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Speaker 1: This is Bloomberg Crypto, a daily Bloomberg I Hood podcast,

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Speaker 1: and I'm Stacy Marie Ishmael, Managing editor of Crypto for

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Speaker 1: Bloomberg News. It's Tuesday, December. I'm an era in today

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Speaker 1: for Stacy Marie Ishmael. In the aftermath of the ft

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Speaker 1: X collapse, one of the most significant crypto exchanges in

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Speaker 1: the industry, investors and hedge funds are seriously questioning the

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Speaker 1: future of crypto. F t X was once among the

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Speaker 1: top centralized exchanges. It was a haven for professional and

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Speaker 1: amateur investors, but now billions of investors dollars have disappeared,

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Speaker 1: and its former CEO, Sam bankmn Freed, has been arrested

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Speaker 1: and denied bond and is facing conspiracy and fraud charges.

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Speaker 1: Earlier this week, Finance, the largest exchange by volume and

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Speaker 1: a formal rival of FTX, suffered a wave of withdrawals

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Speaker 1: after releasing its proof of reserve report, leaving many investors

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Speaker 1: and crypto proponents wondering should they trust any crypto exchange

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Speaker 1: at all, and if so, what should it do Differently.

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Speaker 1: For mar In this, I'm joined by Bloomberg reporter Justina.

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Speaker 1: A lot of the time you do need to imitate

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Speaker 1: the practices of Wall Street in order to make these

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Speaker 1: people feel secure, but that kind of defeats the whole purpose.

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Speaker 1: So I'm joined today by Justina Lee, who sits quite

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Speaker 1: close to me in the London bureau. So I'm gonna

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Speaker 1: like Justina introduce herself and tell us sort of what

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Speaker 1: her day job is and how she also does crypto. Yeah,

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Speaker 1: so I'm on a Bloomberg team that covers all the

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Speaker 1: asset classes UM, which of course includes crypto. So I

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Speaker 1: still write quite a bit about trad five. So it's

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Speaker 1: been especially interesting to kind of see a lot of

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Speaker 1: crypto people UM look at trad five market structure and

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Speaker 1: compare that to what they have UM, which I guess

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Speaker 1: is the nerdy topic that we're discussing today. Indeed, so

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Speaker 1: let's take a step back. Obviously, the biggest news this

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Speaker 1: month there a little bit longer now, has been the

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Speaker 1: collapse of ft X, the swift and chaotic collapse of FTX.

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Speaker 1: Do you want to give us a bit of background

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Speaker 1: on what FTX meant for sort of the more trad

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Speaker 1: five aspect of crypto, like the funds that perhaps you

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Speaker 1: would cover, the multi asset ones sort of the professional traders.

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Speaker 1: Why was it such a big deal for them? Yeah, So,

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Speaker 1: to begin with, fd X is one of the top

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Speaker 1: five exchanges in terms of trading volumes. They're far from

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Speaker 1: the biggest. I mean, we all know that's finance, but

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Speaker 1: I think ft X occupied are pretty unique role for

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Speaker 1: institutional prose in particular because it was an exchange that

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Speaker 1: was built by a team that was already familiar with,

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Speaker 1: you know, the stock market and all that, and so

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Speaker 1: they built it in a way that particularly suited you know,

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Speaker 1: the algorithmic traders for instance. Um it kind of had

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Speaker 1: leverage built into the system. It also had a lot

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Speaker 1: of inherently leveraged products that were very attractive. The liquidity,

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Speaker 1: by the sounds of it, was pretty good for most

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Speaker 1: of its history. So obviously, you know, as you said,

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Speaker 1: it was built by traders for traders, and that meant

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Speaker 1: that it attracted lots of professional funds, which then means

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Speaker 1: that when it collapsed, and now we know this week,

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Speaker 1: the biggest news was that the founder was arrested and

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Speaker 1: and charged with with fraud and misappropriating the funds. What

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Speaker 1: happened was a lot of these funds officer money. So

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Speaker 1: what has that meant broadly, what has it meant for

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Speaker 1: just crypto trading in general. Yeah, I mean it's really

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Speaker 1: been a big shock. We've heard from some asset managers

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Speaker 1: that they have, you know, a large majority of assets

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Speaker 1: even on FTX, and I think it's fair to say

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Speaker 1: that for a lot of crypto hedge funds that had

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Speaker 1: an active trading strategy, they would at least have some

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Speaker 1: assets on FTX which are now essentially lost to them

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Speaker 1: or at least into the bankruptcy process. And so I

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Speaker 1: think for a lot of funds that are still trying

