Off-exchange liquidity venues have been widely used by institutional investors to keep large trades confidential. Although they are not perfect and can be gamed by high-frequency traders, off-exchange alternative trading systems remain popular in equities. They are starting to gain traction in the cryptocurrency sector, prompting industry participants to seek out more advanced, institutional-grade tools to most effectively trade “in the dark.” For investors concerned with order information leakage, there are platforms that are engineered to prevent this critical pain point.
Off-exchange use is on the rise
Recent data from Tabb Group shows that the share of United States equities traded off-exchange ticked up from 34.7% in December 2018 to 38.6% by April 2019. This trend is also being mirrored in Europe, where trading within off-exchanges accounted for 9.6% of all on-exchange activity for the same period.
According to a report, this is the highest it has been since October 2017, before the Markets in Financial Instruments Directive II, or MiFID 2, implementation — introduced as a part of the EU’s January 2018 financial reforms — and a jump from April where off-exchange trading volumes accounted for 9.1% of activity.
In the burgeoning crypto sector, take-up is also increasing. Research firm Aite Group estimated that 65% of all cryptocurrency trading volume will happen in the over-the-counter market in 2019. This is a significant increase from 2016, where OTC activity only made up 32% of trades.
Why off-exchange?
For hedge funds and institutional investors, off exchange liquidity venues have been traditionally used to make large block equity trades private until that trade is executed. This allows for optimal pricing and provides safeguards against impacting the market by signaling an intention to a trader. There are now around 30 equity off-exchange venues in operation, with some of the biggest being run by big-name banks including Swiss bank UBS Group AG and JPMorgan Chase. A growing group of off-exchange pools for crypto are emerging to meet demand from investors.
Despite their expanding popularity for both crypto and equities, there is still a trade-off that comes with trading off-exchange that investors must consider — the associated lack of transparency.
Order information leakage is another perennial concern for institutional investors, and the use of off-exchange pools has been touted as one solution to this. However, an issue with this scenario is that off-market trading still requires investors to expose their order flow to one or more third parties, who may either intentionally or unintentionally leak the information, or worse, act upon it.
Solving the problem of information leakage
We should know by now that regulatory solutions, while sometimes necessary, often come with unintended and unexpected results. Market structure complaints do not always need regulatory interference. If possible, investors should search for solutions in the private sphere, as these can be more efficient and less costly. These innovative solutions could have the ability to turn market structure complaints and disadvantages into greater liquidity sources and build a sustainable market infrastructure for the future.
When users send an order to a third party for matching, they can never really be sure who is looking at it, analyzing it, or talking about it. They are forced to trust the third party and take a “leap of faith” in believing that all the proper security controls are in place and working to prevent both intentional and unintentional leakage of information about the order.
I have been involved in developing a matching engine called Cyberian that eliminates the need to trust a third party with order data. Cyberian enables institutional investors to trade cryptocurrencies such as Bitcoin (BTC), with zero information leakage at superior prices to what could be achieved on other exchanges or with OTC desks.
Cyberian uses a field of cryptography called multiparty computation, or MPC, to break up each bit of an order’s data into fragments. It then distributes the fragments among a network of nodes. These nodes then interact with each other using MPC protocols to perform order matching without revealing orders details such as quantity or limit price. This ultimately ensures that no single machine or entity is ever entrusted with an order’s data.
Conclusion
While off-exchange pools have been used in equities since the 1980s, crypto investors are now seeing their value as the sector rapidly evolves. OTC trading desks and off-exchange venues have become rather helpful for those wanting to execute large block crypto trades, but it still remains very important that institutional investors are able to use tools that have the proper controls in place to prevent information leakage and guarantee data safety.
Cyberian starts to address some of these issues and provides institutional investors a dedicated platform to place their large trades in a secure environment that not only meets their high infrastructure standards but also significantly enhances liquidity in the market.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of CryptoX.
Gerrit van Wingerden is a co-founder of Cyberian, an institutional crypto off-exchange liquidity venue. It is the world’s first trustless venue for trading blocks of digital assets. The new system is the first practical platform for matching blocks of digital assets without a single point of trust, which ultimately enables investors to buy and sell digital assets with zero information leakage and superior prices.
