WEBVTT - Hedge Funds Question Crypto’s Future

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<v Speaker 1>This is Bloomberg Crypto, a daily Bloomberg I Hood podcast,

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<v Speaker 1>and I'm Stacy Marie Ishmael, Managing editor of Crypto for

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

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<v Speaker 1>for Stacy Marie Ishmael. In the aftermath of the ft

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<v Speaker 1>X collapse, one of the most significant crypto exchanges in

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<v Speaker 1>the industry, investors and hedge funds are seriously questioning the

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<v Speaker 1>future of crypto. F t X was once among the

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<v Speaker 1>top centralized exchanges. It was a haven for professional and

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<v Speaker 1>amateur investors, but now billions of investors dollars have disappeared,

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<v Speaker 1>and its former CEO, Sam bankmn Freed, has been arrested

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<v Speaker 1>and denied bond and is facing conspiracy and fraud charges.

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<v Speaker 1>Earlier this week, Finance, the largest exchange by volume and

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<v Speaker 1>a formal rival of FTX, suffered a wave of withdrawals

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<v Speaker 1>after releasing its proof of reserve report, leaving many investors

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<v Speaker 1>and crypto proponents wondering should they trust any crypto exchange

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<v Speaker 1>at all, and if so, what should it do Differently.

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

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<v Speaker 1>A lot of the time you do need to imitate

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<v Speaker 1>the practices of Wall Street in order to make these

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<v Speaker 1>people feel secure, but that kind of defeats the whole purpose.

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<v Speaker 1>So I'm joined today by Justina Lee, who sits quite

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<v Speaker 1>close to me in the London bureau. So I'm gonna

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<v Speaker 1>like Justina introduce herself and tell us sort of what

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<v Speaker 1>her day job is and how she also does crypto. Yeah,

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<v Speaker 1>so I'm on a Bloomberg team that covers all the

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<v Speaker 1>asset classes UM, which of course includes crypto. So I

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<v Speaker 1>still write quite a bit about trad five. So it's

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<v Speaker 1>been especially interesting to kind of see a lot of

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<v Speaker 1>crypto people UM look at trad five market structure and

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<v Speaker 1>compare that to what they have UM, which I guess

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

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

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<v Speaker 1>month there a little bit longer now, has been the

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<v Speaker 1>collapse of ft X, the swift and chaotic collapse of FTX.

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<v Speaker 1>Do you want to give us a bit of background

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<v Speaker 1>on what FTX meant for sort of the more trad

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<v Speaker 1>five aspect of crypto, like the funds that perhaps you

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<v Speaker 1>would cover, the multi asset ones sort of the professional traders.

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<v Speaker 1>Why was it such a big deal for them? Yeah, So,

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<v Speaker 1>to begin with, fd X is one of the top

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<v Speaker 1>five exchanges in terms of trading volumes. They're far from

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

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<v Speaker 1>I think ft X occupied are pretty unique role for

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<v Speaker 1>institutional prose in particular because it was an exchange that

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<v Speaker 1>was built by a team that was already familiar with,

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<v Speaker 1>you know, the stock market and all that, and so

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<v Speaker 1>they built it in a way that particularly suited you know,

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<v Speaker 1>the algorithmic traders for instance. Um it kind of had

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<v Speaker 1>leverage built into the system. It also had a lot

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<v Speaker 1>of inherently leveraged products that were very attractive. The liquidity,

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<v Speaker 1>by the sounds of it, was pretty good for most

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<v Speaker 1>of its history. So obviously, you know, as you said,

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<v Speaker 1>it was built by traders for traders, and that meant

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<v Speaker 1>that it attracted lots of professional funds, which then means

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<v Speaker 1>that when it collapsed, and now we know this week,

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<v Speaker 1>the biggest news was that the founder was arrested and

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<v Speaker 1>and charged with with fraud and misappropriating the funds. What

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<v Speaker 1>happened was a lot of these funds officer money. So

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<v Speaker 1>what has that meant broadly, what has it meant for

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

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<v Speaker 1>been a big shock. We've heard from some asset managers

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<v Speaker 1>that they have, you know, a large majority of assets

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<v Speaker 1>even on FTX, and I think it's fair to say

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<v Speaker 1>that for a lot of crypto hedge funds that had

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<v Speaker 1>an active trading strategy, they would at least have some