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Speaker 1: to survive, the first instinct hast just been to cut

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Speaker 1: back risk. And what that means is, you know, they're

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Speaker 1: deleveraging their um, cutting back positions, they're selling their assets

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Speaker 1: and turning them into stable coins or even FIAT. And

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Speaker 1: so we've really seen this period of risk aversion all

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Speaker 1: across the market, and because of that, we're actually seeing

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Speaker 1: the market become a bit less efficient and less liquid,

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Speaker 1: precisely because a lot of these funds that usually arbitrage

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Speaker 1: away these inefficiencies have really pulled back. And part of

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Speaker 1: the issue, maybe you want to tell us is how

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Speaker 1: exchanges in crypto operate A bit differently from exchanges in

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Speaker 1: other markets, and I guess many of our listeners might

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Speaker 1: be familiar with one and not the other. Perhaps it

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Speaker 1: might be are familiar without crypto works. But a big

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Speaker 1: part of it is that there's no real separation of powers, right, yeah, exactly.

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Speaker 1: I mean in tratfy you also have I guess centralized exchanges,

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Speaker 1: but the difference here is that you also have a

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Speaker 1: lot of other intermediaries like brokerages and custodians and clearing houses.

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Speaker 1: And essentially what that means is the exchange is not

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Speaker 1: holding your asset directly. But I think because crypto developed

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Speaker 1: without any infrastructure and without any regulations, and it's always

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Speaker 1: been a very exchange centric system from the very start,

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Speaker 1: and so the exchanges actually hold your assets directly. And

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Speaker 1: what that means is that, for instance, if you want

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Speaker 1: to use leverage to trade, you need to put your

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Speaker 1: coins on the exchange as margin, and also your profits

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Speaker 1: and losses are on the exchange. And so what people

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Speaker 1: have realized is that that has really created a concentration

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Speaker 1: of risk as well as possibly a conflict of interest

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Speaker 1: for these exchanges, and so when one collapses, you essentially

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Speaker 1: lose a lot of money in one go. Yeah, because

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Speaker 1: you're not only losing your coins that you were training,

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Speaker 1: you're losing the collateral you'd posted on there as well.

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Speaker 1: So it's like you're you're losing really everything. And I

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Speaker 1: guess the point is now, although you know, crypto is

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Speaker 1: supposed to revolutionize finance in a way, what you're hearing,

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Speaker 1: I guess is that some of these funds actually wanted

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Speaker 1: to go the other way. They do want to have

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Speaker 1: these intermediaries again, or they'd rather have those intermediaries. Yeah,

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Speaker 1: it's kind of funny because it's almost like a lot

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Speaker 1: of people in crypto are realizing that that's there's a

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Speaker 1: reason why traf fy does things a certain way, even

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Speaker 1: if it sounds like really clumsy, but that is a

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Speaker 1: way to kind of diversify the risk, and that is,

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Speaker 1: you know how Wall Street has traditionally done things. So

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Speaker 1: what does that mean for the exchanges? Like does that

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Speaker 1: potentially mean that they'll make less money if like these

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Speaker 1: roles are separated or not really? Or like do you

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Speaker 1: get a sense speaking to the funds that exchanges are

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Speaker 1: actually even contemplating this or not? Really? Exchanges have always

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Speaker 1: been a bit resistant because these illusions are not entirely new,

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Speaker 1: and the reason they haven't been implemented is because the

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Speaker 1: exchanges had no incentive to really change the status quo.

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Speaker 1: And I guess you know a simple reason for that

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Speaker 1: is the way things currently are. They have direct control

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Speaker 1: and visibility into your assets, and so they know that

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Speaker 1: if you're gonna you know, trade on margin, you're not

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Speaker 1: going to go broke on them, and they can even

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Speaker 1: liquidate your assets directly. But I think you know now

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Speaker 1: there's definitely more pressure from institutions, from a lot of

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Speaker 1: big investors for exchanges to change, and we're now watching

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Speaker 1: whether that's actually going to happen. So what do you

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Speaker 1: think is going to happen in the short term? Like

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Speaker 1: some some of these funds you spoke to said, they're

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Speaker 1: just like holding and not not are they trading? How

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Speaker 1: are they trading? Like? Is it sustainable to not trade

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Speaker 1: and just wait and see what what's the mood? Yeah,

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Speaker 1: I think a lot of pros are in a dilemma

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Speaker 1: right now because they're all worried about counterparty risk. But

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Speaker 1: at the same time, you can't really change crypto market

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Speaker 1: structure overnight, and so if you if your stances, you know,

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Speaker 1: I will not trade until everything changes, then basically you're

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Speaker 1: not trading right um, And so I think a lot

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Speaker 1: of them are trying to strike a balance. You know,

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Speaker 1: they're putting pressure on the exchanges to implement better measures too,

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Speaker 1: maybe you know, put together like an off exchange settlement

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Speaker 1: system like we discussed to release proof of reserves and

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Speaker 1: all that, while kind of still trading in a way

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Speaker 1: like under the current status quo. Coming up more with

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Speaker 1: Bloomberg reporter to sin Elite on how hedge funds are

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Speaker 1: adapting to a post ft X landscape, will be right back.

