Crypto's dirty little secret: Should we be worried about exchange trading desks? Depends on who you ask

This post first appeared in Frank Chaparro’s weekly column “Mad Crypto,” which is sent to Genesis subscribers’ inbox every Monday morning. 

Market wonks could spend all day pointing out the innumerable flaws in the way digital assets trade. But one specific idiosyncrasy was front and center over the weekend in a Bloomberg News piece about cryptocurrency exchange Kraken's over-the-counter trading operation.

 

Kraken allegedly refused to pay out a $907,631 settlement owed to a former trader, as per a lawsuit. The drama around that employee getting paid is for the birds, as far as I'm concerned. What's more interesting is the debate over whether Kraken should be running a trading desk in the first place. Kraken is not alone, to be sure. Coinbase, BitMEX, Binance, and many other exchanges in crypto operate trading desks. It's a practice my friend Richard Johnson at Greenwich Associates described to Bloomberg's Matt Leising as "the dirty little secret of the crypto exchange world." In traditional markets you rarely see exchanges also running trading operations, making markets on their own venues. Indeed, it has been hotly contested and misunderstood.

 

The controversy lies in a number of unanswered questions about the relationship between these desks and the exchanges. Kraken, BitMEX Coinbase claim they act as agents, trading on behalf of their clients and taking a fee. Still, that hasn't put an end to critics who say those desks could have access to privileged capabilities such as favorable execution speeds and unique data to front-run other customers. Arthur Hayes, for instance, has denied any special privileges for his firm's traders.

 

"They have the same trading rights as any other regular trader, they can't see the liquidation prices of any of our customers," Hayes said in an interview with Yahoo Finance. "We don't trade against our customers. It's actually pretty bad business model and introduces a lot of risk..."

 

Still, crypto exchanges are loosely regulated so customers are pretty much left to trusting the word of executives. "That's the argument, yes," said one over-the-counter trader in the market, conceding that it's difficult to prove to the outside world if a given exchange is market neutral.

 

So why don't exchanges play it safe? The desks are certainly bad marketing and allow competitors, such as Mark Lamb, chief executive officer of derivatives platform CoinFLEX, to take shots.

 

"@krakenfx is among the ranks of @BitMEXdotcom and others that run a trading desk on their own exchange, competing with their own customer base" Lamb wrote in a tweet. "Huge conflict of interest & extremely dangerous/misaligned."

 

The answer to the aforementioned question is simple. They would be stupid if they didn't, at least that's what some of my sources in the over-the-counter trading world think.

 

"It's more of a why not question," an Asia-based trading firm employee, who declined to speak on the record, said over WeChat. He said there are clear synergies between the exchange business. Not to mention most of the action in cryptocurrency occurs OTC. Tabb Group estimates OTC volumes are as much as three times that of exchanges.

 

"If 35-40 percent of crypto trades OTC than an exchange otc desk can be quite valuable in terms of visibility," another source, a former exchange employee, said. 

 

"If I operated an exchange I'd [definitely] do the same," another source said. "The real liquidity is in OTC."

 

"No one's stopping them, they can do what the fuck they want," he said.