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<v Speaker 1>assets on FTX which are now essentially lost to them

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<v Speaker 1>or at least into the bankruptcy process. And so I

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<v Speaker 1>think for a lot of funds that are still trying

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<v Speaker 1>to survive, the first instinct hast just been to cut

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

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<v Speaker 1>deleveraging their um, cutting back positions, they're selling their assets

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<v Speaker 1>and turning them into stable coins or even FIAT. And

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<v Speaker 1>so we've really seen this period of risk aversion all

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<v Speaker 1>across the market, and because of that, we're actually seeing

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<v Speaker 1>the market become a bit less efficient and less liquid,

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<v Speaker 1>precisely because a lot of these funds that usually arbitrage

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<v Speaker 1>away these inefficiencies have really pulled back. And part of

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<v Speaker 1>the issue, maybe you want to tell us is how

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<v Speaker 1>exchanges in crypto operate A bit differently from exchanges in

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<v Speaker 1>other markets, and I guess many of our listeners might

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<v Speaker 1>be familiar with one and not the other. Perhaps it

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<v Speaker 1>might be are familiar without crypto works. But a big

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

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<v Speaker 1>I mean in tratfy you also have I guess centralized exchanges,

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<v Speaker 1>but the difference here is that you also have a

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<v Speaker 1>lot of other intermediaries like brokerages and custodians and clearing houses.

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<v Speaker 1>And essentially what that means is the exchange is not

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<v Speaker 1>holding your asset directly. But I think because crypto developed

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<v Speaker 1>without any infrastructure and without any regulations, and it's always

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<v Speaker 1>been a very exchange centric system from the very start,

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<v Speaker 1>and so the exchanges actually hold your assets directly. And

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<v Speaker 1>what that means is that, for instance, if you want

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<v Speaker 1>to use leverage to trade, you need to put your

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<v Speaker 1>coins on the exchange as margin, and also your profits

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<v Speaker 1>and losses are on the exchange. And so what people

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<v Speaker 1>have realized is that that has really created a concentration

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<v Speaker 1>of risk as well as possibly a conflict of interest

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<v Speaker 1>for these exchanges, and so when one collapses, you essentially

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<v Speaker 1>lose a lot of money in one go. Yeah, because

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<v Speaker 1>you're not only losing your coins that you were training,

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<v Speaker 1>you're losing the collateral you'd posted on there as well.

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<v Speaker 1>So it's like you're you're losing really everything. And I

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<v Speaker 1>guess the point is now, although you know, crypto is

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<v Speaker 1>supposed to revolutionize finance in a way, what you're hearing,

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<v Speaker 1>I guess is that some of these funds actually wanted

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<v Speaker 1>to go the other way. They do want to have

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<v Speaker 1>these intermediaries again, or they'd rather have those intermediaries. Yeah,

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<v Speaker 1>it's kind of funny because it's almost like a lot

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<v Speaker 1>of people in crypto are realizing that that's there's a

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<v Speaker 1>reason why traf fy does things a certain way, even

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<v Speaker 1>if it sounds like really clumsy, but that is a

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<v Speaker 1>way to kind of diversify the risk, and that is,

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<v Speaker 1>you know how Wall Street has traditionally done things. So

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<v Speaker 1>what does that mean for the exchanges? Like does that

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<v Speaker 1>potentially mean that they'll make less money if like these

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<v Speaker 1>roles are separated or not really? Or like do you

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<v Speaker 1>get a sense speaking to the funds that exchanges are

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<v Speaker 1>actually even contemplating this or not? Really? Exchanges have always

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<v Speaker 1>been a bit resistant because these illusions are not entirely new,

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<v Speaker 1>and the reason they haven't been implemented is because the

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<v Speaker 1>exchanges had no incentive to really change the status quo.

