Throughout 2018’s price slump, investors in digital assets hoped for an influx of institutional investors to rescue crypto prices. Retail investors pinning their hopes on large investors breaking digital assets out of their price slump are beginning to make peace with an uncomfortable fact — the institutional investors are already here.
Hedge funds and proprietary trading shops are increasingly becoming some of the largest traders of cryptocurrencies, taking the other side of larger trades in the market. The impact of professional and institutional investors on crypto markets is reflected in collapsing bid-ask spreads and increasing price convergence across exchanges. Spreads on bitcoin (BTC) 00 future contracts trading on the CME have collapsed by as much as eighty percent since the contracts began trading.
Many of the institutional firms entering the crypto space are proprietary trading firms, whose primary business lines typically include market making and arbitraging pricing inefficiencies across markets. Proprietary firms have been trading digital assets using primarily using over-the-counter (OTC) markets, rather than utilizing traditional exchanges. In over-the-counter OTC trades, trades are made directly by buyers and sellers, rather than routing through an exchange or open marketplace.
Better Pricing Through OTC Markets
Some of the biggest sellers on OTC markets are coin miners. Coin miners are increasingly using private sales to distribute their inventory, rather than offloading the newly minted coins directly onto retail exchanges.
By trading with proprietary firms and brokerages — rather than on exchange — miners and other big sellers can lock in pricing before completing the transaction. This eliminates the need for sellers to attempt to time market highs and can make earnings smoother and more predictable. Miners have reportedly begun setting up their own liquidity management teams to streamline their OTC trading operations.
Institutional traders also provide a valuable service to larger buyers hoping to enter the market. Large buyers frequently find that, due to the fragmented nature of crypto markets, they can not purchase large blocks of coins through exchanges without significantly driving up acquisition costs.
Chicago’s Increasing Role
One of the largest OTC market participants is Cumberland, a subsidiary of DRW. DRW has been opening offices globally to build its position as a global market maker for digital assets. Cumberland currently has a staff of approximately fifty people, the majority of whom are based out of Cumberland’s Chicago headquarters.
Other notable entrants include Jump Trading, XR Trading and Transmarket. Many of the market makers entering the space are based in Chicago, which has a large pool of proprietary trading firms and market makers. These emerged from Chicago’s dominant global futures exchanges.
Chicago’s increasing importance in the world’s digital asset infrastructure was highlighted by the launch earlier this year of Coinbase’s Chicago office. Coinbase’s OTC arm is headed by Paul Bauerschmidt, who spent thirteen years working at the Chicago Mercantile Exchange. Coinbase expects to eventually add up to thirty staff at its new office.
While the impact of the entrance of institutional investors hasn’t caused the hoped-for price resurgence, it is a powerful sign of the long-term viability of the crypto markets. Collapsing spreads and greater market liquidity will ultimately benefit all market participants.
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