Goldman Sachs announced they weren’t going to put together a big crypto desk after all. Predictably, the value of all crypto’s fell. This is a tell in a lot of ways.
First, crypto markets have basically been tanking since CME/CBOT listed their respective futures contracts at the end of last year. Futures allowed holders to manage risk and the risk premium that was in the cash contract is slowly finding its way into the futures contracts. Futures have a way of letting air out of balloons.
Second, it shows that the institutions still aren’t there when it comes to buying, selling and transacting in crypto. They certainly are interested but because the SEC/CFTC haven’t laid down any hard and fast regulation, they really can’t jump in. No institutional flow limits Goldman.
Third, it also shows that Goldman couldn’t set up a network. A lot of the flow for the existing cryptocurrency market has been set up and the networks already set up.
Fourth, no institutional flow means Goldman might actually have to take some risk with trading crypto if they were going to enter the market.
I don’t know if you are familiar with how things work behind the curtain when it comes to trading or not. Back in the day, a Citibank Forex trader told us he was pulling in $250k of profit per day for the bank when he traded on their Forex desk. He wasn’t taking much or any risk. All he was doing was taking the opposite sides of orders and pulling in the difference between the bid/ask spread as customers transferred their currency from one fiat to another. The desk was huge with a lot of people on it and Citi wasn’t the only bank in the business. Forex is a trillion dollar market.
In stocks, when you push the button and enter an order you might have this romantic notion that some person gets an order ticket and takes special care with your order shouting the details of it into a competitive bid/ask crowd of people where it gets filled and then reported back to you. The reality is the broker you do business with sells the order to someone like Citadel. Citadel operates a dark pool and makes a penny or half penny off every order they fill. There are lots of Citadel’s out there and they compete for the business. You aren’t really a customer as much as you are a pigeon.
There are rare occasions when a stock will settle through your bid or ask price and you won’t be filled. This happens in more thinly traded stocks or options. Them’s the breaks but it just shows you there isn’t enough order flow in that particular security for the big boys to arbitrage it and make money off of you.
On the CFTC side, if you trade in a standard futures or futures options contract everything that hits the book hits the competitive market. It’s on the OTC customized side where the games are played. If you saw The Big Short you got a taste for that.
On the network, Goldman is late to the party. Cumberland Mining set the table and put out the punch bowl. The network effects push a lot of the existing order flow to Cumberland and they act as trader/broker/facilitator of the market. Goldman cannot compete. There isn’t enough flow, so when they put their line in the river no fish were biting and they cannot break into the Cumberland flow without taking a lot of risk and potentially losing money. Goldman summed up the cost/opportunity costs and folded up their tent.
We have seen this in other contracts. For example, the CBOT was first with bonds. There were network effects that were created with a whole chain of distribution to and from the pit on the CBOT trading floor. When other exchanges attacked CBOT they were unable to bust up those network effects. Even when the contract transferred from the floor to the screen and competitors offered the Treasuries for free, the existing network effects were so strong they were unable to compete and make any headway at all.
For the near term, Cumberland will be king in crypto trading. It will be near impossible to beat them unless the ecosystem expands with a lot more order flow. That can’t happen until the SEC/CFTC do something that allows institutions to feel safe.
There are some folks that think Bitcoin could be seeing a technical bottom as it relates to Gold. Permabear Tim Knight doesn’t see a bottom yet. He sees crypto as the biggest scam in financial history. Until some real applications are delivered and used, he is on the way to being right.
Next week, James Koutoulas and I are going to have a fireside chat about cryptocurrency at a family office conference in New York City. If you are a family office, contact Foley to attend.
For now it’s best to remember even with the numbers you are seeing, cryptocurrency is a pimple on the ass of the Forex market. It’s teeny. That can change for sure. There is huge potential there. The resources of an operation like Goldman though are better allocated to existing markets where they can bring a guaranteed return rather than something speculative like crypto.
UPDATE
My buddy Jimmy Odom points out that Goldman’s CFO says they are not pulling back from crypto.
The CFO said Goldman is working on a type of derivative for bitcoin because “clients want it.”
“The next stage of the exploration is what we call non-deliverable forwards, these are over the counter derivatives, they’re settled in U.S. dollars and the reference price is the bitcoin-U.S. dollar price established by a set of exchanges,” Chavez said.
My analysis holds. Goldman is going to handle client business, but I don’t think they will be able to make a splash in the broader market anytime soon.
