Pro traders scoff at crypto, but trade it anyway: ‘The market structure is evolving’

view original post

As crypto sheds its stigma as nothing but a handy channel for criminals and money launderers, banks have so far treaded carefully. 

Goldman Sachs and JPMorgan are among big banks that have dipped their toes into trading crypto — not crypto per se, but futures contracts and other instruments — to reap the volatility and potential returns enjoyed by armchair traders and HODL fanatics during the pandemic.

This rising institutional interest is changing the architecture of the market, says research firm Coalition Greenwich.

“The market is shifting from spot trading and physical ownership, e.g., holding bitcoin, to both physical and financial instrument ownership, with the market adopting traditional financial products like digital asset securities, futures, options and exchange-traded funds and products,” market structure and technology adviser David Easthope wrote in a Greenwich report this month. “As traditional institutional investors, fund companies, custodians and banks become active in digital assets, the market structure is evolving.”

Data from the firm shows crypto-linked ETFs and other products are favoured by 61% of buy-side institutions, versus 27% who want direct physical ownership.

How this all plays out comes down to the scaffolding of the digital-asset market as it develops and how big a role regulators play going forward — the last thing any financial institution wants is to get sued. Currently, traditional finance firms are loath to hold spot crypto “due to its nature as a bearer instrument,” Easthope says, meaning it behaves much the same way as a £10 note does — no ownership data, no records, no rules about recording any transfers.

That’s terrifying for financial institutions who are regulated to the gills, forced to provide details on custody and security, to say nothing of banks’ already onerous capital requirements.

Easthope says most of traditional finance now accepts crypto “not as a flash in the pan but as a new asset class that must be examined closely.” But, notably, he adds: “Certainty is not a given.” 

In the meantime, the macro environment — skyrocketing inflation, the decade-plus long bull market in stocks — is playing a key part of booming demand for crypto.

Goldman Sachs, which said earlier this month that it predicts bitcoin reaching $100,000, sees crypto as a hedge against expanding inflation and that it could take market share from gold. Bitcoin’s $700bn market capitalisation commands roughly 20% of the “store of value” space — which Goldman defines as bitcoin and the value of gold used for investment combined.

Also stoking demand: the soaring stock market, which is clobbering any- and everyone who isn’t a passive bull just riding the index.

With only a few exceptions, hedge funds for the most part were unable to outperform the S&P 500 in 2021. Understandable — the benchmark surged a hard-to-beat 27% — but for firms that demand high fees and employ the market’s best and brightest stock pickers, it’s an embarrassment nonetheless.

For funds that invest in crypto, though, 2021 was a different story. Hedge fund data firm HFR found that funds investing in cryptocurrencies led all hedge funds in 2021, with the HFR Cryptocurrency Index surging an astonishing 215%. That beat 2020’s return of an only slightly less astonishing 193%. 

It’s telling, then, that while the CEO of Man Group, one of the world’s biggest hedge funds, told the Financial Times last year that crypto has “no inherent worth,” he said his funds go ahead and trade them anyway. The volatility is just too tempting to pass up. JPMorgan’s Jamie Dimon has famously echoed similar views, saying “bitcoin is worthless” while setting up a digital asset unit at the bank.

Indeed, Dimon added a caveat when it came to JPMorgan clients: “If they wanted to have access to buy or sell bitcoin, it’s hard — we can’t custody it, but we can get them legitimate, as-clean-as-possible access.”

Hedge fund boss Paul Britton, CEO of Capstone, told Financial News this month: “We have crypto exposure, but it is because we follow certain trends. We don’t see it as a long-term store of value in portfolios.” 

Professional bank traders are just as pragmatic. A London equities trader told FN last year that he and his pals in banking play the crypto markets via their personal accounts, or PAs: “I’ve never held a stock PA as I’d be fired. But I am invested in 10-plus cryptos as they’re not even mentioned. My compliance officer literally said, ‘Please don’t talk to me about cryptos. I’d prefer it if I didn’t know.’”

As many banks don’t trade physical crypto, there’s no conflict of interest among employees so compliance departments can sleep at night. For risk-addict traders, belief in the viability of the underlying asset class is irrelevant. 

That’s the paradox about crypto when it comes to banks, hedge funds and big professional traders: The smartest in the market may not think crypto is here to stay. But for now, while the markets are ripe and regulators are at bay, they’ll be damned if they don’t try to make some money off it anyway.

To contact the author of this story with feedback or news, email Trista Kelley