Secret business ventures piling into crypto are first sign of widespread adoption – Reuters

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Since bitcoin first appeared on the tape in the early 2010s, a group of secretive investment firms that profit from super-fast trading systems have been working in cryptocurrencies.

Now, the rest of the traditional investing world could finally catch up.

Jump Trading, Jane Street and Tower Research Capital are among the American giants of a class that goes by many names of high frequency traders, or HFTs; algorithmic market makers; liquidity providers; and systematic quantitative trading companies.

Whatever you call them, they are quietly forging a path that experts say other big financial firms are likely to follow. Every once in a while the spotlight finds them, as was the case in 2014 when author Michael Lewis chronicled their exploits in his book Flash Boys.

More recently, the HFT mob materialized in lawsuits against crypto firms Binance and FTX, the cryptocurrency exchange that went bankrupt in November.

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Initially, crypto appealed to them because it was so volatile, Niki Beattie, founder of financial markets advisory firm Market Structure Partners and president of ClearToken, a digital asset clearinghouse, told DL News.

Perfect conditions for cryptos

The conditions in crypto are perfect for sophisticated traders: rocky markets mixed with a relatively uninformed base of retail investors who lack the super-fast computers that big hedge funds have. Fast trading firms use super-fast algorithms that can scan prices, look for tiny slivers of difference, and then pounce.

You might see a company deposit $50 million or something like that. It’s nothing when you manage 100 billion dollars

Once issues such as regulation and risk of default are ironed out, the floodgates for more mainstream adoption will open.

We now have this bridge between retail markets and institutional markets, Beattie said. Companies like BlackRock etc. recognize that digital assets are the way forward. HFTs are the first sign that was pointing in this direction.

Trading in these markets relies on arbitrage strategies that fetch returns from trades bought and sold thousands of times in the time it takes to flash.

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Basically, an algorithm can buy low on one exchange and sell a little more on another, over and over again, to turn tiny price gaps into big profits.

Commercial companies are just dipping their toes, for now. Major financial firms, including $4 trillion asset manager Fidelity Investments, are also building teams and expanding client offerings in crypto.

Sameer Shalaby, president of digital asset trading, financing and lending platform VersiFi, said hedge funds are most concerned about counterparty risk: the high likelihood that people on the other side of your transactions do not fulfill their part of the agreement.

It’s almost play money

Crypto is in its infancy. These managers allocate him very, very small sums, it’s almost fictitious money. You might see a company drop $50 million or something, Shalaby said. It’s nothing when you manage $100 billion.

Crypto speed trading is mostly done by companies investing their own money or that of wealthy investors who are presumed to be sophisticated enough to know what they are doing when it comes to taking big risks. Thus, most players tend to be either small accessory shops, companies investing their own money, or larger companies through their family offices.

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DRW, with its specialist office Cumberland, was one of the first of these fast trading firms to stack up in the asset class. Cumberland was founded in 2017 and has since expanded into providing indices and market making.

Flow Traders, Akuna Capital, and the three companies mentioned in the lawsuit Binance Jane Street, Tower Research, and Radix are all examples of speed traders with crypto desks.

Jump Crypto, the crypto arm of Jump Trading, was launched in September 2021. Its young president, Kanav Kariya, said at the time that Jump wanted to position itself as a major player in an industry that was going to be huge.

Jump Trading is secret even to a secret industry. But Jump Crypto had to be relatively transparent in its crypto investment activities.

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And he was recently named as the investor who posted returns of $1.28 billion before Do Kwons Terra/LUNA collapsed in 2022.

Speed ​​strategies become less profitable in other markets. But Beattie said that in crypto, there are still huge opportunities for latency arbitrage, i.e. using a speed advantage to trade better than other investors.

Flash Boys

In Flash Boys, Lewis describes how an early project attempted to gain a 10 millisecond advantage by tunneling under the Allegheny Mountains in the eastern United States.

By the time the book came out, this project was nearly obsolete, with cables replaced by microwave towers that beamed information through the air at 99% of the speed of light, and special semiconductors optimized for speed.

Today, speed traders can also opt for what’s called co-location: paying a top-tier provider to nest its server as close to an exchange’s as possible in a massive data center.

In crypto, infrastructure is catching up. In 2018, Coinbase became the first exchange to say it would revamp its architecture to allow for co-location.

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Additionally, Beattie said, one of the advantages of Bitcoin is that it is traded globally, expanding the possibilities for arbitrage.

Sources experienced in these markets have said that many crypto strategies are what is known as basis trading arguing the spot price of Bitcoin on an exchange against a derivative, such as a futures contract known as a of perpetual Bitcoin, on another.

Binance’s lawsuit says the three fast trading firms all traded Bitcoin perpetual options on the exchange.

Beattie declined to discuss specific companies and noted that different companies have different strategies and cannot all be lumped together. But, she said, traditional asset managers are eager to transition to digital assets and fast trading companies are at the forefront of this revolution.

But why are these trading companies so secretive, anyway?

They are opaque by design across all asset classes, not just crypto, Beattie said. This is because they don’t want to give any of their strategies to their competitors. Once your strategy is blown, it is no longer a profitable strategy. You have to go back to the drawing board and create new ones.

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