The Crypto Markets Are Broken
The crypto markets are broken.
There, I’ve said it. But what does that mean? Even more importantly, how do I know?
I started my career as a proprietary trader in a tiny office behind a supermarket in Flushing, Queens, shortly after 9/11. We were an oddball group of college kids hired by an eccentric and wealthy fund manager in the heady days of post-dot-com equity trading. Market spreads were huge and had just narrowed to due to decimalization, and the dot-com boom had spawned a multitude of day trading offices, where anyone and everyone came in to live the dream of trading for a living. We were told to “figure it out”. Some, me among them, did.
We had a small edge — our own platform. That meant we weren’t just sending orders “to the market”, or better known as the NYSE Specialists and NASDAQ Market Makers that controlled most of the trading in stocks to “maintain order” but in reality were simply licensed to print money by controlling the inside bid and ask in most equities. We could actually send orders to individual ECNs — otherwise known as Electronic Communication Networks — independent market centers such as Island and ARCA — no names back then — that had sprung up to challenge the supremacy of the establishment with innovative matching engines, marker/taker models to incentivize adding liquidity, and giving direct access to market participants. No one was even sure at first if it was legal to pay customers to add liquidity. But we all knew someone simply had to do it.
My oddball group of traders and I later moved to 50 Broad, a block south of Wall St and the New York Stock Exchange. The building’s basement was Island’s original data center, with the haphazard plywood server housings that hinted at humble beginnings. Later, NASDAQ bought INET — which had previously merged with Island — and NYSE is now known as NYSE ARCA! The dinosaurs were smart enough to see the future — innovate or die (they figured out a third way: buy).
We grew from a small prop shop to a full-fledged clearing firm and broker dealer that also provided DMA execution, a professional trading platform with API and GUI capability, data vendor services, and maintained multiple data centers across the US. I led the effort as the firm’s Managing Director and saw firsthand how advances in technology and the democratization of access to equity markets led to lower spreads, higher liquidity, increased pricing transparency, and the growth of reliable, robust systems that allowed professional traders — and the public — to participate in the markets with confidence.
One of the most innovative developments was the passage of Regulation National Market System (Reg NMS) by the SEC. In short, it mandated that if a better price existed on a different exchange, you got that price on your execution. Now, you had the benefit of multiple competing execution networks that lowered spreads and costs while always getting the best available price on your trade.
Innovation, followed by consolidation and common-sense regulation benefited everyone, and created the equity trading system we see today.
The cryptocurrency trading markets are very different. There are over 50 exchanges, and the same pairs of prices (for example, BTC/USD) frequently trade at huge price differences across those markets. Bitcoin can be $4400 in one market and $4600 in another — at the same time. Why? There is no central “market” or centralized rule-making entity. Instead, the exchanges that exist today each require traders to open individual accounts, frequently involve a hodgepodge of KYC/AML compliance, exclude certain countries, and, quite generally, lack regulation, transparency, and the trust those twin forces bring. In short, crypto trading is a nightmare to navigate.
But the issues don’t stop at account creation and market transparency; once traders enter the market, fundamental technology issues still plague them. Order entry systems are, for a lack of a better word, shit. Most exchanges’ trading systems are barely that — they’re usually basic web pages, where changing your order price, size, and time in force is a real pain. Trading across multiple exchanges at the same time requires a Dr. Octopus level of dexterity and the patience of a Nepalese monk. For all the innovation these exchanges say they bring, they have the functionality of E-trade circa 2007.
The technology issues aren’t limited to individual traders’ experiences, either. Rather, technology has not kept up with demand and infrastructures for crypto exchanges suck. There are no circuit breakers when prices move dramatically. GDAX, one of the most popular exchanges that is owned by Coinbase, saw the price of Ethereum drop from $319 to $0.10 in about a second because someone had fat-fingered their million-dollar order and the exchange had no way to manage that. Thousands of stop orders resident on GDAX’s books were allowed to execute, a meteor crashing through spiderwebs on its’ way to the ground, causing huge losses for account holders due to a lack of infrastructure that would sink any startup exchange in any other product.
As an example of the inefficiency that currently defines markets, one particularly enterprising individual scooped up a bunch of Ether at $0.10 and made a cool million. Was he aware of the huge order in advance? Hard to say. No regulation, no transparency, and outdated technology are equally likely causes for his unlikely enrichment story.
