Hedge Funds Question Crypto’s Future

top centralized exchanges. It was a haven for professional and amateur investors, but now billions of investors dollars have disappeared, and its former CEO, Sam bankmn Freed, has been arrested and denied bond and is facing conspiracy and fraud charges.

Earlier this week, Finance, the largest exchange by volume and a formal rival of FTX, suffered a wave of withdrawals after releasing its proof of reserve report, leaving many investors and crypto proponents wondering should they trust any crypto exchange at all, and if so, what should it do Differently. For mar In this, I'm joined by Bloomberg reporter Justina.

A lot of the time you do need to imitate the practices of Wall Street in order to make these people feel secure, but that kind of defeats the whole purpose. So I'm joined today by Justina Lee, who sits quite close to me in the London bureau. So I'm gonna like Justina introduce herself and tell us sort of what her day job is and how she also does crypto. Yeah, so I'm on a Bloomberg team that covers all the asset classes UM, which of course includes crypto. So I

still write quite a bit about trad five. So it's been especially interesting to kind of see a lot of crypto people UM look at trad five market structure and compare that to what they have UM, which I guess is the nerdy topic that we're discussing today. Indeed, so let's take a step back. Obviously, the biggest news this month there a little bit longer now, has been the collapse of ft X, the swift and chaotic collapse of FTX.

Do you want to give us a bit of background on what FTX meant for sort of the more trad five aspect of crypto, like the funds that perhaps you would cover, the multi asset ones sort of the professional traders. Why was it such a big deal for them? Yeah, So, to begin with, fd X is one of the top five exchanges in terms of trading volumes. They're far from

the biggest. I mean, we all know that's finance, but I think ft X occupied are pretty unique role for institutional prose in particular because it was an exchange that was built by a team that was already familiar with, you know, the stock market and all that, and so they built it in a way that particularly suited you know, the algorithmic traders for instance. Um it kind of had leverage built into the system. It also had a lot

of inherently leveraged products that were very attractive. The liquidity, by the sounds of it, was pretty good for most of its history. So obviously, you know, as you said, it was built by traders for traders, and that meant that it attracted lots of professional funds, which then means that when it collapsed, and now we know this week, the biggest news was that the founder was arrested and and charged with with fraud and misappropriating the funds. What

happened was a lot of these funds officer money. So what has that meant broadly, what has it meant for just crypto trading in general. Yeah, I mean it's really been a big shock. We've heard from some asset managers that they have, you know, a large majority of assets even on FTX, and I think it's fair to say that for a lot of crypto hedge funds that had an active trading strategy, they would at least have some assets on FTX which are now essentially lost to them

or at least into the bankruptcy process. And so I think for a lot of funds that are still trying to survive, the first instinct hast just been to cut back risk. And what that means is, you know, they're deleveraging their um, cutting back positions, they're selling their assets

and turning them into stable coins or even FIAT. And so we've really seen this period of risk aversion all across the market, and because of that, we're actually seeing the market become a bit less efficient and less liquid, precisely because a lot of these funds that usually arbitrage

away these inefficiencies have really pulled back. And part of the issue, maybe you want to tell us is how exchanges in crypto operate A bit differently from exchanges in other markets, and I guess many of our listeners might be familiar with one and not the other. Perhaps it might be are familiar without crypto works. But a big part of it is that there's no real separation of powers, right, yeah, exactly.

I mean in tratfy you also have I guess centralized exchanges, but the difference here is that you also have a lot of other intermediaries like brokerages and custodians and clearing houses. And essentially what that means is the exchange is not holding your asset directly. But I think because crypto developed without any infrastructure and without any regulations, and it's always been a very exchange centric system from the very start,

and so the exchanges actually hold your assets directly. And what that means is that, for instance, if you want to use leverage to trade, you need to put your coins on the exchange as margin, and also your profits and losses are on the exchange. And so what people have realized is that that has really created a concentration of risk as well as possibly a conflict of interest for these exchanges, and so when one collapses, you essentially

lose a lot of money in one go. Yeah, because you're not only losing your coins that you were training, you're losing the collateral you'd posted on there as well. So it's like you're you're losing really everything. And I guess the point is now, although you know, crypto is supposed to revolutionize finance in a way, what you're hearing, I guess is that some of these funds actually wanted to go the other way. They do want to have

these intermediaries again, or they'd rather have those intermediaries. Yeah, it's kind of funny because it's almost like a lot of people in crypto are realizing that that's there's a reason why traf fy does things a certain way, even if it sounds like really clumsy, but that is a way to kind of diversify the risk, and that is, you know how Wall Street has traditionally done things. So

what does that mean for the exchanges? Like does that potentially mean that they'll make less money if like these roles are separated or not really? Or like do you get a sense speaking to the funds that exchanges are actually even contemplating this or not? Really? Exchanges have always been a bit resistant because these illusions are not entirely new, and the reason they haven't been implemented is because the exchanges had no incentive to really change the status quo.

And I guess you know a simple reason for that is the way things currently are. They have direct control and visibility into your assets, and so they know that if you're gonna you know, trade on margin, you're not going to go broke on them, and they can even liquidate your assets directly. But I think you know now there's definitely more pressure from institutions, from a lot of big investors for exchanges to change, and we're now watching whether that's actually going to happen. So what do you

think is going to happen in the short term? Like some some of these funds you spoke to said, they're just like holding and not not are they trading? How are they trading? Like? Is it sustainable to not trade and just wait and see what what's the mood? Yeah, I think a lot of pros are in a dilemma

right now because they're all worried about counterparty risk. But at the same time, you can't really change crypto market structure overnight, and so if you if your stances, you know, I will not trade until everything changes, then basically you're not trading right um, And so I think a lot

of them are trying to strike a balance. You know, they're putting pressure on the exchanges to implement better measures too, maybe you know, put together like an off exchange settlement system like we discussed to release proof of reserves and all that, while kind of still trading in a way like under the current status quo. Coming up more with Bloomberg reporter to sin Elite on how hedge funds are adapting to a post ft X landscape, will be right back.

