This type of vertical integration happens in every business, whether that’s Amazon running the internet or Coinbase trying to own the crypto space. Given the long road of the last couple of years, it’s maybe surprising there hasn’t been more MA activity in the blockchain world.
The big news this week was Coinbase’s acquisition of trading technology and execution platform Tagomi. BitGo Prime also launched its recently announced lending business and bolted on tax-reporting company Lumina. Last week, Genesis Trading (a subsidiary of CoinDesk parent firm Digital Currency Group) bought crypto custody provider Vo1t and spun up “Genesis Prime.”
From starting out as a retail-focused cryptocurrency exchange, or a wallet provider, or an OTC desk, the ambitions of these firms (and others) to become crypto’s prime brokers is aspirational at this stage, as observers like BlockWorks Group co-founder Jason Yanowitz have noted. Indeed, the term “prime broker” is suddenly the latest buzzword in crypto, observed Max Boonen, CEO of cryptocurrency liquidity provider B2C2.
“What puzzles me a little bit is that some people are getting into prime brokerage, not based on a vision, but really because they are looking for the next big thing – and they don’t know what it is. So they are going after the buzzword,” said Boonen.
In traditional capital markets, the term “prime broker” refers to a set of three or four features or components that are normally provided by investment banks to their hedge funds clients.
Top of the list is the financing prime brokers supply to hedge funds to get leverage into their positions, and lending where people running a long/short fund are able to borrow the shorts. Operational efficiency in the traditional world is perhaps overshadowed by the importance of custody in the crypto space, and the final component is providing “best execution,” achieved by tapping a range of liquidity providers and exchanges.
Before Coinbase’s acquisition of Tagomi, there were “precisely zero” firms that had all of the above components, said Dave Weisberger, co-founder and CEO of CoinRoutes, a trading technology and execution provider in the same vein as Tagomi.
“If I were in [Kraken CEO] Jesse Powell’s shoes, or if I were Bitstamp or the Winklevoss twins, I would look at the Coinbase-Tagomi deal and say, ‘Hmm, this is the technology we need,’” said Weisberger.
An obvious question is, why now?
“There is sort of a coincidental element that all of this happened to land in the same week or two,” said Genesis CEO Michael Moro, “but from an industry trend and directional perspective, I think it makes all the sense in the world.”
No doubt there are gaps in Coinbase’s growing institutional franchise that have yet to be cinched together, noted Weisberger.
“But when it comes to trade execution, Tagomi has that and also the tech to facilitate lending,” he said. “Coinbase has deep pockets and, with custody, the ability to have lendable coins. So they just have to combine all that intelligently.”
Boonen of B2C2, which is listed as the top liquidity provider on the Tagomi platform, pointed to financing and leverage as the crucial piece of the puzzle still missing from Coinbase’s plans.
“One of the things that a lot of participants say is missing from Tagomi is the provision of credit, and it’s also something that Coinbase doesn’t do,” said Boonen. “It’s a friction at Coinbase because of their regulatory setup, which obviously has benefits in one sense, but on the other hand it limits them in terms of providing leverage.”
In order to be a full-fledged prime broker, this obvious gap has to be plugged.
“One of the core drawbacks with Tagomi, is also not a strength of Coinbase. I do feel at the moment it’s aspirational in terms of being a prime broker,” Boonen said.
Genesis Trading, which has loaned digital assets valued at $6.2 billion to institutional borrowers since launching its lending business in March 2018, said the availability of credit is more important than smarts, especially for firms that are used to trading on margin.
“We are building all of those fancy trading systems in-house; there’s no question that we are,” said Moro. “But that’s secondary to what we do and certainly not the reason somebody would use Genesis.”
Tagomi’s management has informed its clients it will not deviate from the overarching business plan, including routing orders to multiple liquidity sources, Boonen said. Tagomi aggregates exchanges such as Bitstamp, Gemini and Binance US, as well as a handful of over-the-counter market makers, to scout out the best prices for its clientele of traders.
It’s possible to run a best-execution agency as a separate entity, but prime brokers have a privileged position with their customers including access to their trading strategies and material, non-public information about them.
Technically, a conflict of interest can be avoided, said Boonen. The question is whether it will be done in practice.
“It’s also about whether other exchanges being aggregated still want to do that,” Boonen said. “Obviously, you are happy to work with Tagomi because they are an independent business, but what does it mean when they belong to Coinbase, which is a direct competitor to you?”
Weisberger of CoinRoutes said there are information barriers and procedures that can be put in place to remove any conflict of interest but it remains “a very interesting discussion” that speaks to a broader disparity between crypto and traditional markets trading.
“If I were Binance US, I would have no qualms about Tagomi providing liquidity and accessing liquidy on Binance US; if I were Bitstamp I’d have no qualms,” said Weisberger. “I would, moreover, expect that they would then go over to Coinbase Pro and say, ‘OK, guys, we want to have a unit that can access liquidity on your platforms.’”
The growth of exchange groups like Intercontinental Exchange (ICE) or Nasdaq in the equities markets was because these firms had to allow their competitors to access their quotes and had to allow their competitors to route business to them, Weisberger pointed out, and in the end the whole market benefits as a result.
“Wall Street and the City of London are thought of as the most bare-knuckle capitalists out there,” said Weisberger. “But there are areas where people work with their competitors to make the overall business better, and areas where they compete like hell. Silicon Valley has a different mentality where you have to simply out-compete everyone, and the crypto industry may be the same right now.”
Binance and Bitstamp did not reply to requests for comment.
Last man standing
Technical and regulatory challenges around the safe storage of crypto assets have seen numerous custody providers spring up with various solutions and services on offer. It’s probably going to be the case that more of these highly specialized firms will be snapped up by bigger players, similar to the Vo1t acquisition.
“I think standalone custody businesses are going to be difficult to sustain,” said Moro of Genesis. “Custodial fees are shrinking; it’s a race to zero. So I think standalone custodians are going to partner up with companies that have other business lines, or they will look to start other business lines.”
Nick Carmi, BitGo’s head of financial services, agreed consolidation is well underway.
“This is exactly what happened in the financial markets as well, where custody is provided by few very large custodians,” he said.
As far as broadening out, Carmi said BitGo Prime was always part of the vision, driven by optimism in crypto as much as anything else. Taking a jab at Coinbase’s Tagomi deal, Carmi emphasized the importance of not being an exchange when it comes to offering brokerage services.
“We are not an exchange, we enable connections to multiple exchanges and market makers on a full non-disclosed basis. It is important to partition certain functions in order to have a secure and efficient financial infrastructure for digital assets,” said Carmi.
BitGo acquired some trading capabilities from last month’s purchase of Lumina, Carmi said, without disclosing any trading or lending volumes.
Meanwhile, some firms are still operating on the premise this is the Wild West and they will make a lot of money, said Boonen, but as the crypto market tightens and becomes more efficient it will be the professionals that are left standing.
“There are firms hoping to charge five basis points per trade through some sort of intermediary they are calling a prime broker,” said Boonen. “No one is going to pay that. The problem is, you can charge half a basis point on $100 billion a year in volume, but until you get there it will seem like a very long road.”