Kraken, another popular exchange, had to suspend all “advanced” order types for months (not days or minutes or seconds). Why? Their database system couldn’t carry the resident stop and trailing stop orders. That sounds basic because it is. Kraken’s customers had the distinct pleasure of re-entering their stop orders daily in a market that trades around the clock.
In the event that exchanges have their act together and do function, there still are no regulators to police what happens. Since the volumes are so fragmented across exchanges, an unscrupulous exchange owner, i.e. a “whale”, or large market participant, can move prices and control spreads at whim. Given enough capital, the trader effectively controls the exchange’s matching engine. Since no effective quote aggregation exists across exchanges, price dictation and manipulation is easy. We’re a long way from traders being price takers as they are elsewhere in currency and commodity markets.
Decentralized exchanges aim to solve the bad actor problem by removing a central trusted party, but the reality is that every exchange must attract liquidity — liquidity breeds liquidity — and they have none to start. Decentralized exchanges are also slow, and all transactions are visible on their chain — a huge deterrent to larger players who need to fill institutional orders without falling to predation and exposure of customer order flow.
I set out to solve this.
Simple: Market forces (yes, even though I said lack of regulation is currently a problem).
I founded XTRADE.IO with the goal of creating a unified FIX API — the kind institutions use — to allow all large players seeking to enter crypto markets an effortless way to do so. The real liquidity and stability in these markets will come from institutional order flow. But first, those traders need a way in.
XTRADE will leverage our point of presence at major data centers to cross connect to major exchanges and lower execution latency by a factor of 100x with Virtual Private Server infrastructure.
After creating the way in, my next step is the XTRADE PRO trading platform — a GUI based system, the kind I’ve used and led the development of for over 10 years. This is the sort of system that exists in commodity markets and is necessary for professional traders to want to enter the market, and facilitate more advanced trading by current market participants. XTRADE PRO will have data from all exchanges, advanced client-side orders that do not exist at exchanges (for example, midpoint liquidity and dark pool matching), and a highly secure, end-to-end IPsec encryption system to prevent malicious theft of exchange account data.
After those two fundamentals are pinned down, XTRADE’s multi-market setup will open accounts at all liquid exchanges, fill orders from our inventory, and then deliver them where our customer’s accounts reside at exchanges we partner with. This means that one account at one main exchange gives you access to all of the exchanges we work with — all data, all sources of liquidity. All the time.
The key to XTRADE is that all market trading data will be aggregated — so you will see the best prices. You can self-execute, or we will route your order to the best price, net of fees. It’s a voluntary Reg NMS.
How will XTRADE solve the crypto execution problem?
When stable and transparent systems exist, larger market participants enter the markets, thereby increasing order flow. That increased order flow stabilizes price swings, increases liquidity, and decreases spreads. These market participants will trade with the best available prices — now provided by XTRADE across the entire global spectrum of cryptocurrency markets. Simply put, the exchanges with the best prices and highest liquidity will attract institutional liquidity, which will attract retail order flow, which will attract arbitrage and more institutional liquidity, and so forth. The volume will inevitably consolidate among the top exchanges — the market selects both the best transaction and the best way to execute that transaction.
These top exchanges will likely register with the SEC, FCA, JSDA, and other regulators. They will upgrade their infrastructure to handle the increased volume. They will increase their pricing transparency, reduce spreads, and firm up AML/KYC. They will have to if they want to grow and survive as legitimate alternatives to non-crypto products.
The smaller, unregulated, low volume exchanges will die, or be bought by the larger players. You will see a consolidation of crypto trading activity among major market centers and a coalescence of stable sets of rules and regulations to protect crypto investors and market participants.
With increased liquidity and a global price protection infrastructure provided by XTRADE and others, the cryptocurrency trading landscape will establish digital currency as a legitimate, and in many cases inflation protected asset class. This change will drive worldwide adoption past the current estimated 0.015% to integer percents and beyond.
In lay terms, market caps in the trillions of USD should be a reasonable expectation.
Onwards and upwards, as they say. But sometimes, innovative technologies need a little help from the old guard. Just to point the way.