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Speaker 1: So the spotlight has someone, I mean, it's not really

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Speaker 1: turned from ft X, but there's now a second bot

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Speaker 1: light on Binance, I would, I would say, because you know,

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Speaker 1: they're by far the biggest exchange out there now, and

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Speaker 1: you know, if you talk about concentration of risk, like

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Speaker 1: they are potentially quite uh risky. Now if if something

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Speaker 1: happens to Binance and it's a big deal for everyone.

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Speaker 1: So how are sort of traders thinking about Binance now?

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Speaker 1: Are they changing the way they deal with the firm

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Speaker 1: or not? Really? Like do you see them separating their

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Speaker 1: their sort of functions a bit? More so? Finance has

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Speaker 1: always been in a way more resistant to turning to

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Speaker 1: a more decentralized approach. I mean, what they've come up

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Speaker 1: with is this idea of finance custody, which allows you

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Speaker 1: to put your assets in in a way like a

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Speaker 1: specific finance entity that is there to safeguard or assets

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Speaker 1: and will allow for off exchange settlement. And so I

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Speaker 1: think that kind of finance has benefited from this um

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Speaker 1: situation in that after f takes collapsed, just by virtue

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Speaker 1: of being the most liquid, the biggest exchange out there,

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Speaker 1: they've grabbed market share. And so I think they don't

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Speaker 1: necessarily want to rock the boat, but they can certainly

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Speaker 1: see that a lot of their biggest clients now have

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Speaker 1: these more institutional style demands. So you know, what are

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Speaker 1: some of the solutions that are that are being proposed.

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Speaker 1: You you know, in your story you mentioned Copper, which

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Speaker 1: is like a London based for my belief, what are

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Speaker 1: they proposing and you know, why is it not taken

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Speaker 1: off or why might they take off more? Now? What

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Speaker 1: what were they saying when you reported this? So they

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Speaker 1: have a solution called clear loop, which is where you

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Speaker 1: put your assets with them. You know, a third party

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Speaker 1: custodian and the exchanges are sort of plugged into the

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Speaker 1: same system and so that they can see your collateral

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Speaker 1: and they can settle your profits and losses through the

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Speaker 1: clear loop system rather than on the exchange itself. And

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Speaker 1: traditionally it's never been particular particularly popular with the exchanges,

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Speaker 1: and so it's not connected to any of the top

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Speaker 1: five um and that's basically why it's never been a

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Speaker 1: very practical solution if you want the liquidity and the

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Speaker 1: volumes of the biggest exchanges. You know. I've spoken to

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Speaker 1: them since FTX fell apart, and they have said that

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Speaker 1: they feel like there's more pressure now for exchanges to

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Speaker 1: implement their solution, and they're optimistic about announcing more integrations

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Speaker 1: and so and I can definitely kind of see the

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Speaker 1: reasoning behind that, and so we'll have to see if

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Speaker 1: there are more announcements coming up in the next few months.

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Speaker 1: So obviously, if you're crypto buff you'll say, well, you're

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Speaker 1: all you're talking about centralized exchanges. There's a whole world

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Speaker 1: of about crypto, and actually crypto is not about centralized exchanges,

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Speaker 1: but it's about defy and decentralized exchanges. Why has that

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Speaker 1: not really taken off as much with these with funds

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Speaker 1: for now, I guess you know, we've we've seen a

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Speaker 1: little bit volumes going up or at least not shrinking

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Speaker 1: as much as on centralized platforms. But you know, why

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Speaker 1: is it not absolutely feasible for some of these fun

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Speaker 1: for now? Yeah, that's a that's a great question because

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Speaker 1: I'm sure you've heard a lot of people saying in

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Speaker 1: the wake of ftex is collapse that you know, Defy

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Speaker 1: was the solution all along and of anything. That vision

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Speaker 1: has now been vindicated, and I think to some extent

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Speaker 1: that is correct. But the issue is that it was

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Speaker 1: always a very small part of crypto trading volumes, even today,

