LMAX Exchange: what are the catalysts for the third wave of cryptocurrencies?
David Mercer, CEO of LMAX Exchange Group, discusses the history of crypto, the future of digital currencies and calls for key industry changes to create a more efficient, secure and trusted marketplace
Wave of Change: what are the catalysts for the third wave of cryptocurrencies?
Cryptocurrencies have the potential to revolutionise the way we do business. People understand their long-term potential, yet today they are still misunderstood, underutilised and their divisiveness has earned them an almost pariah status. However, context is everything and assessing where we are in the development of the cryptocurrencies is crucial to appreciating their nascent status.
Cryptocurrencies date back to Satoshi Nakamoto’s whitepaper in October 2008. During this first wave, the early evangelists, scientists and tech engineers, developed a decentralised electronic payment system based on distributed ledger technology. The objective was to bypass mainstream financial institutions after the 2008 financial crisis had eroded trust in the established pillars of finance and their guardians.
2017 heralded the arrival of the second wave of cryptocurrencies with a bang. Retail investors piled into crypto leading to the creation of a plethora of retail trading platforms. This feverish activity and belief in crypto as a store of wealth saw Bitcoin reach a valuation $19,000 in December of that year, before rapidly coming off the boil.
As the media hype still reverberates and commentators opine on the absurd volatility we saw in 2017, along with the governance and trust issues that dog the market, my focus has been placed firmly on the factors which will welcome in the third, and most revolutionary, wave of cryptocurrencies: widespread institutional adoption.
In my view, this third wave of cryptocurrencies is just around the corner, but in order to allow for it to happen, the industry needs to overcome a few barriers:
The third wave of trading crypto begins when cryptocurrency is crystallised as an asset class and institutions begin to trade a regular portion of their portfolio on crypto exchanges. For example, when crypto currencies are normalised, each of us will have a proportion of our pensions in a digital currency – even if it is only a percentage point or two.
For this process to take place we need to establish an internationally trusted marketplace for institutional-only cryptocurrency trading. This hinges on the provision of credit by the banking system, which is at odds with the inspiration behind the Nakamoto whitepaper. However, it is essential for institutions to trade digital currency according to international norms. At the moment, credit – the oil that greases the wheels of institutional finance - doesn’t exist.
Along with trust in financial institutions, credit and settlement play an important role here in providing traditional fund managers or hedge funds with the funds to implement their strategies and trades on the direction of currency pairs.
Take this hypothetical chain of events: Joe Bloggs trusts Allianz with his pension pot; Allianz entrusts Blackrock as their outsourced investment manager to invest these funds; Blackrock trades with other institutional investors through a digital currency exchange, such as LMAX Digital, thereby trusting their rule book and technology.
The key differentiator here between traditional exchanges and crypto exchanges is that there is a tracked ledger of each transaction. For example, when Joe Bloggs asks Allianz where his coin is, Allianz will be able to provide him with an exact location and chain of transactions, which is much more transparent than current traditional models.
It is a fact that cryptocurrency is more traceable than physical money, because we can use the blockchain to trace its usage all the way back to its origin. This is not something you could say about the £10 note in your back pocket!
Crypto, however, is not yet regulated. Regulators haven’t made up their mind about whether crypto should be considered a currency or a security. Digital assets are the future: retail investors are already trading them and the next generation of consumers will most likely be using digital currencies more commonly than physical fiat currencies. Given the involvement of retail investors, the situation demands positive regulatory intervention.
The market also needs an efficient marketplace, like the London Stock Exchange, to facilitate digital currency trading. The current marketplace consists of venues targeted at retail investors, but institutional traders are more concerned with the exchange of risk on their investment positions.
Regulation can supplement this exchange of risk. In traditional markets, in order to trade equities, it’s imperative to pass a suitability test to ensure the traders are experienced and qualified to understand the risks involved, hence why the public can’t trade directly. It is the same when buying a home, the mortgage arranger explains all the risks and rules before allowing us to take out a mortgage.
This is not the case with crypto trading. So why is there a discrepancy? Before a person or entity can trade, they should be required to pass suitability tests as they would when seeking to access other financial products and securities.
Protecting consumer interests by providing clear guidance and checking suitability will lead to a situation where trading flow is segregated between qualified institutions with experienced traders and retail flow, which will be vital to ensure institutional level participation in the market.
Infrastructure and cost
The next barrier to the third wave of cryptocurrency is the lack of current infrastructure needed for institutional crypto trading. The market requires secure and effective storage, large scale banking propositions and proper payment channels.
As they stand, digital currencies are massively expensive to produce due to their energy consumption and there is no efficient way of mining units. Institutions will have a crucial role in supplying this infrastructure, providing the overall system with protection and more liquidity.
