Buy and sellside market participants are looking at derivative and synthetic instruments as a potential avenue for institutional participation in the crypto currency markets, according to a new report – Cryptocurrencies: The Road Ahead May Not Be Cryptic Anymore – from Coalition Greenwich.
The study. which polled over 100 global market participants across the buyside, banks, brokers, exchange operators and fintechs, suggests that non-deliverable forwards (NDFs) could provide an effective solution by fitting the crypto product into existing frameworks of risk management and technology.
This would make the approval process quicker. In addition, due to their OTC nature, NDFs are relatively easy to manage (e.g., there are no margin issues with exchanges), plus the risk-management philosophy is well embedded into the current setup across all banks.
Moreover, the product provides flexible access 24 hours a day and has the ability for contracts to expire on bespoke days.
“Our research makes it clear that, once they receive internal approval, virtually all large liquidity providers would be able to hit the ground running with NDFs and make markets,” says Subodh Karnik, Head of Client Intelligence Marketing at Coalition Greenwich.
Overall, the consultancy found an “interesting divergence of views about the future of the crypto markets.”
While there is broad consensus around the focus on digital assets going forward, bank and broker participants expect a third of crypto volume in the coming years to be executed on fully decentralised exchanges, while the buyside thinks under 15% will be handled by non-Securities and Exchange Commission/Commodity Futures Trading Commission venues.
In contrast, fintech firms expect about half the volume to go through that channel.
It also noted that while request for quotes (RFQ) is pervasive today, market consensus is that over 50% will transact via central limit order books (CLOBs) within two years.
The view is that expanding cryptocurrency demand will lead to wider adoption, as market participants devise innovative ways to repurpose derivative instruments with broad reach, said the report.
However, all market participants were on the same page on the main challenges. They note that for the size of the activity required to make their participation in the crypto market relevant, the current physical format is not fit for purpose.
They cite a lack of regulatory clarity and multiple challenges in adopting the current in-house infrastructure to accommodate physical trading make trading physical crypto assets a non-starter.
This has made many traditional financial market players as either liquidity providers or buyside participants slow to jump on the bandwagon.
In addition, the report said, banks interested in participating in the new asset class face their own set of challenges in the form of product and risk approvals in an entirely new product environment.
©Markets Media Europe 2021