It is estimated that 40 percent of market participants in the financial sectors trade some form of digital assets and interest is growing. Specifically, many sell-side firms are engaging in crypto derivatives trading to benefit from the market growth in cryptocurrencies without having to significantly modify their current trade processing infrastructure.
In this DerivSource Q&A, Solène Khy, head of product management commodity, equity, FX and digital assets, and Léandre Moreno, head of product team, position and data management at Murex, discuss how firms can best accommodate the nuances of digital assets in their existing trading, risk and processing infrastructure and tackle common challenges in risk management, data and regulatory compliance.
Q: Let’s first discuss appetite for digital assets. What do you see amongst your clients in terms of interest and uptake of digital assets?
Solène Khy: Uptake is uneven, but overall interest is growing. Many sell-side firms are engaging in crypto derivatives trading. This enables them to benefit from the market growth in cryptocurrencies without having to modify their current infrastructure. They are generally doing this using their existing resources and infrastructure.
In countries where regulations allow for it, some firms are engaging in crypto spot trading. In this case, firms usually expand their resources and hire traders who have expertise in the digital assets trading space. Additionally, they need to build out their infrastructure to include a dedicated custody system and have the ability to partner with crypto native custodians.
Some institutions are also carrying out use cases on digital assets tokenization, such as bonds or money market funds tokenization, and firms are exploring issuance and redemption of Central Bank Digital Currencies (CBDCs). This is more of a long-term focus and there has been a lot of growth in these areas, especially in Europe, thanks to regulations encouraging these types of use cases.
However, many firms are starting up their digital assets business with a reduced scope and limited resources, and are waiting to see business returns before scaling up.
Q: What are the biggest challenges institutions face as they look to incorporate digital assets into their investment strategies?
Léandre Moreno: There are four main challenges, the first of which is regulatory. Firms cannot approach digital assets in the same way in all jurisdictions, because each of them has a different regulatory framework. The pilot regime in Europe has encouraged digital bond issuance and the use of distributed ledger technology (DLT). In Asia, the latest consultation papers issued by HKMA and MAS related to the adoption of the BCBS standards seem to unlock the appetite from some financial institutions and banks to enter into crypto business. However, in some other regions, there is no regulatory framework for expanding into digital assets, and it is not encouraged at all.
The second challenge is about managing risk. If firms want to engage in the digital assets space and start introducing spot trading, how do they approach the risk on this new product or the new infrastructure they put in place, bearing in mind the distributed data technologies they are dealing with? More on that later.
The third challenge is technology. In deploying a new custody system, they need a completely new infrastructure. Firms are used to working with the major clearing houses, but now they must shift to something more decentralized with new technologies like blockchains or DLT in general, and their custody system must be able to access that new ecosystem.
The last challenge is around market data and data in general. The market data space is fragmented, whether dealing with centralized exchanges or decentralized finance. It is much more complicated to source regulatory data around cryptocurrencies or crypto derivatives.
Given these challenges, many firms are adopting a “wait and see” approach before diving into digital assets. They have the capabilities, and there are providers that can help with the technology and data challenges. While some firms are forging ahead and working with regulators to see what they can do, many are weighing up the risks and prefer to wait for more clarity.
Q: Can you elaborate on the challenges related to data and market data specifically?
Khy: A lack of relevant market data is a significant challenge for firms expanding into digital assets.
There is a shortage of liquidity in some areas of the digital assets space and a lack of consistent analytics and market data generally. Compared with other markets, the crypto market experiences huge volatility jumps with many arbitrage possibilities through options and futures markets. To complicate this further, liquidity providers for options are limited and pricing options is difficult. This means traditional calibration methodologies must be adapted to these market conditions, which again, are subject to swings.
Institutions need to ensure they gain access to relevant market data. To support this clear need in the market, Murex has a partnership with Kaiko, a leader in the crypto market data space, to fine tune the representation of market data in the Murex system, including the specifics of the crypto market. This means Murex’s data solutions can be complemented by Kaiko market data to provide a comprehensive solution for crypto trading.
