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At the recent CfC St. Moritz conference, a panel titled "Building the New (Digital) Factory of Finance" brought together industry experts to discuss the future of finance and the necessary building blocks for a new financial system. Among the esteemed speakers was Greg Carson, representing XBTO Humla Ventures. The panel explored the potential for collaboration between incumbents and innovators to drive success in the evolving financial landscape.
The vision of a revolution in private capital markets
Carlos Domingo of Securitize set the stage by expressing his belief that private capital markets will experience a transformative revolution within the next 5-10 years. This sentiment resonated with the panel as they delved into the key components required for the new digital factory of finance.
Tokenization and the role of regulation
Jean-Baptiste Graftieaux from Bitstamp emphasized the necessity of regulation to enable access to cryptocurrencies and rebuild trust in the ecosystem. The panel agreed that the native issuance of all types of financial assets within the new digital factory of finance would be crucial. They recognized that creating a publicly accessible way to identify beneficial owners of financial assets, as Securitize aims to do, would be an important step.
Efficiency through digitization and stablecoins
The discussion highlighted the inefficiencies caused by the lack of a unified ledger for tracking ownership of private market assets. The separation of ledgers for securities and cash further complicates settlement processes. The panel recognized the potential of stablecoins and a shared public ledger to enhance transaction speed and efficiency. Digitization and tokenization were seen as key drivers to strip trillions of dollars in intermediaries from the financial industry.
Expanding opportunities and collaboration
Bitstamp, known as a major crypto exchange, expressed its plans to offer more than just digital assets on their platform. Tokenization emerged as a trend, with Bitstamp leveraging its technology to list a broader range of assets. The panel stressed the importance of innovation, establishing private permission zones, and focusing on use cases to create revolutionary financial products.
Regulatory landscape, custody solutions, and collaboration:
The panel acknowledged the need for improvements in the regulatory landscape, custody solutions, and partnerships with institutional players to enhance the buying, selling, and trading of digital assets. While regulation is often seen as lacking in the crypto industry, the panel emphasized the importance of compliance and finding technological solutions to navigate within existing frameworks.
Custody emerged as a critical aspect for investing in core infrastructure within the new digital factory of finance. The challenge of custody for real-world assets on the blockchain was acknowledged, and regulated exchanges like Bitstamp were highlighted as viable solutions.
Conclusion
The panel discussion at CfC St. Moritz shed light on the future of finance and the necessary building blocks for the new digital factory of finance. Tokenization, regulation, efficiency through digitization and stablecoins, and collaboration were key themes. Greg Carson's participation on behalf of XBTO Humla Ventures further emphasized XBTO's commitment to driving innovation and shaping the future of the financial industry. As the industry continues to evolve, the collaboration between incumbents and innovators will play a crucial role in building a more efficient, inclusive, and transformative financial system.
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The full breakdown
In our first article, "Navigating Crypto Volatility: The Advantages of Active Management," we explored how the high volatility and low correlation of digital assets with traditional asset classes create unique opportunities for active managers. We discussed how these characteristics enable active managers to execute tactical trading strategies, capitalizing on short-term price movements and market inefficiencies. Building on that foundation, we now turn our attention to the unique market microstructure of digital assets.
Conducive market microstructure of digital assets
The market microstructure of digital assets - a framework that defines how crypto trades are conducted, including order execution, price formation, and market interactions - sets the stage for active management to thrive. This unique ecosystem, characterized by its continuous trading hours, diverse trading venues, and substantial market liquidity, offers several advantages for active management, providing a fertile ground for sophisticated investment strategies.
24/7/365 market access
One of the defining characteristics of digital asset markets is their continuous, round-the-clock operation.
Unlike traditional financial markets that operate within specific hours, cryptocurrency markets are open 24 hours a day, seven days a week, all year round. This continuous trading capability is particularly advantageous for active managers for several reasons:
- Immediate response to market events: Unlike traditional markets that close after regular trading hours, digital asset markets allow managers to react immediately to breaking news or events that could impact asset prices. For instance, if a significant economic policy change occurs over the weekend, managers can adjust their positions in real-time without waiting for markets to open.