Liquidity is essential to institutional investors, encouraging them to use and trust digital currencies. Creating better infrastructure that aids liquidity remains an important piece of the jigsaw.
All of the barriers to bringing about increased institutional participation in the crypto markets can be overcome with the help of a forward-thinking regulatory body. Number one on the agenda should be implementing regulation aimed at making the environment for retail investors safer, protecting their interests with the necessary checks and balances.
On the institutional side, the most astute regulatory bodies are starting to realise that institutional traders need oxygen and room to develop the nascent crypto trading industry into an efficient marketplace. As the Bank of England’s Mark Carney elegantly puts it - maintaining an open mind, but not an open door. This policy approach has its precedents, FX trading markets are self-regulated after all and have been functioning well for years, with the spot market becoming the most actively traded in the world with more than $5 trillion traded on average every day.
Ireland is key launchpad for US expansion into Europe
The first transatlantic cable was laid between Newfoundland and Valentia Island in County Kerry, Ireland, in 1858. It was a flawed effort; the connection was poor, causing enough issues with efforts to send telegrams along it that major repair efforts were set underway immediately - efforts which ended up further damaging the cable line, severing the connection just three weeks later.
This first step towards transatlantic subsea communication, shaky as it was, laid the foundations of more than a century and a half of information exchange across the ocean, between the East Coast of North America and Western Ireland.
It’s been 163 years since the completion of the first transatlantic cable, an event which cemented Ireland’s position as the landing stage for subsea connections between Europe and the Americas. That position has, in no small way, been a driving force behind the country’s modern role as a landing stage for US and Canadian firms looking to do business in Europe.
Today, some of the largest firms in the world, like Pfizer, Janssen, Zurich, Metlife, Google and VmWare use Ireland for their European Headquarters. The combination of an English-speaking workforce (a boon made all the more important as Brexit makes the UK and the north of Ireland an increasingly complex environment that provides diminishing opportunities to access the rest of Europe), a cultural and regulatory landscape that welcomes foreign investment, and world-class connectivity makes the country an unparalleled choice for firms looking to establish a foothold in the EU.
As a result, Ireland has become one of the world’s leading data centre hubs.
Based on leading data centre firm Interxion’s Data Gravity Index, Dublin will be among the top five European cities that will contribute to Europe’s growth in data in the coming years, following London, Paris, Frankfurt and Amsterdam. The amount of data generated in Dublin itself is expected to grow alongside its economic expansion, with the Data Gravity Index also predicting that Dublin will outpace cities and data centre hubs like Mexico City, São Paulo, and even Shanghai, to be among the top 20 cities to experience annual data growth by 2024.
Ireland ranks 6th in the 2020 EU Digital Economy and Society Index (DESI), meaning that it is among the leading ranks of EU Member States in terms of the uptake and use of digital technologies. Likewise, the trend to locate data centres in Ireland serving overseas clients will continue to generate increasing amounts of international traffic
Managing the Dublin Data Boom
According to Interxion, subsea connectivity will continue to play a massive role in helping both international and domestic organisations digitally transform themselves to meet the challenges of changing markets post pandemic.
As the pace of global digital transformation - and the subsequent need for more connectivity - accelerates like never before, this rapidly developing world is driving urther demand for these cables as individuals and organisations become increasingly reliant on subsea cable’s exceptional data speed and capacity.
According to experts at Interxion, this connectivity will be pivotal to Ireland’s continued success in attracting international companies in the technology, pharmaceutical and financial sectors.
The subsea cable industry is a key contributor to the Irish economy across many sectors. The draft National Marine Planning Framework reported that subsea international networks make Ireland an attractive region for investment for the technology and digital sectors. Telegeography states that there are twelve existing subsea cables connecting Ireland to the US and UK, and a further four systems are under development. The Iish government’s statement on the Role of Data Centres in Ireland’s Enterprise Strategy identified Ireland as a location of choice for many different sectors reliant on digital and telecommunications capabilities, all of which in turn rely on subsea cable interconnectivity.
Subsea cables are of strategic importance to Ireland’s future as a catalyst for economic and societal prosperity. Ireland can be the ideal location for your company’s expansion plans. To find out how, you can hear from leading experts throughout the data centre and digital infrastructure industries on June 15, 2021, as speakers from the IDA, Aqua Comms, GTT Communications, euNetworks and Interxion discuss subsea cabling, digital transformation, Data Gravity and the fate of Ireland’s digital economy.
Key topics will include:
- Key facts about existing subsea infrastructure,
- Future plans,
- Challenges (including Marine Maintenance) and opportunities,
- Terrestrial networks (demand vs supply);
- Ireland's role as a gateway to Europe
The virtual panel (which is taking place between 10:30 PM - 11:30 PM JST on June 15, 2021) will conclude with a 20 minute Q&A. Mike Hollands, Senior Director of Market Development at Interxion, will moderate the event.