Source: Tom Wilson and Pravin Char for Thomson Reuters, September 10
“Hi guys, could you please show me a firm bid for 100 bitcoin?” a seller texts on Skype.
“One sec. $10270.”
Two minutes later: “Sorry guys, that was an old order from Friday when skype wasn’t working.”
“I really think we should get off skype. Bad things could happen. Someone is going to make an expensive mistake.”
A messaging exchange over a potential $1 million deal, between a European asset manager looking to sell bitcoin and broker Joel Fruhman, illustrates the casual and often chaotic nature of cryptocurrency dealmaking.
Trades involving hundreds of thousands, or millions, of dollars are routinely struck via brief chats on apps like Skype, WhatsApp, WeChat or Zoom, often with scant certainty over the identities of participants or the legal basis of agreements.
“We’d end up in a Zoom call with about five ‘introducers’ – we didn’t really know who any of them were,” said Fruhman, a physicist by training who started a cryptocurrency brokerage business with his brother Dan in their British hometown of Manchester in 2018.
“And who were we? What was our credibility?”
Over-the-counter (OTC) trading – buying and selling through a broker – is now beginning to change, however.
It is moving towards electronic automation as the cryptocurrency sector matures from the province of online enthusiasts to emerging financial assets drawing increasing mainstream interest, Reuters interviews with more than a dozen industry players show.
This is a fundamental shift, as messaging apps have for years been the predominant platforms.
It is a key front in attempts by cryptocurrency enthusiasts with roots in the traditional finance industry to drag into the mainstream a singular, largely unregulated sector born on the web a decade ago as a symbol of rebellion against the establishment and offering users near-anonymity.
OTC trading is favoured by big investors like hedge funds because cryptocurrency exchanges often suffer from thin liquidity, and large buy and sell orders can move the market.
But the opaqueness of the messaging process and its impracticality for use on a large scale, plus the glitches that could cause the “expensive mistake” warned of by Fruhman, have left it fraught with risk.
Now, as spreads – the differences between bid and ask prices for immediate orders – tighten as liquidity in crypto markets grows, OTC brokers and market makers are seeking to move away from unsophisticated chats and offer quotes electronically, with automated execution and settlement.
“Things have shifted quite rapidly towards electronic trading,” said George Zarya, CEO of London-based cryptocurrency exchange BeQuant, which also runs an OTC desk and is planning to switch towards automation.
“Anything that is liquid – bitcoin or ethereum – these markets are going to go electronic. That’s a natural path that traditional markets have gone through.”
The changes are likely to appeal to larger investors using algorithms and high-frequency trading for whom split-second timings are important, according to the interviews with cryptocurrency OTC brokers, market makers and investors.
Alameda Research, a crypto trader based in California and Hong Kong, launched an almost entirely automated OTC desk around six months ago that is already seeing flows of $20 million-$30 million a day, said Ryan Salame, its Asia-Pacific head of OTC.
For Salame, the future of OTC trading is electronic, with prices for all but the smallest coins to be quoted electronically.
“This is just the next step how you stay more competitive. Each desk is trying to be more competitive and making better systems,” he said. “It’s just a by-product of spreads coming in so much that I can’t update in the chat fast enough to give people the pricing they’re expecting.”
“Can you sell a few mill?”
The Fruhman brothers, Joel aged 29 and Dan 28, built a contact book packed with bitcoin miners they met on internet forums and apps as they grew interested in the emerging technology.
Miners use computers to solve complex mathematical puzzles, competing against others and earning rewards in the form of new digital coins. As recently as a few years ago, individual crypto enthusiasts could mine bitcoin from their bedrooms.
But many had a problem, the Fruhmans found: They were producing bitcoin faster than they could convert them to the cash they needed to clear the hefty electricity bills run up by their high-powered computing gear working overtime.
