What is Prime Brokerage, and Will it Gain Traction in Crypto?

From margin trading to futures, many services have made the leap from traditional financial instruments to cryptocurrency. But there’s one that has yet to enter the consciousness of most crypto traders: prime brokerage.

Here, Bequant CEO George Zarya explains why 2020 could be the year that this technology starts to gain momentum, how it’s used across commodities and equities, and what it could deliver to those who currently own digital assets.

1. Can you explain prime brokerage simply? And why isn’t it common in the crypto world?

The main pain point a prime broker is solving for its clients is efficiency of collateral management. This means that clients may access multiple liquidity venues through one window, manage their collateral and settlements efficiently, and have access to leverage based on their overall portfolio, or so-called portfolio margining. 

The crypto world has been evolving quickly in terms of technology, but traditional finance expertise has yet to catch up. This year, “prime-brokerage” has been increasingly discussed among the community.

2. How common is prime brokerage in the traditional financial sector at the moment?

Prime brokerage is a centerpiece infrastructure for institutional investors, be they foriegn exchange, commodity or equity asset managers. Having an account at a prime broker is a must have, but small funds cannot always afford to meet the requirements of the bulge-bracket primes like Citigroup, Goldman Sachs, Nomura or JPMorgan Chase. So, startup managers go to “mini-primes” that are then plugged to the major primes’ infrastructure. In the retail space, there are names such as Interactive Broker or Saxo Bank that offer multi-exchange, multi-asset class access with some margin trading functionality.

3. So, how would crypto traders benefit from it?

Since prime brokers are in many cases the gateways to the market, institutional investors would greatly benefit from having a one-stop-shop solution to engage with the new, emerging digital assets market by having easy access to major crypto exchanges and a simplified onboarding process. Clients get one screen to manage collateral across a secure whitelisted custody framework, monitor positions, reconcile trades and have real-time net asset value numbers. They also have the flexibility to use a vendor of their choice to execute the trades or connect directly to the exchanges via a native application programming interface/Financial Information eXchange. Bequant can also provide a co-location facility at LD4 in London, where a number of prominent exchanges are hosted, that will benefit latency sensitive traders. And finally and most importantly, they have access to a balance sheet that allows leverage based on their overall portfolio. 

The availability of such services will bring the digital asset class closer to main financial assets and imminent integration into mainstream finance. 

4. Have digital assets like cryptocurrencies threatened traditional assets?

“Threatened” is a strong word, but I would say the crypto industry is poised to disrupt traditional finance. Security tokenization has been a buzzword for quite a while now, and blockchain technology is already being implemented across mainstream finance. We are seeing successful examples in cross-border payments, trade financing and settlements. Banking and finance behemoths operate on outdated legacy technology and will be forced to upgrade. I reckon blockchain technology will become a standard backbone for finance and banking in the future. It’s just a matter of time.

5. How will crypto prices react to the coronavirus and Bitcoin’s halving?

We have seen correlation of Bitcoin to the S&P 500 as panic selling has spread through the markets, but we also have seen decoupling from these trends. I do believe the new digital asset class will recover sooner than any other asset classes, and Bitcoin’s halving will certainly help. As central banks continue to print money and cryptocurrency’s infrastructure matures, we will see the trend of adoption pick up the pace. The pandemic scare is a good test for crypto to show its value as a means of payments, cross-border transfers and settlements that are truly global and are not affected by any country shutting down or imposing restrictions on movements. 

6. Are Know Your Customer rules going to get tougher?

It is an absolute fact that Anti-Money Laundering regulation will continue to spread across the world and will become a must for any business to comply with in order to continue. We’ve seen this trend evolve starting two years ago, and now we see that securities regulations in general will apply to crypto as well. For example, margin trading rules or investor classifications imposed by the Markets in Financial Instruments Directive will most likely be extended to digital financial assets.

7. Is the fragmented state of crypto regulation something to worry about? What about the new Malta government?

I do not believe that this will cause a major hassle for participants, as we are already seeing regulators across the world talking about harmonized regulation across jurisdictions. European regulators are looking at a Pan-European framework that may take its core from the French digital assets framework. 

The new Malta government has yet to show its commitment to drive financial innovation and put actions to its words. It’s like being half pregnant. With Bequant being one of the few companies applying for Virtual Financial Asset licenses, we are hopeful the process will gain traction soon.

8. What are the three biggest threats facing the crypto industry today?

There is a military acronym VUCA — volatile, uncertain, complex and ambiguous — that describes the world after the Cold War. This description can be applied to the state of the crypto market, but the threats are very much hypothetical, and I would argue that the industry does not have any life-threatening conditions. There are milestones that we will need to overcome before we can say that digital assets are another asset class:

  • Regulation: Crystallization of regulation across the globe on how assets are treated and participants regulated. Adoption of already existing securities regulations are imminent. 
  • Infrastructure and security: Custodian solutions are very important to bring peace of mind to investors. Global Digital Finance is an organization of which Bequant is a member. It runs a number of working groups that promote active discussions between market participants to promote best practices in the space and align institutional standards with custodians, exchanges and service providers. We have seen great progress in terms of technology evolution and understanding of critical practices that will ensure the safety of assets and the flexibility to go beyond cold storage custody.
  • Adoption: Slow adoption may cause markets to go into a state of hibernation. Successful progression on the first two points will drive institutional interest and hence bring more adoption. 

9. Can you explain why low latency and deep liquidity are so important?

With the recent market drop and skyrocketing volatility, latency and access to liquidity are most critical for profiting, or in some cases for survival. 

With the majority of the trading flow done via automated algorithmic trading systems, the slippage that one can suffer can be detrimental. Hence the industry is looking at offering institutional grade infrastructure. 

Bequant is the only exchange that offers co-location, multicast market data and a FIX 5.0 connectivity option, which is the market standard for traditional asset classes. Bequant exchange has a tick-to-trade latency of less than 400 microseconds to appeal to the most latency-sensitive traders.

10. What’s your advice for someone who is considering trading crypto for the first time?

Find someone who understands the marketplace and do proper research. The industry still has a lot of myths to bust and prejudice and unprofessionalism to overcome. Only professionals would be able to have a deep inside view and advise properly. 

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