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Bitcoin Custody Giant BitGo Launches Institutional Trading Service

This article is more than 3 years old.

BitGo, a leader in digital asset financial services, announced today that it is now offering institutional trading services through its new entity BitGo Prime.

The ability to seamlessly trade from secure, insured cold storage is being offered exclusively to BitGo Prime clients, whose assets are held with qualified custodian BitGo Trust.

The launch follows a lengthy private beta during which BitGo Prime worked closely with leading institutions to hone and refine its trading and lending offering. 

Institutional Grade Service For Trading Cryptocurrency

It’s an important development that has the potential to be impactful to cryptocurrency markets as institutional investors comprising hedge funds, fiduciaries, asset managers, fund managers and Registered Investment Advisors, will now have the same institutional grade trading services in the cryptocurrency world that exist in the traditional world of securities today.

Institutional grade trading services makes it easier for institutions to participate in cryptocurrency investing and that’s important as while institutional money has been the backbone of global equity and bond markets, the cryptocurrency market hasn’t yet seen large inflows of institutional money and that’s held the market back.

Part of the reticence on the part of institutional investors is that there hasn't been the robust market infrastructure in place that more mature markets, such as equities, have today. Without this in place it is challenging for institutional investors to fully participate in the market.

Institutional participation is important for the success of the cryptocurrency market as their involvement will lead to increased liquidity, a narrowing of spreads, a reduction in volatility and an appreciation of asset price as demand for cryptocurrency increases.

As cryptocurrencies become more mainstream through institutional adoption, they will start showing up in the portfolios of corporate investment vehicles, corporate pensions, trusts and 401(k)’s.

Regulated Investors Need Regulated Partners

I recently sat down with Mike Belshe CEO of BitGo and BitGo Prime CEO Nick Carmi to understand more about the company and why BitGo believes prime services are essential for the adoption of cryptocurrency by institutions.

Established in 2013, the company started with a simple mission — to secure the world’s bitcoin.

In those early days the company was focused on providing wallet technology as opposed to financial services with the assumption that the well known traditional financial services incumbents would adopt BitGo’s technology and start to offer services, such as custody, powered by BitGo’s secure multi-signature wallet technology.

However, as the market was slow to bring these services to market, and with fiduciaries knocking on BitGo’s door looking to get into the cryptocurrency market, the company felt it had no choice but to start offering custody services itself, rather than purely limiting itself to being a technology provider.

Belshe, points to the fact that there are five distinct and separate financial services roles that exist in traditional financial services which service institutional money but weren’t around in the nascent cryptocurrency market of 2013 and arguably are only starting to emerge in a meaningful way today.

In Belshe’s view many of the early institutional custody and trading platforms had significant limitations which made them unappealing for institutional investors because of their lack of regulatory oversight and operational controls.

“Regulated entities need regulated partners, it’s as simple as that. So if you are a fiduciary, RIA, asset manager or hedge fund manager, you need someone who is going to meet your levels of standards of certification” explains Belshe, painting the picture of how institutional custody is somewhat of a different beast to retail cryptocurrency custody.

Over the last seven years, the company has expanded from being a bitcoin wallet technology provider to providing a range of custodial and non-custodial services supporting a dozen blockchains and over 200 cryptocurrencies. “We’re the largest digital asset custodian in the world”, boasts Belshe, before pausing to clarify that Coinbase might be larger. Certainly over 20% of all bitcoin transactions today are performed using a BitGo wallet.

However, the firm has set its sights on a broader aim than simply being a cryptocurrency wallet and the company has been busy building up its digital asset business, under the supervision of recent hire Nick Carmi, a Wall Street veteran from Lehman and Deutsche Bank who was parachuted into the role to build up BitGo’s financial services division.

Carmi was quick to expand the company’s institutional footprint as BitGo which went on a string of acquisitions as it grew into providing integrated financial service to institutions in the digital asset space.

In February the company bought digital security issuance platform Harbor, which provided them with a broker dealer regulated by the Financial Industry Regulatory Authority and a transfer agent supervised by the Securities and Exchange Commission. That was followed by the acquisition of institutional digital asset platform Lumina in April. In March, the company launched a lending service to its institutional investors.

That leads us to today’s announcement that the company’s long-piloted prime services trading business is now live, with Carmi now taking the helm as the CEO of their newly formed BitGo Prime group.

