TradFi exchange takeaways from crypto:
- transparency of digital wallets v omnibus broker accounts
- automated market making and gamification of trading
- value add through post-trade services
- 24/7 trading
- greater use of cloud hosting.
Today during the Hong Kong Fintech Week, executives from HKEX and Nasdaq explored the differences between traditional stock exchanges and cryptocurrency exchanges and what they can learn from each other.
John Buckley, COO at HKEX, spoke about the exchange building a blockchain capability through tokenizing alternative assets. “I don’t see in the near future traditional exchanges trading cryptocurrencies. But I think we have to learn and build that capability internally first. And then expand depending on where our clients take us,” said Buckley. He views the example of carbon credits as a strong application of blockchain technology and a good place to start.
However, traditional exchanges can learn from fintech, and he saw three areas where they can. First is the concept of a digital wallet. Typically brokers have omnibus accounts, which they use to execute trades on behalf of investors. And often, only the broker knows who the ultimate investor is. In contrast, a digital wallet can provide greater transparency about the underlying investor.
The second area is the use of code and automation. So automated market making is one example and gamifying the investing experience is another.
Thirdly the exchanges might want to move their value proposition away from the matching engine to post trade services, and use blockchain technology to solve some of the challenges currently faced by traditional technology. Buckley didn’t elaborate, but typically one of the benefits of blockchain is providing a golden record that reduces reconciliations. And the ability to settle over more flexible timeframes, sometimes without intermediaries.
Buckley also believes that crypto exchanges can learn from traditional exchanges. Traditional exchanges have developed microstructures around market-making programs, incentives, tick sizes, block trading, and price discovery because price discovery is critical to fair, orderly and liquid markets.
The other key aspect is that traditional exchanges are inside the regulatory systems, so he sees the governance of crypto exchanges evolving. And convergence will be driven by crypto exchanges facing steeper regulatory requirements.
The HKEX COO envisages the future exchange being asset agnostic, based on a modular, open architecture and using a hybrid cloud.
Nasdaq: 24/7 is the biggest crypto impact
Ulf Carlsson, Nasdaq’s head of Asia Pacific and Japan, concurred on the cloud point. Exchanges are already using the public cloud for some functionality. During the March 2020 market volatility in the early days of COVID, Nasdaq volumes were triple previous peaks.
“We had to suddenly store one hundred billion messages for a full day. And it would have been impossible without cloud to scale up the capacity for regulatory purposes to store the data,” said Carlsson. Rather than peripheral services, he predicts in the future traditional exchanges will run trading in the cloud.
However, Carlsson believes that the biggest takeaway from crypto exchanges is 24/7 trading. “The exchange technology of all established exchanges today is not built that way.” Instead, they are designed around limited trading hours, after which the data is cleaned and stored before the start of the next trading day. And that process takes hours.
“When we started to approach the (digital asset) market, we learned quickly that our technology is not fit for this,” said Carlsson. “We need to build technology that is 24/7 in order to provide the services that these markets want and that we believe that the established exchanges would like to have in the future as well.”
He gave examples of TradFi exchanges that have extended their hours. For example, Hong Kong derivative exchanges have an after-hours trading session from 5.30 pm until 3 am. He observed that the after-hours volumes are almost as much as the main trading hour volumes. Hong Kong, Japan, Singapore and other places also trade during public holidays. Hong Kong’s holiday derivative volumes are as much as half of a normal trading day.
“The trend is for longer trading hours if it’s 24/5 as for the FX markets or 24/7. I think it will be decided for different asset classes,” said Carlsson.
Meanwhile, Nasdaq has just launched a digital assets custody solution.
DeFi exchanges
The topic of decentralized exchanges was raised. Dave Chapman from BC Technology – which owns Hong Kong’s only regulated crypto exchange OSL – says that DeFi exchanges exist now and will play a bigger role in the future. However, for now, “the participants that want to use them in a regulated institutional way, we’re nowhere near that. Typically, because they want someone to blame when something goes wrong.”
HKEX’s Buckley replied that sometimes there’s a desire for decentralization just for decentralization’s sake. “I think decentralization will only occur at a pace if the centralized solution doesn’t respond and meet the need,” he said.
