With current crypto values exceeding $2 trillion, the market for digital assets is surging and institutional interest is rapidly increasing. A new report from PwC, in partnership with the Alternative Investment Management Association (AIMA) and Finery Markets – which bills itself as the first global crypto-native multi-dealer platform – suggests that we could finally be seeing the first evidence of mainstream institutional adoption.

However, with numerous different digital assets to choose from and (according to Coin Market Cap) over 300 exchange platforms to trade through as of January 2022, the key question is where – given the sophisticated requirements of institutional market participants – is best to execute your trades.   

“A client’s choice of digital asset execution venue may be influenced by the offering and acceptance of fiat and cryptocurrency, the reputation of the exchange in an already polarised market, and the costs associated with the transaction and the market prices that are achieved,” said PwC.  

Centralised exchanges (CEXs) such as Binance (the most popular centralised execution venue among the 77 buy-side participants surveyed), Kraken and Coinbase are strong favourites, due in large part to the security and liquidity they offer, the report noted.  An overwhelming majority of trading (more than 90% of participants, according to PwC) currently occurs via CEXs, which leads to lower liquidity risks and narrows the bid-ask spread for a more accessible market, but there are also downsides, including potential for hacking attacks and the perception that they are often not built to handle the scale of large transactions that institutional players are looking for 

Decentralised exchanges (DEXs) are another option. These mitigate the hacking issue because they don’t exist on an exchange, so from a security perspective, the exchange of digital assets is less prone to an attack. However, a notable drawback of decentralised exchanges is their lower liquidity and the risk of market manipulation. 

“The keywords here are miners extracting value, front runners and automated market-makers. In a nutshell, fluctuations in prices and execution times in the digital asset landscape allow the validators of blockchains to interfere with the orders that are made public,” explained the report.  

There is also a risk that large-volume DEX orders could also face hacks, while another concern is that the emphasis on privacy and lack of transparency could make essential due diligence impossible. Around a third of participants currently trade on DEXs, according to the report, with the most frequently used platforms being Uniswap, SushiSwap and 1inch. 

OTC venues are emerging as an increasingly popular alternative, as they allow investors to trade high volumes at a pre-agreed price. However, they are less efficient than exchanges – when a party submits an order, they need to wait for a counterparty to engage, which can delay execution, while the lack of a delivery versus payment mechanism means there is a risk of a party defaulting. Among the institutionals that trade with OTC desks (which accounted for around half the survey participants), the most popular counterparty is B2C2, followed by Cumberland, Genesis Trading, Galaxy digital, BlockFills and DV Chain.  

Finally, smart order routing (SOR) is also gaining traction among institutional investors, using an algorithm to determine the best price for the transaction. Through a pre-determined scope of trading venues, the SOR seeks to achieve the most favourable trading condition. The method is appealing in terms of best execution because it can access several trading venues simultaneously. This means the range of digital assets traded is broader, and liquidity can be aggregated – a distinct advantage in such a fragmented landscape. However, the method is highly complex which limits take-up even among institutional players.  

“When choosing an exchange, the respondents seem to place importance on execution and liquidity quality,” said the report. “The second most important factor is the assets an exchange supports. Rounding off the top three, regulation and jurisdiction reputation is the final factor in the choice of exchange.” 

Interestingly, fees and commissions came in fourth place, suggesting that players are currently willing to pay more in transaction fees if the exchange has other features they want, such as a wide range of assets, best execution capabilities, and legal certainty.  

In summary, institutional trading of digital assets is still in its early days and the market has yet to consolidate into any identifiable trend or preference. Almost all institutional investors use more than one platform to trade, with at least 25% using more than 10 venues. But consolidation could start to appear as volumes increase – similar to the FX market, which also used to be highly fragmented.  

And the outlook is promising. The report found that almost 70% of the companies that have traditionally traded in financial instruments are now engaging in trade in the digital asset landscape, marking a positive long-term trend. “This shift of traditional finance companies making the transition into digital assets could be the start of mainstream adoption of digital asset by financial institutions,” noted PwC.  

Volumes are still low – the highest number of respondents trade less than $10 million a month in digital assets. But these too are growing. “Even though there are a greater number of companies that trade less volume, the volumes of institutionals that trade more than $10 million are much greater in total,” found the survey. “A bullish market may lead to more institutional entries to the market and may increase the volumes traded in the future. 

With over 60% of participants already looking to improve their current trading setup for digital assets, the market may not yet be fully mature – but it’s certainly moving in the right direction.  

