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Chain News ChainNews (ID: chainnewscom)

, Author: HashKey Capital Research, published with permission.

Cryptocurrency prime brokerage is a new business model that has emerged in the past two years, combining the characteristics of traditional financial prime brokerage and cryptocurrency trading. In two future drivers: the boom in hedge funds and the growth of the derivatives business.

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The clients of prime brokers in the traditional financial industry are institutional investors, mainly hedge funds and high-net-worth clients, and the main services they provide include trading, liquidation, custody, leveraged financing, and technical services. The emergence of prime brokers comes from the heavy burden of hedge fund transaction data, positions and income calculations. Prime brokers provide one-stop management, freeing fund managers from heavy management burdens and starting to provide additional capital savings type (capital efficiency) value-added services. It can be said that the development of prime brokers is inseparable from the prosperity of hedge funds, and their main business categories are as follows:

Main business: capital business

The main business of prime brokers is the part that contributes the most revenue, such as traditional margin financing and securities lending, and new types such as synthetic prime brokerage services. Synthetic prime brokerage services mainly refer to the use of derivatives such as swap agreements to help customers establish corresponding underlying asset positions without the cost of direct purchases, and to solve the difficulty of directly holding positions in certain types of markets.

The purpose of this type of service is to help customers save capital. Prime brokers use their own balance sheets or other sources of assets to borrow money to earn income, which invisibly increases the leverage level of customers.

Other business: expense business

Other businesses include: transaction execution, settlement and settlement, custody, account management, cash and position management, referral funds, and business consulting. Other businesses are not the main source of income, but the basic services of the prime broker mainly rely on the strong background management system and professional institutional customer service team of the prime broker.

In addition, based on the strong customer relationship network of prime brokers, some prime brokers are also leading the match-book or intermediate business, which is to match customers' position needs in the opposite direction without going to the external market for inquiries. The operation can be completed within the merchant, and a certain fee can be charged in the middle. Therefore, on the one hand, prime brokers have relatively high business standards, and on the other hand, it is difficult for users to migrate after the network is established. Therefore, the market share of prime brokers is in the hands of several large investment banks.

Prime Brokerage Revenue Sources and Global Market Shares

Cryptocurrency Prime Brokerage Main Business

The so-called prime brokers of cryptocurrencies are slightly different from traditional prime brokers. Brokers may be a more suitable definition at this stage. In order to adapt to the characteristics of cryptocurrency transactions, the current services provided by cryptocurrency prime brokers include: aggregated transaction services, funds and digital currency lending services, custody services, OTC services and other services.

aggregate transaction

• There is a big difference between Crypto's aggregated transactions and traditional aggregated transactions, that is, the separation of liquidity and the scene of aggregation are completely reversed.

• Traditional standard financial trading product scenario: few exchanges, many brokers, and liquidity aggregated on exchanges.

Crypto scenario: There are few brokers and many exchanges, and brokers aggregate liquidity and distribute it.

In the foreign exchange market similar to crypto, there are more liquidity aggregations, because the structure of the foreign exchange market is also very differentiated, including banks, dealers, major trading companies (PTF), retail traders, etc. The Crypto market is also very differentiated, but the forms of differentiation are different: there are many exchanges, few liquidity aggregators, and there are many currencies and currency pairs, resulting in too fine segmentation of liquidity, so there is an urgent need for liquidity aggregation services.

lending business

Borrowing is generally provided by brokers and prime brokers, but it is an optional business for brokers in the crypto field, which is related to project genes. For example, FalconX, which is good at trading, provides less credit lines, but some brokers who have transformed from custody or lending provide more of these, such as BitGo, BlockFi, etc.

Capital efficiency is a very important requirement for clients, especially institutional investors who use leverage. According to the SFC survey, in traditional finance, 90% of prime brokerage clients will choose margin financing, and nearly 90% will engage in securities lending. Lending needs rank first among all needs.

Of course, this is also related to the client structure. More than 80% of the main brokers are hedge funds. The amount of funds of hedge funds is actually not large. In order to obtain various positions, they need the support of various lending businesses.

baby sitting program

Managed services are generally not a major source of income because managed services have thinner revenues. Crypto's hosting service was very popular at the beginning, mainly because similar licenses were not easy to obtain and the hosting fee was relatively high. But as the number of participants increased, the profits of managed services began to shrink. Some custodians have begun to transform, such as BitGo, Anchorage, etc. A major advantage of hosting services is that they have a large amount of customer assets, and due to the risks of crypto, generally customers are still more sticky to hosting, and generally can benefit by providing some additional value-added services.

