Illustration: Brendan Lynch/Axios
Just as the prime brokerage business in crypto was starting to see some traction, the rug was pulled out from under it.
Why it matters: For the crypto market to go from a trillion to "trillions," it needs prime brokerage — the business that facilitates sophisticated trading and draws the Big Money crowd, like hedge funds.
The big picture: There is no crypto equivalent of the power prime brokers in traditional finance, Goldman Sachs and Morgan Stanley. None match their size, or offer a bundle of services as comprehensive.
- But there has been an ongoing effort to build toward that, to varying degrees of success. (Read: Coinbase, Binance, FTX, BitGo, Genesis Global)
Zoom out: The origin story for crypto prime brokerage is that it emerged, at first, to solve the market inefficiency of digital assets' price discrepancies across crypto exchanges.
- But to bring in the whales of Wall Street, it needed to do more. It needed to offer custodial services, to route and execute trading, to enable capital raising and — key to it all — to lend.
- And lending is where the money is for prime brokers.
Be smart: Lending enables leveraged trading — trading with borrowed money and using it to soup up potential returns.
- It’s also used for shorting, or placing a trade in anticipation that prices will fall (as opposed to rise).
The latest: But then Terra happened and Three Arrows Capital collapsed.
- "Lending has dried up," Noelle Acheson, who recently left Genesis to start an independent macro-focused newsletter, tells Axios. (That's kinda typical: risk management controls tighten after an ugly event.)
State of play: Crypto prime brokerage is now just order routing, without lending activity.
- "If there’s no borrowing and lending, you need custody and trade," Adam Sporn, head of prime brokerage and institutional sales at BitGo, tells Axios.
- "People are positioning their businesses for when more leverage starts taking place."
What to watch: With the third quarter in the rearview mirror, some institutions are plotting for an "all clear signal," according to Matt Hougan, chief investment officer at Bitwise Asset Management.
- "We speak to institutions and financial advisors every day and [they're] completing due diligence efforts with the idea of allocating in 2023. Major broker-dealers are approving more and more crypto funds and the questions we get — compared to 2018's 'is this a Tulip Bubble' — is "should I buy now?"
The bottom line: Prime brokerage will be key for crypto for when lending does return.
- "This is a big deal for crypto prime brokers, because there are many fewer institutions that have access to the kind of leverage that they are used to," Acheson said.