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<v Speaker 1>And I guess you know a simple reason for that

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<v Speaker 1>is the way things currently are. They have direct control

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<v Speaker 1>and visibility into your assets, and so they know that

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<v Speaker 1>if you're gonna you know, trade on margin, you're not

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<v Speaker 1>going to go broke on them, and they can even

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<v Speaker 1>liquidate your assets directly. But I think you know now

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<v Speaker 1>there's definitely more pressure from institutions, from a lot of

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<v Speaker 1>big investors for exchanges to change, and we're now watching

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<v Speaker 1>whether that's actually going to happen. So what do you

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<v Speaker 1>think is going to happen in the short term? Like

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<v Speaker 1>some some of these funds you spoke to said, they're

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<v Speaker 1>just like holding and not not are they trading? How

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<v Speaker 1>are they trading? Like? Is it sustainable to not trade

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<v Speaker 1>and just wait and see what what's the mood? Yeah,

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<v Speaker 1>I think a lot of pros are in a dilemma

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<v Speaker 1>right now because they're all worried about counterparty risk. But

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<v Speaker 1>at the same time, you can't really change crypto market

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<v Speaker 1>structure overnight, and so if you if your stances, you know,

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<v Speaker 1>I will not trade until everything changes, then basically you're

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<v Speaker 1>not trading right um, And so I think a lot

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<v Speaker 1>of them are trying to strike a balance. You know,

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

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<v Speaker 1>maybe you know, put together like an off exchange settlement

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<v Speaker 1>system like we discussed to release proof of reserves and

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<v Speaker 1>all that, while kind of still trading in a way

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<v Speaker 1>like under the current status quo. Coming up more with

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<v Speaker 1>Bloomberg reporter to sin Elite on how hedge funds are

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<v Speaker 1>adapting to a post ft X landscape, will be right back.

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<v Speaker 1>So the spotlight has someone, I mean, it's not really

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<v Speaker 1>turned from ft X, but there's now a second bot

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<v Speaker 1>light on Binance, I would, I would say, because you know,

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<v Speaker 1>they're by far the biggest exchange out there now, and

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<v Speaker 1>you know, if you talk about concentration of risk, like

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<v Speaker 1>they are potentially quite uh risky. Now if if something

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<v Speaker 1>happens to Binance and it's a big deal for everyone.

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<v Speaker 1>So how are sort of traders thinking about Binance now?

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<v Speaker 1>Are they changing the way they deal with the firm

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<v Speaker 1>or not? Really? Like do you see them separating their

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<v Speaker 1>their sort of functions a bit? More so? Finance has

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<v Speaker 1>always been in a way more resistant to turning to

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

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<v Speaker 1>with is this idea of finance custody, which allows you

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<v Speaker 1>to put your assets in in a way like a

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<v Speaker 1>specific finance entity that is there to safeguard or assets

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<v Speaker 1>and will allow for off exchange settlement. And so I

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<v Speaker 1>think that kind of finance has benefited from this um

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<v Speaker 1>situation in that after f takes collapsed, just by virtue

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<v Speaker 1>of being the most liquid, the biggest exchange out there,

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<v Speaker 1>they've grabbed market share. And so I think they don't

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<v Speaker 1>necessarily want to rock the boat, but they can certainly

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<v Speaker 1>see that a lot of their biggest clients now have

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<v Speaker 1>these more institutional style demands. So you know, what are

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<v Speaker 1>some of the solutions that are that are being proposed.

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<v Speaker 1>You you know, in your story you mentioned Copper, which

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<v Speaker 1>is like a London based for my belief, what are

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<v Speaker 1>they proposing and you know, why is it not taken

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<v Speaker 1>off or why might they take off more? Now? What

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<v Speaker 1>what were they saying when you reported this? So they

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<v Speaker 1>have a solution called clear loop, which is where you

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<v Speaker 1>put your assets with them. You know, a third party

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<v Speaker 1>custodian and the exchanges are sort of plugged into the

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<v Speaker 1>same system and so that they can see your collateral

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<v Speaker 1>and they can settle your profits and losses through the

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<v Speaker 1>clear loop system rather than on the exchange itself. And

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<v Speaker 1>traditionally it's never been particular particularly popular with the exchanges,

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<v Speaker 1>and so it's not connected to any of the top

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<v Speaker 1>five um and that's basically why it's never been a

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<v Speaker 1>very practical solution if you want the liquidity and the

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<v Speaker 1>volumes of the biggest exchanges. You know. I've spoken to

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<v Speaker 1>them since FTX fell apart, and they have said that

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<v Speaker 1>they feel like there's more pressure now for exchanges to

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<v Speaker 1>implement their solution, and they're optimistic about announcing more integrations

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<v Speaker 1>and so and I can definitely kind of see the

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<v Speaker 1>reasoning behind that, and so we'll have to see if

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<v Speaker 1>there are more announcements coming up in the next few months.

