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Cryptocurrencies

Institutionalization in Crypto Exchanges: The Ability to Attract Serious Investors and What Is Needed to Succeed

As crypto adoption increases globally, it is essential that crypto exchanges prepare for institutionalization, the participation of banks, broker-dealers, payment providers, and the like, in order to ensure market integrity and flexibly scale with the increasing demand.

Retail investors continue to embrace crypto in the second half of this year, and institutional investors are taking notice of the rapid rise of numerous cryptocurrencies—from Bitcoin and Ethereum to Litecoin and Chainlink, among thousands of others. Already, cryptocurrencies are becoming more recognized as a payment method, with companies such as Microsoft, PayPal and Overstock, among many others, accepting bitcoin. As crypto adoption increases globally, even amid intense volatility and increased regulatory scrutiny, it is essential that crypto exchanges prepare for institutionalization, the participation of banks, broker-dealers, payment providers, and the like, in order to ensure market integrity and flexibly scale with the increasing demand.

To further progress institutionalization, global crypto exchanges can leverage Nasdaq’s marketplace expertise, powering more than 130 of the world’s market infrastructure organizations, including exchanges, clearinghouses, central securities depositories and regulators, in over 50 countries with end-to-end, technology solutions. With reliable and scalable technology and infrastructure that meets current and future regulatory frameworks, crypto exchanges can grow and attract serious investors while ensuring a trustworthy marketplace experience for all participants.

Technology & Infrastructure

One of the key differences between crypto and equity exchanges is that the crypto market never stops – it’s open for trading 24 hours a day, seven days a week. With more investors flooding into the crypto market, ramping up trading activity, utilizing trading technology equipped to handle the large volume of orders is critical to the foundation and success of any exchange infrastructure.

Several crypto exchanges have leveraged Nasdaq’s technology, which provides marketplaces and execution venues of all sizes with reliable, comprehensive, multi-asset capabilities to keep pace with ever-changing market requirements. The Nasdaq trading technology is suited both for retail oriented markets as well as markets designed to cater for low latency and high frequency trading models. Bitstamp, for example, implemented Nasdaq’s technology in 2020, finding that the upgrade “imparted a clear change in the capacity to handle a large number of trades over a short amount of time.” In fact, there was a “reduction in the autocorrelation of the 6-second returns occurred between two-month windows placed before/after the update,” indicating an improved capacity for market participants to adjust prices quickly.

Evolving Regulation

At this time, most crypto exchanges are not regulated; however, crypto continues to be a focal point for global regulators. The U.S. Securities and Exchange Commission (SEC) is closely examining the industry as it seeks to protect retail investors and fight financial crime. In mid-May, the SEC Chair, Gary Gensler, said that he would like to see more regulation around crypto exchanges, explicitly highlighting those that only trade bitcoin and do not currently have to register with the regulatory agency. Gensler further stated during the Financial Industry’s Regulatory Authority’s annual conference that the investing public would benefit from more investor protection on the crypto exchanges.

More recently, Gensler, who views many of the tokens as securities, said that the regulatory agency is encouraging trading platforms to have a “frank discussion” with the SEC about investor protections in the crypto space.

As the SEC and other global regulators explore this area, crypto exchanges can take proactive steps to mitigate manipulation in the market, leveraging technology to protect retail investors and encourage institutional investors to enter the crypto market, providing a safer trading venue for those involved.

If exchanges in this space, and their participants, want this market to succeed, they need to take it upon themselves to ensure fairness, transparency and market integrity.

To further enhance transparency and integrity with its crypto clients, Nasdaq develops and provides surveillance technology. Presently, the top three behaviors to monitor in the crypto market include:

  • Wash Trading: Buying and selling securities by a trader to themselves or within a collusive group for the purpose of creating a false perception of volume, to manipulate prices, or to generate fees for the trader.
  • Layering and Spoofing: Placing orders into one side of the orderbook to give a misleading indication of demand/supply, normally with the intention of attracting new orders which move the bid/ask spread up or down. Often the trader will be trading opposite to their fake orders.
  • Pump and Dump: Artificially inflating the price of a security through false or misleading information or their own trading activity, the trader normally has an existing position which they sell at the inflated price.

Given these vulnerabilities, implementing surveillance technology is critical to establishing trust in the crypto space. There are many learnings from the traditional financial markets that crypto exchanges can consider for a smoother journey to institutionalization, in order to create safe opportunities for retail and institutional investors alike.

The crypto exchanges and participants that implement the same sophisticated surveillance processes and technology that has long been used by the existing exchanges in the capital markets to uphold fairness, transparency and market integrity can likely inspire public confidence and emerge as the market leaders. 

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Paul McKeown

Nasdaq

Paul McKeown is Senior Vice President and Chief Revenue Officer of Market Infrastructure Technology for the Market Technology business unit.

Read Paul's Bio

Magnus Haglind

Nasdaq

Magnus Haglind is Head of Market Infrastructure Technology within the Market Technology division of Nasdaq, and is responsible for roadmap and product portfolio management of a broad suite of mission critical exchanges and surveillance solutions provided to capital markets.

Read Magnus's Bio