OTC service

• There are many OTC businesses. Bloomberg once estimated that the OTC trading volume of crypto is twice that of on-site exchanges. There are two main types of OTC business:

• One is the principle desk. The desk bears the risk of buying coins by itself. The customer places an order and provides a quotation, and then the trader goes to the market to complete the order with a quotation. The desk bears the price risk between the quotation and its own execution.

One is agency desk. The customer gives an approximate price range and order size, and the desk seeks the seller. The customer bears the price risk after placing the order and before the transaction. Generally, it is an additional service that the hoster can provide.

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Other business

Some OTC service providers listed by CAPCO in February 2019

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Other business

Synthetic Prime Broker

There are many such types in traditional finance, and not much in the crypto field. We have seen B2C2 providing similar services. At present, it seems that traditional institutions need the risk exposure of digital currency, but they do not want to directly hold digital currency, and will need similar businesses. Because basically the coins you want to trade can be traded, and OTC traders can also help buy them in the market.

Portfolio Margin

Combination margin is not necessarily provided by the prime brokerage, and exchanges provide more, but if the prime broker is involved in derivatives transactions, it can also provide portfolio margin services. Combination margin corresponds to general margin, and general margin is to calculate the corresponding margin according to each position opened by the trader. Portfolio margin is the sum of all investment portfolios, especially derivatives investments. Because the investment direction has pros and cons, the margins required for these investments are integrated into the positions, so that the margin requirements are greatly reduced, which is based on the entire A method for calculating margin for a portfolio. In short, it is also a method of capital efficiency.

1. Of course, the key to portfolio margin lies in calculation. The traditional calculation method has gone through non-reversible margin system, strategic portfolio margin system, intra-group write-off margin system and combined margin system based on the global risk view. Specifically, various exchanges also have different portfolio margin mechanisms, such as CME’s Span, OCC’s Stan, Eurex’s Prisma, and Nasdaq’s Genium Risk.

2. Multiple account management

3. Multi-account management is closely related to the characteristics of the digital currency market. From the beginning of the birth of the digital currency market, the exchange has always assumed the role of a traditional exchange + brokerage. Whether it is currency listing, trading, clearing and settlement, account management, custody, derivatives and other services, it seems to be an omnipotent role. All parties are participating in the construction of the exchange, and users can directly trade on the exchange without the need for middlemen to make the difference. But it is precisely because of the existence of many exchanges that the demand for brokers is derived. The problem faced by the user is:

Multiple exchange accounts require some funds to be deposited in each account;

If it is an institution, additional OTC transactions and low-cost leveraged capital support may be required.

At this time, the prime broker can participate in the transactions of multiple exchanges on behalf of the client. The client does not have to worry about the differences of each exchange, and can rely on the capital of the prime broker to open positions and trade derivatives, so that the capital can be greatly improved. save.

1. first level title

2. What types of prime brokers are there in the crypto market? Who are the participants?

3. There are roughly three types of major prime brokers in the industry we have sorted out:

Independent Broker: such as Falconx, Crpyo Finance AG

1. Transformation of other institutions/extend to Broker: such as BitGo, Genesis Trading, BlockFi, Nexo

2. Business extension of large exchanges: such as Tagomi acquired by Coinbase and Broker established by Huobi

3. Independent prime brokers exist because:

People with traditional experience are familiar with brokerage business and can directly transform;

Other business organizations extend, such as BitGo is a leading custody company in the industry, but the profit of custody services is getting thinner and thinner. It has a strong customer base and asset accumulation, and can naturally transform into brokerage services, and there are more types of services. The exchange is extended from another category, because the exchange itself will have some relatively large customers or institutional customers, which require a dedicated team to maintain, so whether it is acquisition or self-built, the professional platform can increase customer stickiness and bring customers together. Stay on the exchange. Because the volume of trading orders is relatively large, customers are well retained, but exchange brokers also face the problem of neutrality.

Founded in May 2018, FalconX is a cryptocurrency broker located in Silicon Valley, the United States. Currently, it only provides a small amount of credit and lending services. Its main business is to help customers achieve the best transaction matching in the market through algorithms, without slippage and hidden Fees, timely RFQ quotation response, 365*24 transaction support. API services are also provided for liquidity providers. The main services are divided into three categories: Trading, Settlement and Prime Service. The two founders are from Google and Accel VC respectively.

