the willingness of financial institutions to embrace blockchain, the infrastructure for mining and trading crypto-currencies.
Fraud at bitcoin exchanges such Japan’s Mt. Gox and Hong Kong’s Bitfinex, along with illiquidity and high volatility, have made banks and industry wary of alt-coins.
“Our vision is: that has got to change,” says Dave Chapman, strategy advisor for openANX, as well as COO at ANX International, a Hong Kong-based bitcoin exchange and B2B blockchain services company. The world is a long way from the sort of global regulatory regime to protect consumers that prevails in traditional markets, so ANX International has launched a fundraising for a non-profit effort, openANX, to develop the infrastructure to put the trading of bitcoin and other digital currencies on a more mature path.
openANX is an ecosystem that connects all of the other centralized bitcoin exchanges. The exchanges become local gateways – providing websites and customer service in local languages, linking with local banking systems, and handling compliance based on local regulation. But trading can take place with counterparties anywhere on the network, thus aggregating bitcoin exchanges’ liquidity, and introducing an element of credit analysis on counterparties rather than alt-coin investing focusing solely on market price.
And like in traditional markets, liquidity begets liquidity – an important requirement to make digital currencies a mainstream asset class.
Helping blockchain mature
“Bitcoin reminds me of what FX trading looked like in the 1990s,” says Hugh Madden, technical director for openANX as well as CTO at ANX International, and former architect of FX trading infrastructure at HSBC.
Local gateways could determine risk measures such as collateral requirements; individual players would post collateral in order to receive services; and local regulation would also impact a counterparty’s credit rating.
In another move toward traditional trading, a more liquid, decentralized exchange would enable bigger and complex trades to be first negotiated OTC, rather than on the blockchain (via what crypto developers call ‘state channels’, which in this case are executed through smart contracts using the Ethereum blockchain). Blockchain technology is bilateral and doesn’t allow for lending or repo, and it can be expensive, because creating the blocks to transact eats up electricity.
“It’s like an escrow service without any escrow,” Madden said.
Such an arrangement would allow the trading of alt-coins to more closely mirror trading floors of traditional banks: standardized orders are processed through low-touch algorithms, while big ones are voice-traded by human sales traders.
This also means more flexibility in providing a variety of pairs among crypto-currencies (such as a BTC/ETH trade), between cryptos and fiat (BTC/USD or ETH/JPY) and among fiats (USD/JPY).
However, this is all still meant to be conducted via blockchain, which brings very different properties to the table. Above all, such exchanges are ‘trustless’: the counterparties rely on the mining process in a blockchain to validate the exchanges and the ledger.
Almost as soon as bitcoin was invented, centralized exchanges popped up to enable their trading. However, these operate by having the exchange hold at least some of the assets. This has been necessary to ensure it can settle trades. But it has also made exchanges targets for fraud. Japan’s Mt. Gox (2011) and Hong Kong’s Bitfinex (2016) suffered hacks and customers lost millions’ of dollars worth of bitcoins; and unlike fiat money, stolen bitcoins are almost impossible to trace.
So a big problem that openANX wants to solve is to eliminate the need for a third party to hold on to customer assets. Instead, users would have to post collateral, asserting their solvency, in order to receive services.
“Our proposition for openANX is to build a decentralized exchange on top of the Ethereum blockchain,” Chapman said, speaking at a meeting of Ethereum enthusiasts. “We want to move from the current model of centralized bitcoin exchanges holding custody of your funds, to a collateralized-asset gateway.”
Chapman says the goal is to launch openANX in summer 2018. It involves a lot of technology development, legal and compliance work across jurisdictions, and, now, a marketing effort.
To finance the project, openANX launched an initial coin offering last week, that is slated to close July 17. (ICOs are venture financings raised via blockchain, like crowdfunding; openANX’s executives prefer the term ‘token sale’ of OAX, a bespoke digital currency.)
The foundation has already almost reached its goal of raising the equivalent of $22.5 million in OAX. Participants invest in the project using Ether, the currency of the Ethereum blockchain; openANX set the exchange rate of ETH1 to equal OAX478.68; based on the June 20 closing price of Ether, one coin equals $359.01. They are minting 30 million OAX tokens, which based on the above ratios, equates to $22.5 million.
Tech, legal, PR
Although not all centralized exchanges may want to join openANX, Madden says many peers would like to get rid of having to hold customer assets. Exchanges don’t get paid, and there’s no bitcoin equivalent of money-market funds to park deposits. And they live with the danger of a hack, a software bug, or an inside job to steal coins. “Holding a lot of customers’ crypto assets is really quite stressful,” he said.
Although bigger exchanges may prefer to guard their liquidity, rather than disperse it into openANX, they would have to maintain a staff to safeguard assets and maintain matching engines and other proprietary technology.
Participating exchanges, on the other hand, will be able to pool APIs and collaborate on innovation. And by expanding liquidity, exchanges can offer customers tighter bid-offer spreads and match multiparty trades.
Jehan Chu, managing partner at Jen Advisors, a venture firm focused on digital currencies, and an advisor to openANX, says the initiative represents a transition from bitcoin exchanges as purely commercial entities, into a blended model. “It is a new paradigm of public protocols, public technology and public software that is being used by proprietary, commercial organizations,” he said. “And it’s a Hong Kong story.”