The Need For Prime Services

While BitGo has been building out a number of services for its institutional clients, it remains committed to a vision of providing institutions with the means to plug into into a fabric of services provided by other financial service providers.

That’s a markedly different from the approach taken by some of the large cryptocurrency exchanges in the space which have instead sought to bring all the various services associated with supporting institutions into a one-stop-shop.

Belshe fundamentally believes that this consolidated model won’t work for institutional investors.

“One of the things that differentiates Bitgo, and you will see this with all the things we have put together, is that it is very much in mind with helping that market structure come together.”

In the traditional world, Belshe explains, institutional investors, have come to expect financial services providers to have specialism and tend shy away from organizations that provide multiple services under one roof — such as a combined exchange and trading capability, as well as retail and institutional offerings — as these entities risk becoming spread too thin.

“Specifically I don't think in the end you’ll see a single exchange that is the buyers broker and sellers broker and clearing house all in one,” explains Belshe as he walks us through BitGo Prime’s key philiosphy, “and that’s holding actual back the industry and institutional clients. Why? If you are trying to take a $50m position, you’re not going to write a check to Coinbase. That’s not how markets work. It would be a dereliction of duty.”

By way of an example to explain the dangers of not specializing, Belshe points to how most of the major hacks in the cryptocurrency space have occurred not in companies that specialized in custody solutions, but those that provided multiple services such as exchange and custody services. “Institutions value specialization”, explains Belshe.

Belshe omits to mention that BitGo itself has been associated with a hack — in 2016, Bitfinex, a digital currency exchange using BitGo software, announced it had suffered a security breach. That said, BitGo was not itself hacked, but processed withdrawal requests from the hacker, who had obtained access to Bitfinex's key, so Belshe’s point does still stand.

Sourcing Liquidity And Avoiding Front-Running

Not only do institutions value specialization but they also prefer to distribute their trading activities across multiple venues, which is something that isn’t necessarily possible as a customer of one of the walled gardens that provide both exchange and custody services.

There’s a number of reasons why institutions favor this model of spreading their business around multiple venues. For one, given the large notional sums that institutional investors are trading and safeguarding on behalf of their clients, they need to mitigate the risk that a given counter-party is compromised or becomes insolvent.

Insolvency of a custodian or an exchange isn’t something that is top of mind for retail investors given how relatively small their investments in cryptocurrency tends to be in comparison to institutions that may be managing tens, if not hundreds of millions of dollars in capital.

Another reason that institutions favor diversification of their trading partners is be able to trade without overwhelming the liquidity of a single venue. In the traditional world of equities in the U.S., “best execution order routing” ensures that liquidity can be pooled from across multiple exchange venues to provide the buyer or seller with the best price based on an aggregate inventory of liquidity.

However, this doesn’t exist in cryptocurrency exchanges today as they are not linked together and have no regulatory requirement provide the best bid and offer.

With the average trade made by an institutional investor being thousands of times larger than a typical retail customer — who currently dominate cryptocurrency trading today — it doesn’t take much volume from an institutional player to materially affect the price of bitcoin on an exchange even if there is liquidity in other venues.

For markets to be efficient, there needs to be a prime broker that is able to source liquidity from not just exchanges but also over-the-counter venues, and be able to also manage the clearing and settlement of these assets across these multiple exchanges. That’s a role that institutions would struggle to take on themselves today, and where BitGo is placing a firm bet that the buy side will increasingly be looking to the organization for assistance.

Confidentiality is a another challenge that the buy-side faces, especially in thinly traded markets. With institutional investors being able to move markets given their outsized volume in relation to retail investors, it’s possible for astute investors to make money by front-running large orders — either with exchanges themselves trading ahead of their clients, or by traders using sophisticated algorithms that can detect signals of large buy side orders.

While Belshe is quick to clarify that he’s not suggesting that any of the major crypto exchanges are front-running, it is a fact that crypto exchanges don’t have to play by the same rules as regulated traditional exchanges and therefore, in Belshe’s view, “you can’t prove [to an institutional investor] that they’re not front-running”.

To work round this, prime services both look to drip orders into the market into a number of venues, timing transactions in a way that minimize detection by front-runners. They also offer a mechanism to obfuscate the trading parties which can go some way to provide confidentiality. This fully non-disclosed model places the prime broker in the middle of the counter-parties so that its harder for market participants to detect if there is a buy-side institution placing a large order in the market.

