Tora Trading Services, a cloud-based provider of equity-trading solutions to institutional buy sides, is launching a new business, Caspian Technology, to bring institutional-friendly trading infrastructure to the crypto-currency world. It is a joint venture with Hong Kong-based Kenetic Capital, an investor and advisor in blockchain technologies.
Robert Dykes, CEO at Tora in San Francisco, will also serve as CEO of Caspian. “We’re trying to institutionalize the crypto-trading space,” he said, and help integrate crypto-currencies into institutions’ existing businesses.
A beta version of Caspian is already live with several large hedge funds testing it (DigFin heard several major global names but off the record), and Tora intends to launch formally by the end of March.
But there remain other challenges around getting hedge funds – let alone investment banks or institutional investors – to access crypto-assets, particularly custody.
Experienced traders, market-makers and investors are taking pages from the traditional world to develop infrastructure in crypto assets; Caspian is clearly replicating the Tora story from equities. But it’s unclear whether this new world will resemble that of equities, with trading centered on exchanges, visible pricing, and best-execution mandates, or that of fixed income, with liquidity locked up by an oligopoly of banks.
Michael Oved, founder of AirSwap, which is building a decentralized exchange for digital assets, and former head of Asia trading at market maker Virtu Financial, told DigFin the crypto world will produce a hybrid: a more equities-like outcome for the most liquid tokens and coins, and a more Balkanized, OTC environment for the long tail of the thousands of coins being minted.
The $1 trillion market
Backers of the new Caspian J.V. are bullish that they will facilitate a massive influx of capital and liquidity.
Michael Lerch, the founder of Tora in 2004 and more recently founder of Evolution Capital Management, likens the environment for trading crypto today to what hedge funds faced in the year 2000, with no connectivity between desks and exchanges.
“The biggest concern among hedge funds is the lack of controls” in how they trade crypto, he said, speaking today (March 19) at a blockchain event in Hong Kong organized by Kenetic. Like in the late 1990s and early 2000s, the space is crowding with small funds that are unable to give their investors key information, such as what exchanges they’re trading on.
But he predicts the crypto space will rocket to a $1 trillion market cap within 18 to 24 months – a massive uptick from today’s $2 billion, or even the $8 billion market-cap peak the industry reached in January. “The space is growing to a point now that it is impossible for people not to look at it,” he said. Lerch is chairman at Caspian.
Average daily volumes in crypto are now averaging $50 billion, says Dykes. He cites the $5.5 trillion AVD in foreign exchange markets as an example of what could be possible over time for trading coins and tokens.
Not yet plug’n’play
But institutional clients can’t just open an account at a crypto exchange and start trading. Caspian’s goal is to provide access to all exchanges to join up liquidity, aggregate data, and provide a single interface for order management, execution management, and trading algorithms.
Caspian also intends to offer post-trade services such as trade-cost analysis and portfolio modeling, and other criteria that have emerged in the traditional equities world over the past two decades. Dykes says these should give institutional funds tools to help them meet compliance needs.
David Wills, COO at Kenetic and former Asia head of trading at Och-Ziff Capital, says Caspian is addressing the technology challenge for institutions, providing a way to help process the lifecycle of a trade and generate analytics and reports about that. “It will take a while to find its feet, but crypto trading is moving from retail to institutional,” he said.
But other challenges remain: regulation, liquidity (for moving in and out of fiat money), and most pressing of all, custody.
In theory, blockchain can address issues of storage, clearing and settlement. Decentralized ledgers and smart contracts are meant to remove intermediaries and provide immutable audit trails. Moreover, tokenizing assets can allow them to be traded fractionally, opening up illiquid assets (from real estate to private-equity portfolios) to a new generation of investors and letting them trade tokens among one another without a central exchange.
The biggest obstacle to this vision is not regulation (particularly the lack of licenses for all but a handful of exchanges), but custody: the storage, clearing and settlement of crypto assets. “I haven’t seen any trusted custody offering or storage facility for digital assets,” said Roland Schwinn, head of Eurex Asia.
In the traditional world, institutional asset managers never assume custody of assets themselves: they have to appoint third parties that is trusted. “Asset managers will use an HSBC or a State Street, but they will never use a startup as their custodian,” Schwinn added. “A trusted custodian means a company that can guarantee a service, and be there to fix things when they go wrong.”
DIY versus Who you gonna call?
Paradoxically, another trend in blockchain is the emergence of decentralized exchanges. Oved from AirSwap says that execution, clearing and settlement must be solved before institutions jump into crypto trading. Decentralized trading platforms using smart contracts can remove intermediaries and essentially fold those custody services into the technology – an improvement, he says, on the current use of crypto exchanges that double as custodians and bank-like liquidity providers. “With a decentralized exchange, there is no concern over custody,” because investors hold their own assets in their own cold storage devices.
Caspian’s Dykes says the J.V. may develop some parts of its tech in this direction. “It makes sense for Caspian’s platform to be centralized, but many modules could become decentralized, with APIs that can access the entire platform,” he said.
But some observers are skeptical that decentralized blockchain exchanges will simply make the custody problem disappear.
“It sounds good,” says Schwinn at Eurex, “but from an operational and a legal point of view, it won’t work to have no one in charge…you need someone to call if there is an error in the smart contract, which happens every day.”
Lewis Fellas, chief investment officer at Bletchley Park Asset Management, an investor in digital assets, agreed. In traditional finance, that layer of intermediaries provides a way to correct errors and restore funds. “There’s no takeback in crypto,” he said. He thinks without clawback provisions or other forms of governance, decentralized exchanges will only appeal to smaller players, or be used for smaller deals. “It will remain niche.”
Enter the primes
A final hurdle to hedge fund participation in crypto is collateral for going short or using derivative instruments.
Fellas, a former portfolio manager at Harvard University’s endowment fund, says tech alone won’t bring institutions into the crypto world. He says transparency around counterparty balance sheets and operating procedures will be necessary.
Prime brokers are making enquiries, but Fellas says the lack of a custody element is preventing them from entering crypto. This problem might get solved, however: he expects solutions to become available this year, noting that some crypto exchanges are experimenting with “semi-prime” models that use third-party investor assets to enable short positions.
The incentive for traditional prime brokers to get involved is huge: Fellas says the typical spread on an equity stock borrow in Asia ranges from 15 basis points to 300 basis points – small beer compared to the 140% (14,000 bps) annualized spreads on going short that are technically possible in digital assets.
“Banks aren’t lining up to offer you collateral” in crypto, says Ellwood-Russell at Simmons & Simmons. But he says banks and institutional investors are exploring repurchase agreements and other over-the-counter contracts that trigger a response in the face of a counterparty default. “Right now it’s only for the brave,” he said, “but where there’s assets and money, people will look.”