Crypto prime brokerage lacks teeth without lending

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.