Galaxy Digital's next step on the road to becoming the Goldman Sachs of crypto: prime brokerage

Galaxy Digital is positioning itself to dive into a red-hot corner of the digital asset market, a move that would bring it one step closer to becoming the Goldman Sachs of crypto. 

Founded in 2017, Galaxy Digital was launched as a merchant bank equipped with many of the service offerings of a traditional investment bank — but with a crypto twist. Now, in the interest of further catering to institutional capital wading into the nascent market, the firm is eyeing the roll-out of prime-brokerage services for crypto investors. 

Prime brokerage services are a staple of large investment banks like Goldman Sachs, which assist hedge funds and asset allocators navigate markets, manage risk, and build capital. More recently, it's become a buzzword in the digital asset space.

The buzz makes sense: In traditional finance, prime brokers sit between institutional investors and the market, offering an array of services, including custody, execution and consulting. Crypto traders have long predicted that the addition of prime brokerage services to the market could lure institutional investors from the sidelines.

Companies ranging from Fidelity Digital Assets to crypto custodians like BitGo to over-the-counter trading firms like B2C2 are aiming to break into the potential market for prime brokerage services, eyeing the same kinds of customers that according to Global Custodian will help traditional banks generate $30 billion this year.

Galaxy wants in, too, and this time it thinks it has its timing right. 

Humble beginnings

Galaxy is still at the beginning of its prime journey. At the moment, even its executives are hesitant to throw around the term. But the firm took an important first step toward that end in May, when it partnered with Bakkt. Essentially, the partnership opens the door for Galaxy to source bitcoin for large hedge funds and investors, which can then be stored by Bakkt.

In a sense, this can be seen as an expansion of Galaxy's existing over-the-counter trading operation. Although it currently sits under the trading business, the new service could ultimately fit under the auspices of a prime brokerage unit, according to Galaxy's president Chris Ferraro. In the future, Bakkt could serve as the critical backbone infrastructure on which Galaxy would build-out an array services in the prime suite, including cross-margining, lending, and derivatives trading, Ferraro added. 

Ferraro, an early employee of Galaxy Digital who previously was the chief investment officer of Mike Novogratz's family office, said that "one of the core pieces of infrastructure" the firm will need is the ability to "secure customer assets, to pledge against positions and secure financing."

"Having that sit at a third-party custodian, one that is trusted and recognized is critical, is a key part of the foundation necessary," he said. "That's the genesis of us working with Bakkt as an outside party."

Still, partnering with Bakkt wasn't an easy decision for the firm, which participated in crypto custodian BitGo's Series B fundraise in 2018. Despite having a great deal of respect for BitGo and CEO Mike Belshe, opting for a non-New York regulated financial institution would have been a non-starter for many of the investors Galaxy was targeting. BitGo is regulated by the state of South Dakota. 

Competing in a crowded field 

The shift in Galaxy Digital's business might be a welcome sight for some investors and employees. The firm has traded well below book value and has lost money since it was founded. 

While conditions have slightly improved for the firm more recently, it still shed $32.9 million in the final quarter of 2019. The first quarter of 2020 wasn't much better, bringing a net comprehensive loss of $27 million — the majority of which came from the firm's trading business.

Much of the firm's troubles could be chalked up to it being too early in some businesses while being too late in others. For example, the 2018 launch of its Bloomberg Galaxy Crypto Index —an index aimed at tracking the largest cryptocurrencies—came at a frustrating time given the bear market at the time, Novogratz noted in a conversation with The Block in 2019. Meanwhile, the firm's advisory business—which aimed to guide nascent token projects at the onset—missed the heady days of the 2017 token boom. 

Still, Ferraro and Tim Plakas, a trading executive at Galaxy, are convinced now is the perfect time to get in on prime brokerage. 

"The macro environment for BTC has never been better positioned and actually continues to grow more favorable by the day as economic uncertainty and additional Fed liquidity becomes more pervasive," he said referring to recent monetary policy taken by the Fed to shore up the economy.

"Galaxy Digital has recorded a notable increase in trading volume," Ferraro said. "Our trading desk traded more than $1 billion of volume across BTC and other digital assets in Q1 2020,"  

Plakas added that the macro backdrop has been complemented by an increase in interest among institutional investors "asking us to explain and help them think through bitcoin positioning."

Galaxy will face stiff competition, though. The field of firms looking to lure in large hedge funds to the market is growing in size. Besides startups, big names like Fidelity Digital Assets and Coinbase are also poised to get in on the action. 

Plakas says few have Galaxy's chops, however. 

"Few trading desks in crypto are better positioned with traditional Wall Street investors than Galaxy Digital," he said, noting that Galaxy executed the first bitcoin futures block trades on both Bakkt and CME. "We are uniquely positioned to source liquidity from more than 30 venues and providers, mitigating the risks of market fragmentation and wider spreads impacting counterparty performance."

Indeed, it is rumored that Paul Tudor Jones is a client of Bakkt and Galaxy's new service. 

On that front, the firm offered no comment.