So the spotlight has someone, I mean, it's not really turned from ft X, but there's now a second bot light on Binance, I would, I would say, because you know, they're by far the biggest exchange out there now, and you know, if you talk about concentration of risk, like they are potentially quite uh risky. Now if if something happens to Binance and it's a big deal for everyone. So how are sort of traders thinking about Binance now? Are they changing the way they deal with the firm

or not? Really? Like do you see them separating their their sort of functions a bit? More so? Finance has always been in a way more resistant to turning to a more decentralized approach. I mean, what they've come up with is this idea of finance custody, which allows you to put your assets in in a way like a specific finance entity that is there to safeguard or assets

and will allow for off exchange settlement. And so I think that kind of finance has benefited from this um situation in that after f takes collapsed, just by virtue of being the most liquid, the biggest exchange out there, they've grabbed market share. And so I think they don't necessarily want to rock the boat, but they can certainly see that a lot of their biggest clients now have

these more institutional style demands. So you know, what are some of the solutions that are that are being proposed. You you know, in your story you mentioned Copper, which is like a London based for my belief, what are they proposing and you know, why is it not taken off or why might they take off more? Now? What what were they saying when you reported this? So they have a solution called clear loop, which is where you

put your assets with them. You know, a third party custodian and the exchanges are sort of plugged into the same system and so that they can see your collateral and they can settle your profits and losses through the

clear loop system rather than on the exchange itself. And traditionally it's never been particular particularly popular with the exchanges, and so it's not connected to any of the top five um and that's basically why it's never been a very practical solution if you want the liquidity and the

volumes of the biggest exchanges. You know. I've spoken to them since FTX fell apart, and they have said that they feel like there's more pressure now for exchanges to implement their solution, and they're optimistic about announcing more integrations and so and I can definitely kind of see the reasoning behind that, and so we'll have to see if there are more announcements coming up in the next few months. So obviously, if you're crypto buff you'll say, well, you're

all you're talking about centralized exchanges. There's a whole world of about crypto, and actually crypto is not about centralized exchanges, but it's about defy and decentralized exchanges. Why has that not really taken off as much with these with funds for now, I guess you know, we've we've seen a little bit volumes going up or at least not shrinking as much as on centralized platforms. But you know, why is it not absolutely feasible for some of these fun

for now? Yeah, that's a that's a great question because I'm sure you've heard a lot of people saying in the wake of ftex is collapse that you know, Defy was the solution all along and of anything. That vision has now been vindicated, and I think to some extent that is correct. But the issue is that it was always a very small part of crypto trading volumes, even today, and so in a way it was never a feasible alternative to centralized exchanges. And that's probably because liquidity is

just simply not there for defy right now. And so if you're the kind of crypto hut fund that has very active strategies, then you need the liquidity. And and the other issue here is that, you know, because the whole idea of Defy is that there's no centralized entity, and so there's no one checking your identity, there are no like users per se Um with kind of k I C and all that, and so there's always been a lot of regulatory issues behind that. You know, how

do you think about money laundering? Ask how do you think about you know, the know your customer risk? And that's why a lot of institutions actually will not touch DeFi at all. So I guess one thing that's quite ironic is that, you know, for a lot of the past year, SPF has been trying to get regular markets to turn more into like crypto markets. Right, he had like a proposal with the CFTC. So you know, what do you think about that now? Actually it seems like

he may have made crypto more like trad five. Actually, these funds asking for more separation of powers and more intermediaries succeed and managed to get the exchanges to accept that the fact that they might not post the collateral

with them but somewhere else. Yeah, exactly. And I think, you know, in my reporting about crypto, I think I always come back to the same irony in a lot of cases, because if the crypto industry really wants to grow, and then they needs to draw institutional money, right, and needs to draw these existing big pots of money of like pension funds or hatch funds and all that. But in order to do that, a lot of the time you do need to imitate the practices of Wall Street

in order to make these people feel secure. But that kind of defeats the whole purpose. But the problem is if you if you stick to defy, there's a chance that you'll never be as Vegas. You know, you you

envisioned yourself to be. And I think, you know, I always think of crypto is kind of walking the line between the two, And I think what seems to be happening here is that because there's already a lot of institutional interests, there are a lot of people that haven't kind of an inherent interest in pushing for the more

Wall Street version of things. I mean, it doesn't necessarily mean, you know, there won't be defy, But then the question here is, you know, we'll we'll defy always be just a small fraction of the system, or will it ever actually you know, take over trad fy So in closing, what are some of the things you're watching to see and spot whether this evolution sort of goes more towards Wall Street or more towards Defy, Like what are the

signs what what will you be interested in seeing? Yeah, I think you know there there's also another future here, which is it's it's possible that a lot of institutions have now just lost interest and so kind of crypto goes back to to where it was and in a way, I guess, you know, it kind of becomes a much smaller community. And so I think we're we're kind of seeing, you know, what happens to finance. Obviously there's been a lot of outflows lately. Kind of does it continue to

retain the trust of a lot of its users? And I think that's sort of the biggest question here because we have seen its market share grow after f t X went under. And in a way, it's kind of ironic because a lot of people are now talking about counterparty risk, concentration risk, but kind of in ft X falling apart, finance has become a much concentration more concentrated risk of the industry. All right, thank you so much, just Tina, Thanks all for having me. That was Bloomberg

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