Integrity will determine the future leaders in crypto

February 12, 2021

The cryptocurrency markets have evolved at a rapid pace and, with the recent surge in institutional interest, that growth looks set to accelerate. Yet, as an emerging asset class underpinned by nascent technology, cryptocurrency markets remain largely inefficient and riddled with opaque practices to the detriment of investors. As cryptocurrency reaches the mainstream, the importance of integrity among participants and the need to implement best practices becomes ever more pressing.

Latency, Revenue Leakage & Disorderly Markets

Latency issues in the cryptocurrency markets are notorious. Countless investors have suffered at the hands of exchange outages and "unscheduled maintenance" as the infrastructure struggles to keep up with volatile markets and unexpected frenzied trading. But even when all digital asset exchanges are up and running, inefficient markets continue to be a problem leading to widespread 'latency arbitrage' by algo traders that cost other investors dearly.

Of course, this isn't an issue reserved for the cryptocurrency markets alone. The UK's Financial Conduct Authority (FCA) found that the high-speed trading practice of latency arbitrage costs investors in global stock markets around $5 billion a year, as well as reduces global trading volume. However, latency in cryptocurrency markets is amplified due to its high volatility relative to equities. Excessive latency here can lead to huge unexpected losses and even amplify market moves.

This problem is exacerbated by the myriad of cryptocurrency exchanges that are simply not financial services institutions by design. This leads to inefficient markets with wide spreads that cause further revenue leakages. Worse still, customers are sometimes taken advantage of by disingenuous players trading on inside information, against their own customers, making markets inside their exchanges, and using bots to simulate trading volume.

We still see large global banks being fined by regulators for poor treatment of their customers. Yet, poor customer treatment has been a feature of some cryptocurrency markets too, but with increased regulatory oversight and institutionalization, these practices will ultimately be unsustainable.

Cryptocurrency Markets Have 'Very Important Design Flaws'

According to Richard Olsen, co-founder of Forex trading platform OANDA and founder and CEO of Lykke, a blockchain and financial products provider, the main problem with the cryptocurrency markets is the way they have evolved. He says, “They have grown up in a very organic way with computer developers creating what they think is a market place. In that journey, some very important design flaws have happened and people are suffering because of that. These are computer engineers, not financial engineers who know how financial markets work. Finance is a very difficult discipline and the excessive volatility that we are seeing every day is due to these design flaws.” 

It would be hard to find a better-versed expert in financial markets than Richard Olsen or a more ethical company in the FX space than OANDA. While many other larger participants have tarnished FX’s reputation and been fined for unfair markups, OANDA dates back to 1995, staying the distance in the world’s largest financial market by maintaining a commitment to integrity and a customer-centric culture. In fact, HSBC bank made the decision to white label OANDA’s FX retail platform based on the company’s longevity and solid reputation. 

Through Olsen’s latest venture Lykke, he aims to bring the lessons learned in the FX industry to the cryptocurrency markets and help the industry to mature. One of Lykke’s main offerings is market making to make exchanges more efficient. He says, “Lykke wants to provide narrow spreads to give all customers the chance to transact at the most efficient possible price, bringing in best practices and making exchanges more attractive by reducing the volatility in the market.”

Rectifying the Design 

Oslen firmly believes that in order to grow and make crypto markets fair and orderly, a fundamental change is needed. In part, that means getting more experienced financial engineers on board who can bring their expertise with them.

“The players that are not behaving with integrity will not be left standing," he says in no uncertain terms. "It's like the first and second internet waves. Today, we don't remember any of the successful companies of the first wave and the same can happen now by reputable and integrity-first players such as EQUOS and Lykke bringing best practices on board to rectify all the craziness that is going on. It's up to serious players to shift the dial and help the market mature."

He continues, “The forex market is easily the biggest financial market in the world and cryptocurrency markets have volatility at least 4 times bigger than FX markets. There is no lack of participants, but a lack of design and thought about how to create a market that is seamless and that doesn't collapse by 10% every second day, or in which one big order can zoom the price of Bitcoin.”

As Bitcoin becomes increasingly attractive to investors thanks to its scarcity, many analysts, including Rothko Research, predict that the number-one cryptocurrency will capture between 3-5% of the gold market in the medium to long term. Olsen agrees that "especially with the printing press on full steam to keep the world ticking over,” cryptocurrency is emerging as the new gold… 

“But this new gold has design flaws that create excess volatility. Only serious players will address these concerns, gain market share, and make it more orderly.” 

How This Will Play Out

With increased regulation and “no way around” stringent KYC and AML requirements, industry participants who fail to meet these standards will soon be shaken out of the market. Olsen believes this is a good thing, however, he also acknowledges that regulation needs to be more progressive and technology-driven. In his opinion, the parameters being used to regulate existing markets are “completely outdated,” and “from the last century.” So it is up to the players to innovate and execute.

Olsen is quick to point out that the regulators "do not have bad intent," but are simply not equipped with the knowledge to regulate the markets. Reputable industry players can, therefore, gain regulatory approval and trust, and then work hand-in-hand with regulators to innovate and improve from the inside out… And this transformation could happen very fast.

“Just think about how quickly the smartphone had success,” he says. “The transformation in the cryptocurrency markets could happen overnight, very little is required. We need the right regulatory rafters, and players like EQUOS, and Lykke applying for the correct licenses, and satisfying regulatory requirements. Then, we can innovate very quickly… 

… Over-perform, that is what we have to do. Professional players with the right mindset should collaborate aggressively – and have the conviction that they are really bringing added value that will inspire customers. This is a real threat to existing players. Through rigor, discipline, treating the customers fairly, and acting with integrity, we can gain market share very fast.”

By Paul Goldman, Group Head of Sales at Diginex

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