12 November 2020

The future of crypto market infrastructure

Yara Ainsworth

Yara Ainsworth

Head of Marketing und Communications bei Crypto Finance AG

Über den Autor

Author: Paul Gordon, Founder, Coinscrum

Source: Building Blocks – Crypto asset developments in the wake of COVID-19. Would you like to read our Building Blocks magazine? Please sign up for your digital copy via the form at the bottom of the page.

The future of crypto market infrastructure

The traditional investment community has shifted its view about bitcoin and other crypto assets from complete disdain to serious consideration and even perhaps outright acceptance over the last two to three years. Consequently, the drive to lay down the market infrastructure to support institutional access to these still immature markets, has picked up pace.

Some of the biggest investment and M&A deals over the past year have targeted this segment:

  • Hong Kong’s electronic broker, Amber AI closed a USD 28 million Series A round in February this year.
  • Coinbase acquired US-based agency broker Tagomi for more than USD 70 million.
  • Long-established OTC broker, Genesis Trading, acquired custodian Vo1t to support its move into crypto prime services.
  • Agency broker FalconX raised a USD 17 million seed round.
  • SBI Financial invested USD 30 million in leading European market-maker B2C2.
  • VC veterans Lightspeed Ventures made their first crypto play with a USD 2.5 million stake in London-based liquidity providers Wintermute.

Added to the mix, the growth of clearing and settlement services has gained traction with the likes of Koine and Copper in the UK. There was also a move into digital asset custody by Fidelity, Nomura, Standard & Chartered, and Northern Trust.

Meanwhile, regulatory clarifications from Germany’s financial authority BaFin were offered last year on the banking sector’s right to take custody of these assets. The US Office of the Comptroller of the Currency (OCC) also permitted national savings banks and federal savings associations in July, to provide cryptocurrency custody services to their customers.

What we can safely assume from these developments is that a more substantive and compliant foundation is finally being laid down. We still have some way to go, however, before all of the pieces have fallen into place. When these do, this will enable direct institutional interaction with physical spot markets.

Interestingly, this is where the vast majority of liquidity still resides on what are mostly unregulated and retail-focussed trading venues. Hedge fund manager Paul Tudor Jones may have for instance argued strongly for owning bitcoin directly with his investors, but in the end he chose to gain exposure within his fund using cash-settled CME futures.

To put this into context, Fidelity’s June 2020 Institutional Investors Digital Asset Survey showed that the number of US respondents indicating that they already had direct exposure to digital assets had increased by 7% year-on-year from 55% to 59%. In stark contrast, there was a 244% year-on-year increase from 9% to 22% for those who gained exposure by using futures: this could be seen by similar levels of growth in trading volumes and open interest in the CME futures product over this period.

Conversely, the physically settled contracts offered by ICE-owned exchange Bakkt, has so far failed to achieve the same level of growth in capturing market share as daily traded volumes are just a fraction of those reported on the CME.

By contrast in Europe, the asset class was overall more positively perceived during the survey period (35% vs 24% for their US counterparts). This may well indicate that the more proactive approach taken by regulators in Switzerland, Germany, and the UK has helped engender an increased level of trust in the industry.

Indeed, with the US SEC having persistently rejected multiple bitcoin ETF applications so far, the approval by BaFin to list the first centrally cleared bitcoin ETC on XETRA represents a positive step forward.

These moves in Europe will have no doubt, influenced the OCC’s move mentioned above.

The tide is clearly turning with the cautious, if not outright dismissive, commentary that once emanated from regulators and legislators towards the industry. It is gradually being replaced by tentative support on a trans-jurisdictional basis.


I can safely say that I began thinking about how the market’s infrastructure for digital assets might need to evolve earlier than most.

I have traded financial derivatives for the best part of 20 years. When I first became interested in bitcoin back in 2011, I was convinced from the beginning that this new asset class would eventually attract the attention of the traditional investment community.

I was equally convinced that a trading ecosystem that consisted of an ever-increasing number of stand-alone, unregulated trading venues was certainly not going to meet their needs.

The prevailing model where the functions of exchange, custody and settlement were all performed by the same single entity would clearly need to be unbundled. This would not only address the obvious and inherent counterparty risk, but also the massive levels of market fragmentation that was rapidly occurring.

Although I did myself put many of these ideas into action with a startup project back in 2014 – like two or three companies did around the same time – we had arrived too early in the market.

However, with many important lessons learned along the way, it is gratifying to see how this market is now rapidly heading towards the architecture I envisioned back then.

Building blocks

I always thought – to begin with at least – we would need to model some basic level of infrastructure on top of what existed in traditional markets to conform with both clients’ needs and existing regulatory requirements. This would no doubt become the standard in this industry. However, it would be an injustice to bitcoin’s ground-breaking innovation if, over time, the technology itself was not utilised in such a way as to improve upon the out-dated market infrastructure we have in general.

Yet at the same time, future inventions would always continue to emerge and enable iterative upgrades and improvements along the way. And, this would happen within an open source software design ethos, which would lay the foundations for these new concepts. By knitting together these building blocks, the industry would gradually evolve in unison.