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Speaker 1: and so in a way it was never a feasible

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Speaker 1: alternative to centralized exchanges. And that's probably because liquidity is

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Speaker 1: just simply not there for defy right now. And so

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Speaker 1: if you're the kind of crypto hut fund that has

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Speaker 1: very active strategies, then you need the liquidity. And and

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Speaker 1: the other issue here is that, you know, because the

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Speaker 1: whole idea of Defy is that there's no centralized entity,

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Speaker 1: and so there's no one checking your identity, there are

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Speaker 1: no like users per se Um with kind of k

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Speaker 1: I C and all that, and so there's always been

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Speaker 1: a lot of regulatory issues behind that. You know, how

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Speaker 1: do you think about money laundering? Ask how do you

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Speaker 1: think about you know, the know your customer risk? And

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Speaker 1: that's why a lot of institutions actually will not touch

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Speaker 1: DeFi at all. So I guess one thing that's quite

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Speaker 1: ironic is that, you know, for a lot of the

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Speaker 1: past year, SPF has been trying to get regular markets

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Speaker 1: to turn more into like crypto markets. Right, he had

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Speaker 1: like a proposal with the CFTC. So you know, what

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Speaker 1: do you think about that now? Actually it seems like

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Speaker 1: he may have made crypto more like trad five. Actually,

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Speaker 1: these funds asking for more separation of powers and more

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Speaker 1: intermediaries succeed and managed to get the exchanges to accept

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Speaker 1: that the fact that they might not post the collateral

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Speaker 1: with them but somewhere else. Yeah, exactly. And I think,

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Speaker 1: you know, in my reporting about crypto, I think I

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Speaker 1: always come back to the same irony in a lot

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Speaker 1: of cases, because if the crypto industry really wants to grow,

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Speaker 1: and then they needs to draw institutional money, right, and

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Speaker 1: needs to draw these existing big pots of money of

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Speaker 1: like pension funds or hatch funds and all that. But

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Speaker 1: in order to do that, a lot of the time

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Speaker 1: you do need to imitate the practices of Wall Street

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Speaker 1: in order to make these people feel secure. But that

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Speaker 1: kind of defeats the whole purpose. But the problem is

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Speaker 1: if you if you stick to defy, there's a chance

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Speaker 1: that you'll never be as Vegas. You know, you you

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Speaker 1: envisioned yourself to be. And I think, you know, I

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Speaker 1: always think of crypto is kind of walking the line

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Speaker 1: between the two, And I think what seems to be

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Speaker 1: happening here is that because there's already a lot of

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Speaker 1: institutional interests, there are a lot of people that haven't

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Speaker 1: kind of an inherent interest in pushing for the more

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Speaker 1: Wall Street version of things. I mean, it doesn't necessarily mean,

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Speaker 1: you know, there won't be defy, But then the question

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Speaker 1: here is, you know, we'll we'll defy always be just

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Speaker 1: a small fraction of the system, or will it ever

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Speaker 1: actually you know, take over trad fy So in closing,

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Speaker 1: what are some of the things you're watching to see

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Speaker 1: and spot whether this evolution sort of goes more towards

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Speaker 1: Wall Street or more towards Defy, Like what are the

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Speaker 1: signs what what will you be interested in seeing? Yeah,

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Speaker 1: I think you know there there's also another future here,

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Speaker 1: which is it's it's possible that a lot of institutions

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Speaker 1: have now just lost interest and so kind of crypto

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Speaker 1: goes back to to where it was and in a way,

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Speaker 1: I guess, you know, it kind of becomes a much

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Speaker 1: smaller community. And so I think we're we're kind of seeing,

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Speaker 1: you know, what happens to finance. Obviously there's been a

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Speaker 1: lot of outflows lately. Kind of does it continue to

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Speaker 1: retain the trust of a lot of its users? And

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Speaker 1: I think that's sort of the biggest question here because

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Speaker 1: we have seen its market share grow after f t

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Speaker 1: X went under. And in a way, it's kind of

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Speaker 1: ironic because a lot of people are now talking about

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Speaker 1: counterparty risk, concentration risk, but kind of in ft X

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Speaker 1: falling apart, finance has become a much concentration more concentrated

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Speaker 1: risk of the industry. All right, thank you so much,

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Speaker 1: just Tina, Thanks all for having me. That was Bloomberg

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Speaker 1: reporter Justina Lee. You can find more of a reporting

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Speaker 1: on the Bloomberg terminal and on Bloomberg dot com. For

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Speaker 1: Mark be sure to check out our twice weekly newsletter,

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