Part Three: Calling all crypto asset managers—it’s time to update your App!
As covered in Parts one and two of this series on Bitcoin Financialization, there are many challenges for crypto portfolio managers. The question is no longer, “should we invest in crypto?” but rather “how do we get started?”
There is much for asset managers to figure out, from where to hold coins to finding the right exchange or counterparty to trade with, and of course, having the right software to support crypto trading. Most firms will need to upgrade their portfolio and execution management systems or purchase systems specifically designed for crypto trading. Additionally, security and custody procedures as well as tax and accounting software may need to be updated to properly handle crypto currencies.
In Part two of this series (The Many Stages of Bitcoin) we discussed how Bitcoins I and II led to fractioned liquidity on many exchanges around the world. Achieving best execution can only be done with connectivity to multiple trading venues using a Smart Order Router (SOR) to buy the cheapest coin at a given point in time. Despite recent exchange consolidation, having an SOR for crypto trading operations is a must.
Bitcoin III with its torrent of derivatives is requiring asset managers to be able to access futures (regulated or not), options, swaps and perhaps even digital asset lending. With these highly volatile instruments comes great risk and an even greater need for risk management. All crypto traders need to have an app for that! Forced liquidation at these derivatives exchanges is provoking fast market crashes, even “flash crashes”. Portfolio managers, traders, and to a greater extent risk managers, need the tools to handle these highly volatile instruments, monitor correlation, stress test the most recent crypto flash crash, run “what-if” scenarios, analyze VAR or expected shortfall, and monitor margins on their leveraged positions.
All crypto asset managers need to make sure they have the proper systems in place – the good news is that the technology already exists.
Bitcoin IV, the “Financialized era” is bringing an enormous number of players to the table: countries, corporations, ETF issuers, lenders, borrowers, banks, mortgage issuers, and retail investors. To respond to and service all of these players, banks and fund management companies need to provide direct crypto exposure or package Bitcoin with other assets within in a fund or ETF, as an arbitrage strategy between stocks and Bitcoin, or packaged with a loan for collateralization. This requires trading and portfolio systems that are capable of managing a wide number of asset classes simultaneously – not only crypto but futures, options, equities and bonds.
Additionally, Bitcoin IV brings the need to trade in size, as some market players are now trading several hundred millions of USD per day in crypto currencies. At these levels, liquidity cannot be found on exchanges or even across several venues using an SOR. This requires new trading protocols like RFQ (Request for Quotes) and RFS (Request for Stream) to access liquidity in size from OTC players such as banks or market makers. These are must-haves for crypto asset managers, along with arbitrage tools and a multi asset class risk, portfolio and execution management system.
But wait… there’s more! What about Bitcoin 0? Created on the blockchain, it contains the entire history of BTC transactions recorded on-chain including every move, size, quantity, time stamp, etc… Crypto traders can harvest this data and use smart analytics to improve decision making. Systems that were thought to be sufficient to manage trading are now in need of an overhaul. Can you identify the hidden signals of whales accumulating coins when weak hands are capitulating? Are you able to identify an increase in Coin-age coupled with a spike in open interest and an abnormal skew level? These are the types of tools that will help crypto traders to keep up with and gain an edge over their competitors.
Innovations in blockchain and crypto trading are provoking market disruptions and forcing asset managers to review and upgrade systems. All crypto asset managers need to make sure they have the proper systems in place – the good news is that the technology already exists. With a robust, multi-asset class trading, portfolio and risk system, crypto traders can gain invaluable foresight and transparency, which leads to greater efficiencies and better performance.