Speaking The Same Language

While the infrastructure that enables access to multiple venues and custody solution is key to adoption, there is a softer, more subtle side to prime brokerage services that is equally important. And that’s the high-touch human element that is provided to institutional investors by prime brokerages.

Unlike the retail model whereby hundreds of thousands of investors are handled at scale through automated call triage, customer service robots, and large impersonal call centers, the institutional investor pool is smaller, and the notional value of their trades far higher.

Institutional customers expect to be able to contact their account manager whenever they need them, and be able to receive a “white-glove” service from someone with a Wall Street background that speaks in their vernacular. Institutional clients want guidance, insight into the market and advice as opposed to purely transactional based execution services.

That’s an area where the BitGo team also believe they have a leg-up having recruited a team from traditional Wall Street banks.

Field Of Dreams?

While Kevin Costner’s character in the iconic movie “field of dreams” was guided by a disembodied spectral voice that assured him that “if you build it they will come”, it’s unclear whether institutional investors, now provided with the infrastructure to be able to invest in cryptocurrency, will actually enter the market.

After all, cryptocurrencies still represent a small asset class with relatively little historical information with which to be able to understand correlation with other assets. It’s also an asset class with an exceptional level of volatility which would violate the mandates of many asset managers and fiduciaries who are focused on stable and predictable returns.

Although Belshe accepts that uptake of cryptocurrency among institutional investors “has been elusive”, he’s sanguine about the prospects for cryptocurrency adoption, pointing to a common pattern in new asset classes where the aggressive early adopters, such as hedge funds are increasingly replaced in a second wave by the larger conservative institutions. These organizations are far more driven by the demands of their clients which takes longer to materialize.

And while the launch of bitcoin futures on the CME was a spectacular flop out of the gate, seemingly suggesting that institutions weren’t that interested in bitcoin after all, other indicators, such as this month’s record amount of open interest on Panama based bitcoin exchange Derabit, suggests that institutional demand may be a lot stronger than many had feared.

That timing may not be co-incidental as it may be that inflation fears surrounding global fiscal stimulus efforts in response to the Covid-19 pandemic may actually be spurring demand at both the retail and institutional level. An accelerated adoption of bitcoin as a form of digital gold to hedge against inflation concerns may be the industry’s silver lining on an otherwise very gloomy cloud.

Belshe doesn’t believe that the full effects of the current round of global quantitive easing has been felt in the market yet which means inflation could be coming soon. Topping $7 trillion, the Fed’s balance sheet doubled in the first quarter of 2020 after the central bank printed over $3 trillion through rescue packages and quantitative easing.

That bitcoin may be an effective hedge against the looming threat of global inflation is a viewpoint shared by a number of hedge funds and investment banks.

Paul Tudor Jones, a leading hedge fund manager, revealed earlier this month that he has a firm crypto investment strategy in place, allocating 1-2% of his assets in Bitcoin. While Goldman Sachs GSBD has already invited investors to an event to discuss Bitcoin, Gold and Inflation.

Digital Assets - 24 Months Down The Road

What’s next for the company? With its recent digital asset and brokerage focused acquisitions, it seems that the next frontier for the company could be asset backed securities, as opposed to pure cryptocurrency.

But that appears to be a longer play for BitGo which today still derives 85% of its business from bitcoin transactions and remains one of the largest liquidity providers of the booming wrapped BTC / wBTC asset class that represents bitcoin on the Ethereum network.

The company clearly sees an opportunity in the digital asset space, but it’s not something that is going to materialize any time soon. Belshe acknowledges that getting digital assets going has been “hard job”, stating that while there are irons in the fire “by that’s more of a 24 month horizon.”

Institutions vs. The Cypherpunks

Wall Street adoption of cryptocurrency has been somewhat of an oxymoron for the bitcoin community given that part of bitcoin’s initial appeal was that it was able to circumvent the perceived greed and abuse of power of investment banks.

Yet institutional adoption is key for cryptocurrency to achieve mainstream adoption and for that you need middle men such as prime brokers with ties to the investment banks.

That’s a bitter pill to swallow for the crypto cypherpunks, but maybe a neccessary one.

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