Eliminating credit risk will lead to increased flows into digital
Capital inflow into digital assets from active asset managers is expected to increase in the near future. Investor concerns regarding exposure to credit risk from exchange venues are being overcome as a result of new infrastructure developments.
“The elimination of credit risk signifies considerable progress in this area. The biggest thing it does is that it unlocks the capital due to arrive into the space. So far, this factor has been a major deterrent, according to most of our client feedback,” explains Dmitry Tokarev (pictured), CEO at Copper.
He says the firm’s recently launched tool – ClearLoop – does just this: “We built a clearing network to resolve the issue of investors and traders having collateral sitting at the venue. If one of those venues disappears, as has happened in the past, then all that money would be lost. Our tool, however, allows investors to face the exchange directly, get better pricing and settle trades instantly.”
This means investors can bypass the exchange’s hot wallets and settle trades off-exchange, allowing them to be more agile given they have full control over their response to market movements and pricing changes.
The way it works is that ClearLoop ensures both the client and the exchange have enough assets to cover any position submitted by a trader before it is opened. Copper then settles fiat and crypto trades instantly between parties after the trade has taken place.
Tokarev discusses the impact such infrastructure will have on the value proposition of crypto from the perspective of institutional investors: “The crypto space offers plenty of trading opportunity as there are many inefficiencies there to exploit. Also, the funds are returning 5% per month, which is attractive especially given the return in many other areas has dried up. But the risks have often outweighed the appeal of the sector. If you eliminate some of those risks, such as the credit risk to exchanges, then it becomes a more attractive value proposition, thus improving investors’ willingness to allocate to these assets.”
Essentially, Copper is driven by the guiding principle that the problems its clients face can be solved efficiently, collaboratively, and securely to the benefit of the entire digital asset ecosystem.
Asked about volatility in the digital space, Tokarev points out: “Volatility is a trader’s best friend and an investor’s worst enemy. The industry is still young and is still developing so the volatility is expected and is not a problem. Once people understand the value proposition I don’t think anyone can do the research and come away thinking it’s all smoke and mirrors. If you understand the math and the money I don’t see how this can not make sense on a longer term horizon.”
Copper’s aims as a firm go beyond the crypto and digital assets market. Tokarev outlines his ambition to have the infrastructure the firm is building be applied to traditional finance: “Many of us come from a traditional capital markets background and we know the difficulties back and middle office professionals face in dealing with a system which is archaic and has not changed in the last 30 to 40 years.”
Although there are characteristics which differentiate a digital assets fund from a traditional active fund, Tokarev details how from a fund management standpoint, the two differ very little: “We’re talking about the exact same structure as any other fund. They have a structure, a manager, a PMS system. They go to the same lawyers to put together a prospectus and a DDQ, they have an administrator and auditor to onboard LPs and receive subscriptions, custodians, etc. Ultimately you can be in a situation where your digital assets funds can have the exact same structure as in the traditional space.”
He acknowledges legacy systems which underlie trillions in assets are hard to change and integration can take longer. However, Tokarev believes this change, should it be undertaken, would revamp work practices: “It would improve life for people working in back and middle office functions. So the next generation of CTOs can work more efficiently.
“It’s about giving tools to the middle and back office to allow buyside players to operate more efficiently, more transparently. Using such infrastructure would allow them to work faster and generate more value for their investors by doing what they do best which is manage funds.”
Lessons from B2C
Tokarev also describes how within traditional finance, there is no single source of truth of information, which is a problem blockchain can solve: “Blockchain is the most secure database in the world because it is driven by a central source of information. Blockchain is the only system where that central database is immutable and cannot be modified. But, critically, it can be accessed by everyone. This offers a secure central source of information, as opposed to traditional markets which rely on disparate databases belonging to asset managers, prime brokers, custodians, exchanges, clearing houses, etc, all trying to execute and settle the same trade. At the end of the day, financial markets are driven by data about who has what.”
He also says this technology can lead to the end of T+2 settlement: “Different assets can live on blockchain and people can trade them in a trustless environment, in seconds rather than in days. Technically, T+2 settlement, which is the norm, can be abolished. There is no physical reason for T+2 to exist. With blockchain you can settle instantly and in such a way that it will be verified and proved – It will not only prove the entry exists but also that the entry is not forged and is correct. It’s robust recording keeping and its free.”
The goal of embedding this technology in the business to business world is bold but the potential makes it a worthwhile undertaking, especially if lessons are learnt from the B2C market. “If B2C fintech is a Ferrari, B2B is still very much a cart being pulled by a cow. However, we would like to create the infrastructure which traditional financial services will use because B2B fintech is 50 times larger than B2C fintech, and could operate more efficiently if given half a chance.” Tokarev says.
Dmitry Tokarev, CEO, Copper
Dmitry Tokarev started his career as a Quant, having graduated from Imperial College, London, with a Distinction in Risk Management and Financial Engineering. He later helped to build an asset management firm as its CTO and as a partner, which currently oversees c. USD5 billion in assets. It was there he observed a gap in the market for Copper, as he found there were no feasible options available to institutional investors in the Crypto space that allowed for the necessary security, control and speed of storing crypto assets.