“Tokenization eliminates all corruption”

- Larry Fink

The Exquisite Agony of Crypto UX

A few years ago, I heard a quote that changed the way that I think about UX.

“If you can make a product 100X better, but you have to add an additional step, you are sunk. But if you find a way to make an existing process easier, you have a billion dollar business.”

Unfortunately, I can’t remember who said this. I consume an irresponsible amount of podcasts and the origins of the quote have faded into my memory — but to whoever said this, thank you and apologies that I can’t attribute you properly.

This principle is relevant to crypto, because crypto market infrastructure has added a LOT of additional steps for institutional traders, and it’s holding back adoption.

To call a spade a spade, the trading experience for professional money managers in crypto today is far worse than it is in TradFi.

Getting your average hedge fund manager onboard with the idea of magic internet money is a difficult enough sell, but asking them to learn an entirely new trading setup is next to impossible.

Luckily, that’s changing fast. Today, the industry is on the brink of solving one quirk of crypto market structure that has always been very unappealing to more traditional traders.

In crypto, we call this the pre-funding problem.

The Pre-Funding Problem

Capital efficiency is a critical metric for sophisticated money managers because it directly impacts returns.

Every second that capital is sitting idle and not earning a return, the more negatively it impacts performance.

In TradFi, funds have excellent capital efficiency because they all use prime brokers.

TradFi funds custody with prime brokers that fund their trades, allowing them to trade on any exchange.

Most hedge funds use leverage as well, so their exposure exceeds their equity capital. Assuming the funds are good investors, it’s a very good setup.

Things could not work more differently in crypto today.

Instead, the status quo is that centralized exchanges require traders to custody and prefund accounts before they are allowed to trade.

This is a bad setup for a number of reasons.

1. It’s very capital inefficient. At any given time, a significant portion of a fund’s capital will be sitting idle, not earning any yield.

2. It requires funds to take on counterparty risk with these exchanges (remember FTX, anyone?)

3. It’s a pain in the ass and adds needless cost, overhead and complexity.

To drive home the point, let’s consider a hypothetical hedge fund called Degen Capital.

Degen has $100M in assets and runs a long short liquid token fund. Their strategy is to systematically trade the majors (BTC and ETH) and take bets on the long tail of tokens as well.

The exchange landscape is fragmented, and Degen typically doesn’t know where tokens will get listed or where liquidity will migrate.

Degen has to make a decision about where to custody their $100M. They decide to keep $50M on both Coinbase and Binance to trade the majors, and spread the remaining $50M across the top 10 exchanges by volume so they can trade the long tail tokens when they launch.

At any given moment, Degen is not earning yield on the vast majority of its capital and losing out on millions of dollars per year in interest.

Not only that, but there is an opportunity cost here which is harder to quantify. Imagine XYZ token launches on an exchange where Degen holds only $5M — but Degen would have preferred to long with $10M.

The pre-funding problem is also exacerbated by crypto’s unique market structure. The exchange landscape is fragmented, and counterparty risk is a real concern.

Funds will never onboard at the rate we’d all like if they are forced to take on needless risk and overhead.

A Peek Into the Future

Luckily, this problem is being solved. One of the more interesting solutions to this problem is a product called ClearLoop from Copper.*

(Shameless plug — Copper’s Global Head of Sales, Mike Roberts, will be at DAS London talking all about this in March, so you should come and hear it directly from him!)

You can think of ClearLoop as a third party, MPC custody solution that seamlessly plugs into a bunch of exchanges.

It’s a deceptively simple solution that solves a bunch of issues at once:

1. No more counterparty risk! Not only do funds retain control of their assets, but they are protected by a trust structure even against the extreme tail risk of a Copper bankruptcy

2. Capital efficiency — no more depositing at twenty different CEXs! Funds can hold their assets in one place and even earn yield through instruments like USYC.

3. Off exchange settlement — this is table stakes in TradFi.

4. A big reduction in operational overhead and complexity — no more analysts running around and praying to their gods that they’ve entered the right address on transfers.

Here’s why this is exciting. Every friction that the industry is able to eliminate directly leads to more adoption and capital flowing into the space.

The market is just starting to digest the sea change that the Bitcoin (and perhaps soon Ether) ETFs introduce.

Larry Fink is doing a press tour on CNBC talking about tokenization. BlackRock and Fidelity both are mobilizing their armies to put the ETFs in their clients hands.

This industry is at an inflection point. Onboarding institutional capital is our game to lose, and secure custody and trading experiences are a critical part of that.

Shout-out to everyone who is fighting the good fight to onboard the next wave of market participants, we all collectively owe you one.

― Mike Ippolito

*(Copper, a sponsor of DAS London, is also a sponsor of this newsletter) 

We're Watching

This week, David Choi Founder of MetStreet Labs joins the show to discuss a viral thread he wrote on the GBTC "widowmaker" trade that blew up in 2021. We deep dive into the mechanics of the GBTC arbitrage trade, the role of Bitcoin lenders (BlockFi, Genesis) & how the unwind of the GBTC widowmaker trade dragged down the industry in 2021 - 2022.

Watch or listen to On the Margin on Youtube, Spotify or Apple.

An Enchanted DAS Afterparty 🔮:

Transcend the Ordinary at The Copper Experience 🪄 

All DAS attendees are invited to an enchanted evening in the heart of Mayfair for the official DAS Afterparty.

Experience a magical night of networking, cocktails, a mentalist 🔮, and more – brought to you by Copper!

Details:

📅 Date: Tuesday, March 19th
🕒 Time: 6:30 PM to 10:00 PM
📍Location: Mayfair, London

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