- Managing volatility: Continuous trading provides more opportunities to capitalize on price movements and volatility. Active managers can take advantage of this by implementing strategies such as short-term trading or hedging to mitigate risks and lock in gains whenever market conditions change. For instance, if there’s a sudden drop in the price of Bitcoin, managers can quickly sell their holdings to minimize losses or buy in to capitalize on the lower prices.
Variety of trading venues
The proliferation and variety of trading venues is another crucial element of the digital asset market structure. The extensive landscape of over 200 centralized exchanges (CEX) and more than 500 decentralized exchanges (DEX) offers a wide array of platforms for cryptocurrency trading. This diversity is beneficial for active managers in several ways:
- Risk management and diversification: By spreading trades across various exchanges, active managers can mitigate counterparty risk associated with any single platform. Additionally, the ability to trade on both CEX and DEX platforms allows managers to diversify their strategies, incorporating different levels of decentralization, regulatory environments, and security features.
- Arbitrage opportunities: Different venues often exhibit price discrepancies, presenting arbitrage opportunities. For example, managers can buy an asset on one exchange at a lower price and sell it on another where the price is higher, thus generating risk-free profits.
- Access to diverse liquidity pools: Multiple trading venues provide access to diverse liquidity pools, ensuring that managers can execute large trades without significantly impacting the market price.
Spot and derivatives markets (Variety of instruments)
The seamless integration of spot and derivatives markets within the digital asset space presents a considerable advantage for active managers. With substantial liquidity in both markets, they can implement sophisticated trading strategies and manage risk more effectively.
For instance, as of August 8 2024, Bitcoin (BTC) boasts a daily spot trading volume of $40.44 billion and an open interest in futures of $27.75 billion. Additionally, derivatives such as futures, options, and perpetual contracts enable managers to hedge positions, leverage trades, and employ complex strategies that can amplify returns.
Overall, the benefits for active managers include:
- Hedging and risk management: Derivatives offer a powerful tool for hedging against unfavorable price movements, enabling more efficient risk management. For instance, a manager holding a substantial amount of Bitcoin in the spot market can use Bitcoin futures contracts to safeguard against potential price drops, thereby enhancing risk control.
- Access to leverage: Managers can use derivatives to leverage their positions, amplifying potential returns while maintaining control over risk exposure. For instance, by employing options, a manager can gain exposure to an underlying asset with only a fraction of the capital needed for a direct spot purchase, thereby enabling more capital-efficient investment strategies.
- Strategic flexibility: By integrating spot and derivatives markets, managers can implement sophisticated strategies designed to capitalize on diverse market conditions. For instance, they may engage in volatility selling, where options are sold to generate income from market volatility, regardless of price direction. Additionally, managers can leverage favorable funding rates in perpetual futures markets to enhance yield generation. Basis trading, another strategy, involves taking offsetting positions in spot and futures markets to profit from price differentials, enabling returns that are independent of market movements.
Exploiting market inefficiencies
Digital asset markets, being relatively nascent, are less efficient compared to traditional financial markets. These inefficiencies arise from various factors, including regulatory differences, market segmentation, and varying levels of market maturity. For example:
- Pricing anomalies: Phenomena like the "Kimchi premium," where cryptocurrency prices in South Korea trade at a premium compared to other markets, create arbitrage opportunities. Managers can exploit these by buying assets in one market and selling them in another at a higher price.
- Exploiting mispricings: Active managers can identify and capitalize on mispricings caused by market inefficiencies, using strategies such as statistical arbitrage and mean reversion.
The unique aspects of the digital asset market structure create an exceptionally conducive environment for active management. Continuous trading hours and diverse venues provide the flexibility to react quickly to market changes, ensuring timely execution of trades. The availability of both spot and derivatives markets supports a wide range of sophisticated trading strategies, from hedging to leveraging positions. Market inefficiencies and pricing anomalies offer numerous opportunities for generating alpha, making active management particularly effective in the digital asset space. Furthermore, the ability to hedge and manage risk through derivatives, along with exploiting uncorrelated performance, enhances portfolio resilience and stability.
In our next article, we'll delve into the various techniques active managers employ in the digital asset markets, showcasing real-world use cases.