Murex has similar partnerships with other market data providers for traditional asset classes. Murex is not a market data provider, but requires a feed of market data to perform all the business processes related to position management, Greeks calculation (option sensitivities), and P&L revaluation, as well as compute stress tests and value-at-risk (VaR).
Experience is key and Kaiko has been in the crypto space for 10 years and has acquired deep specific knowledge of this market. Together, Murex and Kaiko are also doing research and development work to further improve Murex’s functional businesses processes in a way to better support pricing and analytics for crypto trading.
Q: You also mentioned risk management is a key challenge. How can a firm create a risk management framework that can easily manage this new asset class effectively and efficiently?
Khy: Many firms have tried to use a classical representation of traditional assets to model risk for digital assets. This is tempting because it does not cost much to do so. However, this approach is quite short-term and can be very limiting. As we have been digging into the specifics of digital assets, we have discovered that there are a lot of very small details that would be limitation factors in the long run. So, while we know we need to leverage the traditional world, we have to view digital assets as new types of assets to manage them effectively. It is crucial to look at the specifics for example at the DLT dimensions that are needed to smoothly reconcile positions of digital assets with custody systems. On the risk management side, Murex has a module to perform valuation, risk sensitivities and FRTB capital calculation that we are adapting with the latest BCBS requirements related to crypto class products.
Moreno: On the tech front, the technology of DLT enables firms to remove some risks. For example, smart contracts allow firms to remove or reduce some liquidity, settlement and credit risks. However, DLT also adds new risks because firms in many cases are bringing custody back in house. Additionally, firms have the risk of being hacked by someone in their wallet. This means that perhaps they need a new strategy of having several digital wallets, and need to build a new ecosystem. Finally, there is the risk of entering a space where they cannot even model what is happening.
But the biggest risk of all is regulatory noncompliance. It depends which region a firm is in, but this could be very complex and costly. Regulation is changing all the time, and firms could suddenly find that an established practice is suddenly no longer permitted, and they must comply with a new requirement very quickly.
Q: How do you think solutions providers, such as Murex, can assist firms as they look to increase activities in digital assets?
Khy: As a global platform covering front-to-back office and risk, Murex has adapted its solution to include new digital asset specifications, while at the same time leveraging the strengths of the platform’s large catalog of payouts and analytics. Traditional institutions can easily expand their business activities on digital assets using Murex’s new module, which can be deployed with a low total cost of ownership (TCO). Several banks have been able to develop their digital asset activities on either derivative or spot trading within a few months using the Murex platform.
As with Kaiko, crypto native companies are also looking to leverage Murex’s platform to benefit from our proven capabilities in terms of scaling and performance, because Murex is equipped to work with large institutions and has several large clients.
Q: How would you like to see the digital assets space evolve in 2025?
Moreno: Over the last two to three years the focus has been on expanding digital asset derivatives products because this was where market participants wanted to enter to explore this new asset class. And some firms also experimented spot trading. Such activities are now expected to scale depending on regulation evolutions.
In 2025, the evolution will also be more focused on tokenization—digitalizing bond markets, money market funds or any tokenized funds. This is an area where most of the benefits of these new technologies and of this new ecosystem will be realized.
With a tokenized bond, firms can afford to settle in real time and leverage intraday repos. We are seeing a rise in solutions for lending and borrowing cash or cryptocurrencies. With a new DLT ecosystem, firms will be able to manage operations more smoothly and lower their settlement costs and risk. We will see increased take-up of smart contracts toward the end of 2025. A smooth standard that allows us to implement smart contracts within the blockchain will further smooth the derivatives processes.
CBDCs could become a major trend in 2025 depending on the jurisdiction and what happens with regulation. It is an evolving space as well, and the missing piece to bring value to the whole chain when tokenizing assets.
Khy: We are looking for the market to scale in 2025. Many clients are live now with low volumes. We expect increasing activity and more diversification of use cases.
