Friday, February 14, 2014
We may be witnessing the final months of the large international bitcoin exchanges for retail purposes. On the road to maturity, the survivors are most likely to emerge as supra-regional bitcoin clearing houses.
Today’s global bitcoin exchange plays the mega-role of both retail and wholesale exchange, providing the platform for individual traders, corporate traders, and smaller bitcoin exchanges. Due to a dearth of functioning exchanges in many active bitcoin countries, traders are forced to look outside of their home jurisdiction for liquidity and they tend to go international.
In finance, a clearing house is an institution that provides clearing and settlement services for financial and commodities derivatives and securities transactions. The origin of cheque clearing for banks can be traced back to the 1770s.
With bitcoin, a clearing house can be thought of as a wholesale liquidity provider clearing transactions in an over-the-counter (OTC) market or a futures exchange.
By standing between two member clearing firms, a clearing house reduces the settlement risks by netting offsetting transactions between multiple counterparties and by providing independent valuation of trades and collateral accounts.
When bitcoin derivatives are inevitably introduced, margin deposits will be involved, requiring the clearing house to monitor the credit worthiness of member clearing firms and, ideally, to establish and maintain a guarantee fund that can be used to cover losses that exceed deposited collateral from a defaulting clearing firm.
The Russia-based ICBIT exchange offers a bitcoin derivatives market today.
As more and more trading for bitcoin occurs locally, the need for international bitcoin exchanges will diminish and the remaining exchanges will have to evolve in order to remain relevant. Initially, some may function in a dual capacity as both exchange and clearing house during the transition period.
Forces of changeTwo separate forces are at work driving this trend within the local bitcoin environment.
Local bitcoin exchanges catering to a country or region allow the easiest method for buying and selling bitcoin because, as local players, they understand the existing electronic payment networks and the dynamics of how best to integrate with their country’s banks. Also, since bitcoin is ultimately more frightening to central banks than it is to normal retail banks, the inevitable is starting to happen.
Banks are beginning to explore methods of incorporating bitcoin services directly into their proprietary online offerings. And why not? Banks have the proven expertise in currency trading, deposit holding, secure IT environments, and payments. They should exploit this advantage.
If retail bitcoin exchanges cannot provide greater privacy and service than banks, then why are they needed to sit between you and your bank? The answer is that they probably are not needed – at least not in the same way. As more bitcoin exchanges request the opening of commercial bank accounts, the banks are gradually realizing that bitcoin services may be a direct opportunity for themselves.
Losing the middlemen
Exemplified by the recent announcement from South Africa’s Standard Bank, a bitcoin pilot program tested by the bank eliminates the need for a retail bitcoin exchange in the middle of the transaction. Partially owned by China’s biggest bank, ICBC, Standard Bank is the largest bank operating in Africa.
Similarly, Germany’s Fidor Bank pioneered the integration of bitcoin as a competitive advantage for the bank when, in July 2013, they agreed to a large-scale partnership with the Bitcoin.de exchange in Munich. The agreement called for a “liability umbrella” for bitcoin trading and represented the first direct banking cooperation in the regulated EU bitcoin sector.
Shortly thereafter, Fidor Bank signed an exclusive arrangement with Payward Ltd, operator of the Kraken bitcoin exchange. Under the deal, Kraken became Fidor Bank’s exclusive digital currency trading platform throughout the European Union, with the exception of Germany where Fidor Bank already had the local partnership with Bitcoin.de.
Turning the tables on owning the bitcoin customer relationship, Fidor Bank CEO Matthias Kröner said: “Digital currencies are emerging as serious and useful alternatives to government-issued currencies. With Kraken we can enable our customers to trade bitcoin and other digital currencies just as securely, easily and flexibly as they trade other foreign currencies today.”
Shifting rolesThese are still early days, but it could forecast the beginning of a trend where regional banks take on the role of building online platforms and interfacing with the millions of bitcoin customers.
In this scenario, the banks become local liquidity providers and bitcoin position takers. As the service offerings mature, banks will require a bitcoin trading desk, complete with portfolio-hedging strategies and multiple avenues for two-way liquidity.
Global bitcoin exchanges emerge as bitcoin clearing houses – less retail-oriented and more wholesale-oriented – providing deep liquidity and sophisticated offerings for the local market participants.