Crypto firms are passing in-house functions to third-party providers but research shows that outsourcers still have a way to go before they can offer everything the market needs. Gill Wadsworth reports.
Crypto currency firms are shifting front-office services to third party vendors as cost constraints and challenges with building in-house systems force them to outsource, but the market remains disparate and lacking a single comprehensive vendor.
New research from Acuiti and Trading Technologies (TT) covering Crypto derivatives experts across hedge funds, asset managers and proprietary trading firms, finds most have set-up crypto trading functions in house and of those, the vast majority have experienced challenges in doing so.
Results from a recent a Q4 2022 survey of the research firm’s Crypto Derivatives Expert Network, and shared in the recently published Acuiti whitepaper, “Changing Approaches to Crypto Trading Technology,” show that settlement and connectivity layers functions presented the biggest challenges.
Will Mitting, founder of Acuiti, says until now crypto firms had been underserviced by the third-party vendor market which had failed to keep pace with the rate of acceleration in the digital asset space.
However, he adds: “The quality and sophistication of third-party technologies often lagged the in-house builds of the early pioneers. Today there are many institutional-quality third-party offerings in the market, and more being launched. This is lowering the barrier to entry for firms coming into the market and tilting the calculus in favour of third-party development for both incumbents and new entrants.”
Further he notes that firms have been under considerable cost pressures following the collapse of FTX and the ongoing crypto winter, which makes it harder to secure funding for native crypto projects.
Lack of coverage
Yet the survey shows crypto firms are not completely happy with the services available in the third-party vendor market with respondents noting there is no ‘one-stop-shop’ for front-office services.
Jason Shaffer, executive vice-president of product development and head of Americas at TT, says a comprehensive solution from one vendor “is very likely”, but adds “it will take strong partnerships”.
“To cover all aspects of crypto trading, a third-party vendor would need to integrate with listed derivatives exchanges like CME and Cboe Digital, offshore exchanges like Binance and OKX, DeFi smart contracts, and third-party custodians and prime brokers,” Schaffer says. “If a third-party vendor emerges as a one-stop-shop, it must embrace the entire ecosystem, and this will take strong partnerships and a willingness to work with companies that may look like your competitor. Crypto-native firms have operated with this ‘coopetition’ model from the beginning and see plenty of room for everyone in a massively expanding market.”
Meanwhile Rick Maloney, director at Sionic, says a that a single comprehensive vendor is unlikely to be able to meet the needs of the entire crypto market.
“Successful third-party vendors will need to provide a platform which takes into account the many challenges across as many coins that each manager requires. The less liquid the market is, the fewer data points there are, and the value of the service potentially starts to disappear. For managers active in the most liquid coins, it is not inconceivable to imagine a third-party vendor providing a solution which suits their needs however one suspects as you start to move into the smaller cap, less liquid markets then a bespoke internal model may well be the better alternative.”
Deficient risk management
While respondents to the Acuiti survey were positive towards most third party services, they say risk management is an area where “the coverage of third-party product was seen as deficient”.
Maloney says this dissatisfaction reflects there are multiple challenges in providing risk management within the cryptocurrency environment “not least due to the often-differing values of a specific coin across the complex of exchanges”.
“Added to which there is a stark absence of consensus when valuing a specific coin, many metrics have been proposed, one example being mining costs associated with the proof of work required for Bitcoin,” Maloney says.
Schaffer adds that the amount of work it takes to write to each exchange and manage thousands of instrument definitions, as well as the immaturity of some of the exchanges and their APIs “makes it very difficult to create a comprehensive risk management application”.
But he adds: “There is plenty of work to be done, but with larger institutions now trading digital assets, the established platform providers and risk management technology firms are responding with an investment in expanded coverage. The ability to now manage risk and position limits across listed and offshore exchanges is evidence that risk systems are improving.”
And commentators predict that as third-party vendors improve their services both in terms of coverage and quality as the trend to outsourcing will continue.
Mitting says: “The quality of third-party offerings in the crypto market continues to increase as more vendors come into this market. Some of these are native to the crypto market, but others are incumbent vendors in the traditional market leveraging their expertise to build products tailored to the nuances of crypto trading. I would expect to find this trend evident across the trading lifecycle.”
Related reading:
Digital Infrastructure: The Evolution of the Digital Asset Trade Lifecycle So Far
ISDA Readies Contractual Standards for Crypto Derivatives Space