Tagomi is a crypto asset trader serving the institutional level. Tagomi also provides the best price transaction service, especially the best execution price for institutional-level large transaction orders. The main method is to split the order, break up a large order into several small orders and enter each exchange to complete the transaction. The transaction fee of Tagomi is not high, the lowest level is 0.1% (full fee), which is consistent with the current highest fee rate for retail investors. Tagomi was acquired by Coinbase in 2020 and became Coinbase's institutional services business. In early 2019, Tagomi received a BitLicense issued by the New York State Department of Financial Services.

B2C2 is located in London and provides OTC trading services and Prime service services. It has received a $30 million investment from Softbank. B2C2 also provides 7*24 hours trading services, as well as a variety of fiat/digital currency trading pairs. Similar to traditional prime brokers, B2C2 also provides synthetic asset services, which is relatively rare among encryption service providers. B2C2 has obtained the MiFID investment license and the CFD license issued by the UK FCA

Crypto Finance AG is located in Switzerland and provides similar traditional economic services, including asset management and storage of digital assets. Asset Management offers two funds, an actively managed and a passively managed crypto fund, tracking the Crypto Market Index 10 index. Storage is a special service of Crypto Finance, which provides hardware wallet HSM services, similar to many other Swiss companies. The trading service also claims to get the best price and fast transaction.

BitGo itself is a custodian service provider, and it has also begun to transform into a Prime service and provide lending services. Bitgo's own hosting customers can directly become prime service users. The biggest feature of BitGo prime is that users can directly use the digital assets in the cold wallet provided by BitGo to participate in the transaction, the assets do not need to be moved, and the security guarantee is not available in other types of PB. BitGo also provides lending services. BitGo Trust was approved by the South Dakota Department of Banking Services in March 2018 to provide compliant custody services to institutional-level clients.

Genesis Trading is the trading and lending arm of Digital Assets Group (DCG). In May of this year, it announced its entry into the field of prime brokerage through the acquisition of Vo1t, a British custody service provider. The monthly spot transaction volume of Genesis Trading reached US$1.7 billion, the total loan amount reached US$1.4 billion, and the monthly transaction volume of derivatives trading reached US$400 million in June. Vo1t itself is also a diversified service provider that provides cold wallet hosting, trading, and staking. Genesis Trading has obtained a BitLicense issued by the New York State Financial Services Authority.

BlockFi is an American company that provides services such as digital currency lending, storage and trading for retail and institutional investors. Although BlockFi does not take the banner of a prime brokerage, judging from its establishment of institutional services this year and the hiring of experts from former investment banks responsible for clearing/prime brokerage to lead its business, the nature of its business is close to what we call prime brokerage. BlockFi is also one of the largest lending service providers in the market. The total amount of digital assets on its lending platform has reached 1.5 billion U.S. dollars, and its monthly income is close to 10 million U.S. dollars. It has received investment from many well-known VCs and plans to go public in the second half of 2021 at the earliest .

At present, there is no specific license to regulate prime brokers or similar businesses, but in the previous description, we can see that some players have begun to comply with the regulations as much as possible, and the licenses overlap with many licenses of exchanges. Such as BitLicense/MTL, etc. We list the licenses of some of the participants as follows:

outlook

outlook

The main service target of the prime brokerage is institutional investors. There is no doubt that it can liberate institutional investors from heavy account management and position management. However, the prime brokerage business of cryptocurrencies mainly relies on two The direction of development: 1) the vigorous development of encryption funds; 2) the growth of the derivatives market.

At present, the number of crypto-type hedge funds is still too small, and the assets under management are not large enough. According to PWC’s estimation, the total AUM of crypto hedge funds at the end of 2019 is about 2 billion US dollars, which is about 1% of the total market value of cryptocurrencies. . Hedge funds of this magnitude are difficult to support the business of prime brokers. Even if high-net-worth and large investors are added together, it is estimated that they will not exceed 5% of the total market value, and the current market value is estimated to be less than 20 billion US dollars.

Derivatives business is one of the biggest trends in cryptocurrency in the past 3 years, and futures, options, etc. have flourished one after another. Since 2017, the derivatives market has developed very rapidly, and the trading volume of futures has been very close to that of spot trading.

The option market has also developed relatively fast this year, but the trading volume is still too small, with a daily turnover of about 200 million US dollars. But these are all good aspects. The derivatives market will eventually be much larger than the spot market, especially after the variety of these complex derivatives increases, the broker's account function can be reflected.

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