"Leverage is the touchstone of most of the bubbles in the world."
A few years ago, that comment by Murray Stahl, chairman and CEO of asset manager Horizon Kinetics, would have been so typical for a cryptocurrency conference as to escape notice. But at CoinDesk's Consensus: Invest event on Tuesday in New York, Stahl's credit-wary sentiment stood out as an outlier.
Instead, "leverage," "lending," "margin trading" and "credit" were painted as elements of the market that need to be further developed (along with better custody services) in order for the nascent crypto asset industry to flourish – not sins of the legacy financial system to avoid repeating.
Call it a sign of selling out, an early warning of systemic risk or simply an indicator that the cryptocurrency world is maturing. Either way, the arrival of institutional and high-net-worth investors in the space has created openings for services similar to the prime brokerage that financial institutions have long provided to hedge funds, several speakers said.
"There is a strong demand for leverage in the space," said Adam White, a vice president at Coinbase and general manager of GDAX, its digital asset trading platform.
To meet that demand, GDAX hopes to reintroduce a margin service that it put on "pause" earlier this year, White said during a morning panel discussion. (He didn't say why the service was suspended, but it apparently happened sometime after the ether "flash crash" this summer.)
But the desire of traders to amplify returns with leverage is not the only reason some see a need for more lending in this market.
Rather, some provision of credit on an intraday basis and post-trade settlement is inescapable even when assets are settled on a blockchain, said Max Boonen, CEO of B2C2, an electronic market making firm based in London.
During his morning presentation, Boonen challenged one of the long-touted selling points of blockchains: the instant settlement of trades.
He told the 1,300-strong crowd:
"Could settlement become faster? Yes. Could settlement become instant? Absolutely not, and nor should it be."
For one thing, the block size debate in bitcoin has underscored that there is a "trade-off between the speed of settlement and the resilience of the payments infrastructure," he said. "The more transactions you push through the network, the more brittle it can become."
Moreover, gross settlement – a pre-blockchain term for trades that are settled as soon as they are processed – "imposes a lot of pressure on the balance sheets of market participants," said Boonen.
For example, he told the audience, "if I buy $1 million of Treasuries in the morning, and I sell my Treasuries in the afternoon, I need to maintain at all times that $1 million on my balance sheet."
On the other hand, net settlement (the type of system that real-time gross settlement and later blockchains were supposed to replace) allows for a more efficient use of balance sheets – but requires intraday credit, he said.
Credit creeps in
Echoing these speakers, Dan Matuszewski, the head of trading at Circle Internet Financial, said during a morning panel that there is a "real strong need" for the ability to borrow in this market.
It would not only facilitate short positions but also provide working capital for trading desks to make markets, he said.
During his talk, Boonen of B2C2 acknowledged the irony of the situation given that bitcoin was born as a reaction to the 2008 credit crisis.
"Bitcoin enthusiasts really, really do not like credit," he said. But, he added, "for better or for worse, credit is an important part of a functioning and liquid financial market."
Even before the institutional money started flowing in, he noted, "by necessity, credit did creep back into bitcoin and crypto markets in general," with the major exchanges offering leverage to the early retail investors.
The "beauty" of cryptocurrency is that trusted third parties are not required to simply transfer funds between wallets, Boonen said. But for now, he added, they are needed for the more complex business of trading crypto assets, "to a much greater extent than in the mainstream financial markets."
Disclosure: CoinDesk is a subsidiary of Digital Currency Group, which has an ownership stake in Coinbase
Photo via Michael del Castillo.