The Post Trade: Settlement solutions are popping up in crypto, but large traders aren't impressed

On the surface, the bitcoin trading world doesn't look that different from that of equities. Both have traders, exchanges, and custodians facilitating the storage and trading of assets. Most people want to make money, of course. 

But a quick look under the hood reveals two very different market structures. In U.S. equities, after a trade is executed it enters into what is known as the post-trade period in which the transaction is cleared and settled. During that process, a third-party entity, known as a clearinghouse, typically becomes the seller to the buyer and the buyer to the seller, effectively taking on the entire risk of the trade. At the point of settlement, the buyer receives the securities purchased and the seller receives the proper amount of cash in return. This process can be done bilaterally between firms, but the addition of a back office to the back office, as it is often referred, helps mitigate risk. 

Source: William C Spaulding, The Block

Clearinghouse entities also calculate the net transactions of a given firm during the course of a trading day. For instance, if a broker such as Morgan Stanley buys 100,000 shares of Google and then sells 90,000 later in the day, DTCC will net those trades into a single transaction to settle. DTCC CEO Mike Bodson described this process during the inaugural episode of The Block's podcast, The Scoop:

We take those hundred million trades and we net them down to 3 million. So somebody like Goldman Sachs, you mentioned, will be trading in and out of Apple all day long. So instead of doing every trade individually and saying “I’ve got to pay Morgan Stanley for this; I got to receive stock from Citibank” or whatever. What we do is net them all down and say look Goldman at the end of the day you bought 10,000 shares with this price. So this creates incredible efficiencies for the marketplace.

This infrastructure is virtually non-existent in crypto.

Crypto market is growing up

In crypto, most of the large over-the-counter trading deals are conducted bilaterally without a third party clearing or post-trade services provider sitting in the middle. But a number of firms are stepping up to the plate to offer various post-trade solutions. 

Gemini is the most recent example, announcing the launch of Gemini Clearing, a post-trade solution aimed at OTC firms. As per a blog post, the firm will provide a solution that will electronically — and immediately – settle over-the-counter cryptocurrency trades executed between two external parties. Gemini won't act as a counterparty to every trade — as DTCC does — but will settle trades once both parties fully fund them.

"Gemini Clearing™ provides regulated clearing and settlement services for such pre-arranged trades, which helps to ensure timely settlement and mitigate counterparty risk," reads the post penned by Gemini managing director Jeanine Hightower-Selitto. 

Elsewhere, Seed CX offers a similar solution via its Zero Hash unit. Seed CX offers on-chain settlement, according to its website. It claims that it nets and finalizes transactions between clients on the blockchain. 

BitGo has been testing its own settlement and clearing solution. Announced in May, the new system allows clients of BitGo's qualified custodian business to trade with each other while keeping their assets in cold storage. BitGo settles those trades off-chain, according to the firm's website. It is still in testing as BitGo awaits a final sign-off from its North Dakota regulators, a spokeswoman told The Block in a phone interview Monday. 

While these solutions differ in various ways, the through line is to lure large trading clients in the hopes that middlemen will make their activity less risky. 

OTC desks aren't really interested

The old saying, "If you build it, they will come," might not apply when it comes to settlement and clearing services in cryptocurrency. 

That is at least according to The Block's sources in the industry, who tell us they are perfectly happy engaging with counterparties on a bilateral basis — executing, settling and clearing using their own systems. 

"If I am not comfortable enough to face you directly, most likely I am not going to trade with you," said one executive. "It seems to me that these solutions are attempting to transfer risk to a third party for a hefty premium with the end goal of driving volumes to their exchange."

Furthermore, the executive added that such solutions change the economics of a given trade. 

"I have additional operation and legal steps," the person added. "Now, I've added risk that something happens to the exchange or clearing provider. I just don't see how it would result in enough/any return to warrant the lift."

Another OTC trading executive was more blunt, saying, "it is adding an unnecessary complication." 

"When you have trust with your counterparties, if I am buying bitcoin then I send them cash. It happens in 15 minutes."

Still, The Block's sources did concede that there could be smaller desks which might utilize such services to offer counterparties a level of risk guarantee. 

"I can't see any compelling reason that would attract business from the current world ... especially with that kind of pricing," one source noted.  

Notably, these new crypto-specific offerings don't fully step into the role of a clearinghouse.

"A true clearinghouse is the counterparty to each trade," one finance executive told The Block. "That way there is never trader-trader counterparty risk." 

Settlement providers take note. 

This post first appeared in Frank Chaparro’s column “The Post Trade,” which covers the intersection of market structure and crypto and is sent to The Block Daily members’ inbox every three weeks on Monday.