Ever since Bitcoin first hit the tape in the early 2010s, a group of secretive investment firms that squeeze profits from ultra-fast trading systems have been at work in cryptocurrencies.
Now the rest of the mainstream investing world may finally be catching up.
Jump Trading, Jane Street, and Tower Research Capital are among the US giants in a class that goes by many names — high-frequency traders, or HFTs; algorithmic market-makers; liquidity providers; and systematic quantitative trading firms.
Whatever you call them, they’re quietly forging a path that experts say other big finance firms are likely to follow. Every now and then the spotlight finds them, as it did in 2014 when author Michael Lewis chronicled their exploits in his book “Flash Boys.”
More recently, the HFT crowd has materialised in regulators’ lawsuits against crypto firms Binance and FTX, the cryptocurrency exchange that went bankrupt in November.
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“Initially, crypto was attractive to them because it was just so volatile,” Niki Beattie, founder of capital markets consulting firm Market Structure Partners and chair of ClearToken, a digital assets clearing house, told DL News.
Crypto’s perfect conditions
Conditions in crypto are perfect for sophisticated traders: rocky markets mixed with a relatively uninformed base of retail investors who don’t have the super-fast computers that big hedge funds do. Speed-trading firms use lightning-fast algorithms that can scan prices, looking for tiny slivers of difference, then pounce.
‘You might see one firm put down $50 million or something. That’s nothing when you’re managing $100 billion’
Once snags like regulation and default risk are smoothed over, the floodgates to more mainstream adoption will open up.
“We’ve got this bridge now between retail markets and institutional markets,” Beattie said. “Firms like BlackRock, etc, acknowledge that digital assets are the way forward. The HFTs are the first sign that we’re moving in that direction.”
Trading in these markets relies on arbitrage strategies that scrape returns off of trades bought and sold thousands of times in the time that it takes to blink.
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Put crudely, an algorithm can buy cheap on one exchange and sell for slightly more on another, over and over and over, to turn minuscule price discrepancies into big profits.
Trading firms are just dipping their toes in, for now. Big finance firms, notably the $4 trillion asset manager Fidelity Investments, are also building up teams and expanding client offerings in crypto.
Sameer Shalaby, president of digital asset trading, financing, and lending platform VersiFi, said that hedge funds are most concerned about counterparty risk: the high probability that the people on the other side of your trades might not meet their end of the deal.
‘It’s almost play money’
“Crypto is in its infancy. These managers are allocating very, very small amounts to it, it’s almost play money. You might see one firm put down $50 million or something,” Shalaby said. “That’s nothing when you’re managing $100 billion.”
Speed trading in crypto is mostly done by firms investing their own money or that of wealthy investors, presumed to be sophisticated enough to know what they’re doing when it comes to taking on big risks. So most players tend to be either smaller “prop shops” — or firms investing their own money — or bigger firms through their family offices.
Among the first of these speed trading firms to pile into the asset class was DRW, with its specialised desk Cumberland. Cumberland was founded in 2017 and has since expanded into providing indexes and market-making.
Flow Traders, Akuna Capital, and the three firms mentioned in the Binance lawsuit — Jane Street, Tower Research and Radix — are all examples of speed traders with crypto desks.
Jump Crypto, the crypto arm of Jump Trading, launched in September 2021. Its young president, Kanav Kariya, said at the time that Jump wants to position itself as a big player in an industry that is “going to be enormous.”
Jump Trading is secretive even for a secretive industry. But Jump Crypto has had to be relatively transparent in its crypto investing activities.
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And it was recently named as the investor that booked $1.28 billion in returns before Do Kwon’s Terra/LUNA collapsed in 2022.
Speed strategies are becoming less profitable in other markets. But Beattie said in crypto there are still massive opportunities to arbitrage latency — that is, to use a speed advantage to make a better trade than other investors.
‘Flash Boys’
In “Flash Boys,” Lewis describes how one early project tried to wring a 10 millisecond advantage by tunnelling under the Allegheny Mountains in the eastern US.
By the time the book came out, that project was all but obsolete, with cables replaced by microwave towers that beamed information through the air at 99% the speed of light, and special semiconductors optimised for speed.
Speed traders today can also opt for what’s called co-location: paying a vendor top dollar to nestle their server as close as possible to that of an exchange in a massive data centre.
In crypto, the infrastructure is catching up. In 2018, Coinbase became the first exchange to say it was going to revamp its architecture to allow for co-location.
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Plus, Beattie said, one advantage of Bitcoin is that it’s traded globally, widening the possibilities for arbitrage.
Sources with experience in these markets said many strategies in crypto are what’s known as basis trading – arbing the spot price of Bitcoin on one exchange against a derivative, such as a futures contract known as a Bitcoin perpetual, on another.
The Binance lawsuit says that the three speed trading firms were all trading Bitcoin perpetual options on the exchange.
Beattie declined to discuss specific firms, and noted that different companies have different strategies, and can’t all be lumped together. But, she said, traditional asset managers are eager to move into digital assets and the speed trading firms are in the vanguard of that revolution.
But why are these trading companies so secretive, anyway?
“They are opaque by design in every asset class, not just in crypto,” said Beattie. “It’s because they don’t want to give away any of their strategies to their competitors. Once your strategy is blown, then it’s no longer a profitable strategy. You’ve got to go back to the drawing board and create new ones.”