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<v Speaker 1>So obviously, if you're crypto buff you'll say, well, you're

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

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<v Speaker 1>of about crypto, and actually crypto is not about centralized exchanges,

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<v Speaker 1>but it's about defy and decentralized exchanges. Why has that

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<v Speaker 1>not really taken off as much with these with funds

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<v Speaker 1>for now, I guess you know, we've we've seen a

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<v Speaker 1>little bit volumes going up or at least not shrinking

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<v Speaker 1>as much as on centralized platforms. But you know, why

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<v Speaker 1>is it not absolutely feasible for some of these fun

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<v Speaker 1>for now? Yeah, that's a that's a great question because

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<v Speaker 1>I'm sure you've heard a lot of people saying in

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<v Speaker 1>the wake of ftex is collapse that you know, Defy

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<v Speaker 1>was the solution all along and of anything. That vision

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<v Speaker 1>has now been vindicated, and I think to some extent

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<v Speaker 1>that is correct. But the issue is that it was

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<v Speaker 1>always a very small part of crypto trading volumes, even today,

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<v Speaker 1>and so in a way it was never a feasible

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<v Speaker 1>alternative to centralized exchanges. And that's probably because liquidity is

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<v Speaker 1>just simply not there for defy right now. And so

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<v Speaker 1>if you're the kind of crypto hut fund that has

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<v Speaker 1>very active strategies, then you need the liquidity. And and

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<v Speaker 1>the other issue here is that, you know, because the

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<v Speaker 1>whole idea of Defy is that there's no centralized entity,

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<v Speaker 1>and so there's no one checking your identity, there are

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<v Speaker 1>no like users per se Um with kind of k

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<v Speaker 1>I C and all that, and so there's always been

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<v Speaker 1>a lot of regulatory issues behind that. You know, how

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<v Speaker 1>do you think about money laundering? Ask how do you

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<v Speaker 1>think about you know, the know your customer risk? And

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<v Speaker 1>that's why a lot of institutions actually will not touch

0:13:06.000 --> 0:13:10.079
<v Speaker 1>DeFi at all. So I guess one thing that's quite

0:13:10.360 --> 0:13:13.160
<v Speaker 1>ironic is that, you know, for a lot of the

0:13:13.200 --> 0:13:17.760
<v Speaker 1>past year, SPF has been trying to get regular markets

0:13:17.760 --> 0:13:20.600
<v Speaker 1>to turn more into like crypto markets. Right, he had

0:13:20.640 --> 0:13:24.880
<v Speaker 1>like a proposal with the CFTC. So you know, what

0:13:24.960 --> 0:13:26.840
<v Speaker 1>do you think about that now? Actually it seems like

0:13:26.880 --> 0:13:30.240
<v Speaker 1>he may have made crypto more like trad five. Actually,

0:13:30.280 --> 0:13:32.959
<v Speaker 1>these funds asking for more separation of powers and more

0:13:33.000 --> 0:13:37.200
<v Speaker 1>intermediaries succeed and managed to get the exchanges to accept

0:13:37.200 --> 0:13:39.160
<v Speaker 1>that the fact that they might not post the collateral

0:13:39.200 --> 0:13:42.880
<v Speaker 1>with them but somewhere else. Yeah, exactly. And I think,

0:13:43.240 --> 0:13:45.520
<v Speaker 1>you know, in my reporting about crypto, I think I

0:13:45.559 --> 0:13:47.920
<v Speaker 1>always come back to the same irony in a lot

0:13:47.960 --> 0:13:51.880
<v Speaker 1>of cases, because if the crypto industry really wants to grow,

0:13:52.160 --> 0:13:55.280
<v Speaker 1>and then they needs to draw institutional money, right, and

0:13:55.360 --> 0:13:58.320
<v Speaker 1>needs to draw these existing big pots of money of

0:13:58.400 --> 0:14:01.600
<v Speaker 1>like pension funds or hatch funds and all that. But

0:14:01.640 --> 0:14:03.400
<v Speaker 1>in order to do that, a lot of the time

0:14:03.480 --> 0:14:06.280
<v Speaker 1>you do need to imitate the practices of Wall Street

0:14:06.320 --> 0:14:09.320
<v Speaker 1>in order to make these people feel secure. But that