Relying on entirely proprietary systems would be doomed to failure in this new environment. In the traditional sense, seeing brands such as Fidelity, Nomura, and Standard & Chartered stepping in to provide full, yet centralised, digital asset custody will certainly open up the market to institutional participants. It will do so in a compliant manner, where regulatory clarity will continue to open up banking service provisions for more diligent exchange operators.

Banking service providers such as Silvergate & Signature in the US, BCB Group in the UK, and SEBA in Switzerland are now providing what has always been the most challenging service for crypto firms to attain. With all of them innovating simultaneously, distributed ledger technology (DTL) is already bringing efficiencies to payment processing ahead of the much-touted versions that commercial banks and central banks are currently experimenting with.

Industry veterans such Genesis Trading in New York are now in a strong position with their USD 1-billion-plus lending book and new custody division, to provide prime services in a recognisable fashion. Bitgo, B2C2, and Coinbase are also making their moves into this sector.

Exchanges are finally recognising that independent custody and settlement services provided by the likes of Koine and Copper provide both capital efficiencies and ring fences that institutional clients demand.

In terms of innovation, multi-party computation key management solutions from FireBlocks, Qredo, and Sepior among others, are rapidly emerging as a viable alternative to the cumbersome cold storage custody model which, while certainly secure, pretty much defeats the purpose of bitcoin’s ambitions and benefits by design.

Independent policy control systems such as Lacero’s, are enabling the adoption, management and control of digital assets within larger organisations.

X-Margin and Recap have developed calculation agent and accounting platforms using zero-knowledge proof technology that not only enhances the digital asset trading arena, but could also loop back and enhance traditional market infrastructure too.

Meanwhile, more experimental innovations, including second-layer scaling solutions, may ultimately bring about even greater speed and efficiencies for settlement without the need for trusted third-parties and are already being trialled. Examples include Digital Garage’s clearing network built on top of Blockstream’s Liquid Sidechain system and LN Market’s derivatives trading and settlement platform built on the Lightning Network.

The killer app

So why still the adoption-gap between physical and synthetic exposure for institutional participants?

As many front-office personnel within regulated financial institutions will attest, any resolve they may have to enter the digital asset market often meets its end at the door of their compliance departments.

Blockchain forensics platforms like Chainalysis and Elliptic are admittedly, proving themselves as proficient tools for validating the transaction history of crypto assets. However, any requirement to document the exact identity of a transacting counterparty is unlikely to satisfy current needs.

It may not be the view of your average bitcoin purist, but I am (boringly) a bit more of a pragmatist. I have always believed that “digital identity” would ultimately be the killer app to enable mass adoption of the technology.

Law is still more powerful than software and legislators will usually get their way. The signs are there that they are starting to force the industry’s hand.

Last year, the Financial Action Task Force (FATF) stated that virtual asset service providers (VASPs) must apply the travel rule, and share originator and beneficiary information in cryptocurrency transactions above a certain threshold with exchange operators, who are now working out how best to enact these rules.

Meanwhile, Facebook is pressing ahead with its Libra stablecoin project. It has already agreed to conform with regulatory demands and although digital cash is the headline use-case for their technology, digital identity is clearly baked into its design. This is something that will be welcomed by government authorities when it instantly lands in the hands of three billion global Facebook users, even if they do not yet realise it.

It seems clear that we are heading in that direction. What this will mean once it proliferates, however, is the million-dollar question?

In its simplest form, digital identity could indeed be the killer app that opens up mass adoption, getting compliance officers comfortable to boot.

However, if its design is enforced by the legislators themselves, it could lead to an invasion of privacy and a level of oversight that does not bear thinking about. It is therefore essential that those operating within the blockchain and crypto asset industry lead the charge and utilise the tools at their disposal to develop identity systems that introduce an appropriate balance between privacy for the individual and oversight for law enforcement (but only when absolutely necessary).

Companies such as GlobaliD (among others) are already working on such solutions and it will certainly be a fascinating area to watch evolve over the next few years.

In recent weeks the operators of both the Tether and USDC fiat-backed stablecoins, the precursors to what will inevitably lead to central bank issued digital money, have both announced the blacklisting of account balances at the behest of law enforcement bodies.

Ultimately, money, in whatever form it takes or on whatever rails it runs, is just a dumb object and should not in itself be given a clean or dirty status.

It is the reputation of the transacting parties that matters.

When we reach the point that both money and identity can be transmitted in parallel, discreetly and privately through the same pipes, then the magic will really happen.

About the author

Paul Gordon, Founder and CEO of Coinscrum, is a former interest rate derivatives trader and broker with over 20 years’ experience. He organised Coinscrum, one of the world’s oldest bitcoin and blockchain networking groups in London in 2012. Since then, Coinscrum has introduced over the years, some of the industry’s most prominent projects. He invests in and advises a number of early-stage blockchain-based projects and is currently producing a weekly video podcast that covers news, analysis, and opinion from across the crypto trading ecosystem.