Coinbase's Wall Street team is luring in billion dollar hedge funds as it tries to fix the biggest pain point in crypto
Anthony Harvey / Stringer
- Coinbase has a team of former Wall Street executives building out a business to lure big money into the crypto market.
- The prime broker business launched earlier this year as Coinbase Prime. But the Coinbase team is working on expanding its services.
- Prime brokers are commonplace on Wall Street, but don't exist in crypto which is keeping out big money, experts say.
Coinbase is best known for being one of the largest venues for mom-and-pop investors in the US to buy cryptocurrencies such as bitcoin and ethereum.
But the San Francisco-based firm also has a band of ex-Wall Street executives working on addressing the biggest pain point in the crypto market: the lack of a full scale prime-broker.
On Wall Street, middlemen called brokers sit between institutional investors, like a hedge fund or money manager, and exchanges and other trading venues. Such operations are hard to come by in the crypto world because the barriers to entry are high.
Coinbase, however, is looking to overcome these barriers. It launched earlier this year a prime broker business, Coinbase Prime, joining a family of businesses spanning asset management, venture capital investing, and retail trading.
As part of the business, Coinbase is offering some of the services of a traditional prime broker, including the onboarding of large institutional clients and custody, which had previously been announced by the firm. What's new, however, is that Coinbase is preparing to offer margin finance as early as the end of the year, people familiar with the matter said.
Anthony Harvey / Stringer
That would allow institutional investors to borrow to trade, which can help magnify returns, or leverage a short position, according to the people.
In the future, it is possible that Coinbase's broker business could help clients find the best venue to make a trade, even that means sending it to a rival trading outfit, a service known as best execution.
"Coinbase is pursuing a lot of different initiatives that make sense and take it closer to or are more similar to traditional finance: custody, financing, lending, security tokens, and the institutional portal," said Greenwich Associates' consultant Richard Johnson. "They have the resources to fund them and will surely have some successes."
Already, the firm has onboarded a $20 billion hedge fund through its prime business, the people said, declining to specify which fund. The team is working on getting other large hedge funds onto its trading platform.
At the same time, the firm is actively building out its teams in New York, Chicago, and London. Notably, it hired Christine Sandler from the New York Stock Exchange as cohead of institutional sales, as well as Hunter Merghart from Barclays as a sales trader.
Prime brokers arose in the equities markets in the early 1990s, about the same time the hedge fund industry started to take off. According to the banking research firm Coalition, the 12 largest banks collectively brought in $4.9 billion from their prime-broker units in the first quarter of 2018, the highest level in three years.
Colleen Sullivan, the head of the crypto venture firm CMT Digital, said the lack of a end-to-end prime broker was among the bigger issues holding back large Wall Street firms from entering the crypto space.
Having to self-finance at each exchange opens the firm to above-average risk on Wall Street. She described the lack of prime services in crypto as CMT Digital's "biggest pain point."
"Without a prime broker, trading firms are directly subject to events that an exchange may suffer like hacks, regulatory issues, operational issues, technology issues (and many more) - all of which may lead to loss of the trading firm's cash and coin," she said.
Coinbase's decision to enter into the broker business is a bit ironic. Bitcoin, the largest digital currency on the market, was founded in the aftermath of the financial crisis as an alternative peer-to-peer financial system to Wall Street that would render middlemen useless. Coinbase's entrance into the institutional broker business also raises red-flags to some market observers.
"There are many potential conflicts of interest in such a vertically integrated model," David Weisberger, a market structure specialist and CEO of CoinRoutes, said.
The SEC, according to Weisberger, has been keen on keeping strict barriers between different Wall Street businesses because of the various conflicts that could arise. Specifically, Weisberger said he was concerned about confidential exchange info - who is trading and what funds are sitting on their accounts - leaking over to the broker side, which could be used to provide color to trading partners.
Institutional exchanges have historically taken steps to address potential conflict of interest.
NYSE Group spun off Waves Securities, a brokerage unit, which it acquired when it bought Arca in 2003, after the SEC expressed concerns about conflicts.
There are parallels between the two situations, insiders say, although it may take some time to play out since the crypto market is so nascent.
"But right now, there's so many mature players, it is probably a good thing for Coinbase to do this because it is filling a much bigger gap," said Kyle Tuskey, a former Waves executive.
Since Coinbase is not a registered securities exchange, it isn't clear whether the SEC would have the authority to step in and create firewalls or flat out prohibit Coinbase from operating such a business.
A representative for SEC could not be reached for comment about Coinbase's ambitions. A spokesman for Coinbase also could not be reached for comment.
Still, Robert Hockett, a professor of law at Cornell University, said "it seems likely the SEC will take interest in Coinbase's intention to offer prime brokerage services."
"This raises conflict concerns, given Coinbase's also running a coin exchange, reminiscent of those that the Commission has found when securities firms have attempted to combine these two roles."
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