“We saw something very clear: A bunch of guys with a lot of bitcoin valued in USD, who had no idea how to turn that into money,” said Joel. “It started with one request, which was just one of these guys, our mate, who was like: ‘Can you sell a few mill?'”
Late last year, in an attempt to tap bigger investors and offer more sophisticated back-office services, the brothers swapped their contact book for a stake in a startup run by ex-financiers well-versed in the infrastructure of the financial system, from escrow accounts to settlement systems.
The startup, BCB Group, then based in London’s financial district, offered something the Fruhmans lacked: regular access to clients from mainstream finance willing and able to buy the regular supply of digital coin offered by their mining contacts.
“It’s not the stoned 22-year-old that we were dealing with a year and a half ago,” said Joel. “And it’s not the equity traders, the Goldman Sachs. They’re kind of in between – it’s growing from one into the other.”
Trade blossoms in bitcoin bubble
Global cryptocurrency trading volumes are highly erratic. Over the past year, bitcoin alone – by far the largest coin – has seen daily volumes of between $900 million and $3 billion, according to research firm Coin Metrics.
Brokers estimate the OTC market typically accounts for 10% to 30% of global volumes on any given day.
The OTC market blossomed as bitcoin’s value soared during its 2017 bubble. That was when miners, wealthy individual investors, hedge funds and companies earning revenue in crypto grew active in the market.
Now, said the industry players who spoke to Reuters, the market is seeing a new shift as the predominance of messaging apps wanes and the more sophisticated tools used in traditional markets like equities and bonds become increasingly common.
“Doing stuff over Skype and over these voice chats is not really scalable,” said Kevin Zhou, co-founder of San Francisco-based OTC desk Galois Capital.
The evolution is partly being driven by newer entrants to the sector, many of whom are tooled up with cutting-edge tech. Some, like Chicago-based Jump Trading, are from the traditional proprietary trading worlds. Others, such as Alameda Research, specialise in cryptocurrencies.
And the changes are popular with big investors.
“I prefer to use electronic because all our algorithms are fully automated,” said Andrea Leccese, president of Bluesky Capital in New York, an investment firm that often runs orders of $5 million-$10 million through OTC desks. “If we can send our quote electronically to the OTC broker, it’s much better for us.”
“It’s fair to say more or less half of OTC trading is going through technical innovation like making fully electronic platform, and that’s even better on our side.”
Cryptocurrency regulation is patchy across the world, with curbs on the illegal use of digital coins the priority, and the implications of increasing automation in OTC trading are unclear. But, some market players say, because the changes are likely to attract more mainstream investment they could be a factor in speeding up the introduction of the kind of securities rules seen in traditional markets.
Machine VS Man
While increasing automation may be inevitable, many OTC desks are in a bind. Some clients are loath to ditch the personal relationships they have established with their brokers and the apps they use to communicate.
New York-based Genesis Global Trading sees around $1 billion a month in volume, CEO Michael Moro said. While that’s down from the $2 billion-$2.5 billion a month during bitcoin’s 2017 boom, volumes are now rising between 10% and 20% a month.
Genesis uses TradeBlock, a New York firm that provides tools for trading cryptocurrencies, to execute its deals – but can’t completely abandon messaging apps.
“We will give market colour over (Skype), but the actual transactions are over TradeBlock,” Moro said. “When your clients that are buying $5, $10 million say, ‘Hey, let’s just chat on Skype’, to get them to change their behaviour and say, ‘No, we don’t do Skype’, you end up creating a friction.”
For the Fruhman brothers, personal relationships will remain key.
“The plan is to go to an automated platform, where they’ll be able to request quotes on our front-end website,” said Dan. “But the interesting thing is that a lot of people actually like the human-to-human interaction.”
“It’s not just ‘like’,” said Joel, quickly. “If you’re trading $20 million, you’re not clicking a button – you want to push on the price, you want to get a feel, you want to maybe break it up.”
“I think there’ll always be this human OTC component for institutional clients.”