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US crypto exchange FTX US has confirmed that it will be making a strategic investment into IEX Group, the operator of the US-based Investors’ Exchange, in order to develop a transparent market structure for the buying, selling and trading of digital asset securities.

The question of crypto regulation has long been a thorny problem , and FTX US has been clear about its ambitions to become a regulated exchange, working with regulators to create a platform that enables both retail and institutional engagement with digital assets.  

The new partnership with IEX, an alternative trading system first launched in 2013 with a focus on investor protection, is another step down this road.  

“To unlock its full potential, the crypto and digital asset industry needs to engage with regulators and truly scale what has been built,” said CEO and Co-Founder of IEX, Brad Katsuyama.  

“From the first conversation with Sam [Bankman-Fried, CEO of FTX and FTX US], it was clear to me that FTX and IEX were truly aligned on the future potential for digital assets and the unique roles our firms could play as partners in shaping market structure that benefits the end investor. We both see the regulators as important allies in providing a clear path forward and attaining the highest possible standards for investor protection. The US market should be the largest player in digital assets globally and we believe that this partnership will help facilitate that.”

Earlier in March, parent company FTX Trading partnered with US-based crypto platform West Realm Shires Services to launch a new unit targeted at institutional investors. FTX Access will initially provide institutional investors interested in gaining exposure to digital assets with trade execution, analytics, index products, advisory services  and capital introductions, with plans to expand into custody, derivatives, structured products and other asset management products later down the line.

The recent developments accompany a growing interest in regulatory oversight for the sector. On 9 March, President Biden signed into law the ‘Executive Order on Ensuring Responsible Development of Digital Assets’, the first real attempt by US authorities to comprehensively address supervision of the fast-growing crypto space – including the potential development of a US central bank digital currency.  

“The order is a significant step toward developing a comprehensive federal approach on digital assets,” explained law firm Shearman & Sterling in a recent analysis. “Although the order does not prescribe a regulatory framework itself or require the issuance of new rules, it directs various parts of the federal government to issue reports and recommendations on potential regulatory or legislative actions concerning digital assets.” 

In November 2021, non‑state issued digital assets reached a combined market capitalisation of $3 trillion, up from approximately $14 billion in November 2016, marking a compound annual growth rate of 192.5% over the past five years, and this explosive growth has not gone unnoticed.  

“The unique and varied features of digital assets can pose significant financial risks to consumers, investors, and businesses if appropriate protections are not in place,” stated President Biden in March. “In the absence of sufficient oversight and standards, firms providing digital asset services may provide inadequate protections for sensitive financial data, custodial and other arrangements relating to customer assets and funds, or disclosures of risks associated with investment. 

The latest partnership between FTX and IEX Group looks to be preparing for the potential advent of further regulation, and the two firms have promised more information in the coming weeks on how they plan to broaden investor participation in the digital asset securities market – including a new initiative encouraging all investors to join the conversation about the future of market structure for digital asset securities. 
 
“Investing in IEX created a tremendous opportunity for FTX US,” commented Bankman-Fried. “With this investment, we’re aligned with one of the most trusted and innovative companies in equities markets. I’ve long respected Brad’s vision for IEX to be an exchange that caters to the needs of the investor and treats them fairly – part of the reason why we’ve operated similarly at FTX. As a result, we will collaborate on the further establishment of crypto market structure and work closely with regulators, allowing institutions around the world to enter the marketplace seamlessly.” 

The move comes as institutional interest in digital assets continues to grow. In December 2021, research from London-based digital assets hedge fund manager Nickel Digital Asset Management revealed that over $60 billion worth of Bitcoin is currently held through various Bitcoin closed-ended trusts and exchange traded products, with US and Canadian funds accounting for an overwhelming 75% of the holdings. 

Anatoly Crachilov, CEO and founding partner of Nickel Digital, said analysis of digital assets performance versus traditional asset classes shows sizable outperformance by digital assets over the medium to long term. “This helps explain the increasing interest in digital assets by corporations and institutional investors as part of their wider asset allocation.” 

In January, MSCI moved into the digital asset sphere for the first time through a collaboration with institutional digital asset investment product and services provider, Menai Financial Group; while sector is also creaming off industry talent, poaching numerous high-level executives from more traditional roles.

Most recently, decentralised Financial Market Infrastructure (dFMI) firm Bosonic hired former global head of LCH ForexClear, Paddy Boyle, as its global head of clearing and derivatives; while in November 2021 Citi promoted Puneet Singhvi from its global markets business to head up digital assets for its institutional client group, with plans to hire up to 100 more within the division.  

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