0:14:09.440 --> 0:14:12.160
<v Speaker 1>kind of defeats the whole purpose. But the problem is

0:14:12.200 --> 0:14:14.360
<v Speaker 1>if you if you stick to defy, there's a chance

0:14:14.360 --> 0:14:16.720
<v Speaker 1>that you'll never be as Vegas. You know, you you

0:14:16.840 --> 0:14:19.280
<v Speaker 1>envisioned yourself to be. And I think, you know, I

0:14:19.280 --> 0:14:21.680
<v Speaker 1>always think of crypto is kind of walking the line

0:14:21.680 --> 0:14:24.160
<v Speaker 1>between the two, And I think what seems to be

0:14:24.240 --> 0:14:26.720
<v Speaker 1>happening here is that because there's already a lot of

0:14:26.760 --> 0:14:29.960
<v Speaker 1>institutional interests, there are a lot of people that haven't

0:14:30.560 --> 0:14:33.160
<v Speaker 1>kind of an inherent interest in pushing for the more

0:14:33.280 --> 0:14:36.880
<v Speaker 1>Wall Street version of things. I mean, it doesn't necessarily mean,

0:14:37.040 --> 0:14:40.640
<v Speaker 1>you know, there won't be defy, But then the question

0:14:40.680 --> 0:14:42.760
<v Speaker 1>here is, you know, we'll we'll defy always be just

0:14:42.840 --> 0:14:46.040
<v Speaker 1>a small fraction of the system, or will it ever

0:14:46.160 --> 0:14:51.040
<v Speaker 1>actually you know, take over trad fy So in closing,

0:14:51.040 --> 0:14:52.960
<v Speaker 1>what are some of the things you're watching to see

0:14:52.960 --> 0:14:56.880
<v Speaker 1>and spot whether this evolution sort of goes more towards

0:14:56.880 --> 0:14:59.920
<v Speaker 1>Wall Street or more towards Defy, Like what are the

0:15:00.040 --> 0:15:03.960
<v Speaker 1>signs what what will you be interested in seeing? Yeah,

0:15:04.040 --> 0:15:07.760
<v Speaker 1>I think you know there there's also another future here,

0:15:07.800 --> 0:15:10.120
<v Speaker 1>which is it's it's possible that a lot of institutions

0:15:10.120 --> 0:15:13.000
<v Speaker 1>have now just lost interest and so kind of crypto

0:15:13.160 --> 0:15:16.280
<v Speaker 1>goes back to to where it was and in a way,

0:15:16.840 --> 0:15:18.960
<v Speaker 1>I guess, you know, it kind of becomes a much

0:15:19.560 --> 0:15:23.000
<v Speaker 1>smaller community. And so I think we're we're kind of seeing,

0:15:23.040 --> 0:15:26.040
<v Speaker 1>you know, what happens to finance. Obviously there's been a

0:15:26.080 --> 0:15:30.320
<v Speaker 1>lot of outflows lately. Kind of does it continue to

0:15:31.120 --> 0:15:34.600
<v Speaker 1>retain the trust of a lot of its users? And

0:15:34.880 --> 0:15:37.040
<v Speaker 1>I think that's sort of the biggest question here because

0:15:37.080 --> 0:15:40.480
<v Speaker 1>we have seen its market share grow after f t

0:15:40.760 --> 0:15:44.360
<v Speaker 1>X went under. And in a way, it's kind of

0:15:44.360 --> 0:15:46.440
<v Speaker 1>ironic because a lot of people are now talking about

0:15:46.520 --> 0:15:50.320
<v Speaker 1>counterparty risk, concentration risk, but kind of in ft X

0:15:50.400 --> 0:15:54.840
<v Speaker 1>falling apart, finance has become a much concentration more concentrated

0:15:54.920 --> 0:15:57.240
<v Speaker 1>risk of the industry. All right, thank you so much,

0:15:57.280 --> 0:16:03.400
<v Speaker 1>just Tina, Thanks all for having me. That was Bloomberg

0:16:03.480 --> 0:16:06.440
<v Speaker 1>reporter Justina Lee. You can find more of a reporting

0:16:06.520 --> 0:16:09.680
<v Speaker 1>on the Bloomberg terminal and on Bloomberg dot com. For

0:16:09.800 --> 0:16:12.600
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