Why does a CCP matter

 

Note: This post was originally published on LinkedIn in Oct 2023

Why does a CCP matter?
When everything else was going wrong during the 2008 financial crisis, some things were still going right. The Lehman default triggered a collapse of confidence in financial markets. But what was going right? On Friday the 12th of September, LCH (the Central Counter Party Clearing House) had called Lehman for the required margin to cover the market risk of their positions. This cover was sufficient to cover the events as they unfolded when Lehman filed for bankruptcy on the 15th of September.

The result of this, was that all the trading counterparties to Lehman saw their positions (and in many cases hedges) honoured. Chalk up one for Financial Market Infrastructure (FMI).

What is an Intermediated Model?
As a child, my big brother taught me how to play poker (not very well). I soon learnt that if I lost, I could cry, run away, and not honour my debts. Welcome to the peer-to-peer transaction model. Much later in life I observed in Vegas the need for trusted intermediaries. The dealer at the casino ensures each counterparty places their chips on the table.  As the game progresses, you continue to pay to play. If your counterparty has a bad game and chooses to run away, no problem. The chips are down and the trusted intermediary will honour your winnings. We all know this model. And like it. This is business to consumer (B2C).

But how do we scale this model for financial services? Membership of these wholesale clubs requires additional checks e.g. regulatory licenses. This is the B2B model. And this is the critical role our CCP partner plays in the GFO-X market model: acting as a trusted counterparty, having the confidence in the abilities and capitalisation of all their Members (who in turn back our market Participants).

What can we learn from this?
2023 was a bit of a shakeout year for the crypto markets. Fraud, conflicts of interest, etc. All the age-old illegal and unethical practices that traditional finance markets are unfortunately no stranger to. Things that we’ve seen before in TradFi, just under different guises. What it highlights is the importance of decoupling the transaction value chain into its components of Trading (price discovery), Clearing (risk mitigation) and Settlement (fiat payment rails). These have been hard lessons learned by TradFi markets, and the crypto market must learn from these mistakes, lest another FTX occurs.

The importance of partners.
GFO-X has chosen an intermediated model, with LCH as our CCP so our Participants have both certainty of contract performance and recourse in the event of default. This is underpinned by a legal and regulatory framework. Choosing LCH as our CCP was not a decision taken lightly. It is about delivering a trusted framework, in good times and bad, for our users.

And as for the photo credit? That’s AI for you. Thanks Leonardo.AI (It’s not really Brett, ‘The Lehman guy’ in the iconic photos).

A store of value....or purchasing power?

Note: This post was originally published on LinkedIn in Sep't 2023


The iPhone 4s cost 162 BTC. iPhone 15 cost 0.031 BTC.

Triggers a double take? Maybe because your reference point, or unit of account, is fiat currency.

What is money?
Money has three main purposes – it acts as a unit of account, a means of payment and a store of value.
(https://lnkd.in/eTsBzn5W)

Every now and then we hear noise about BTC transaction fees.
The Block has some nice tables that demonstrate this over time. Bitcoin Average Transaction Fee (7DMA) is one table I like. Sometimes, those transaction fees spike. But why? Well part of the problem is your unit of account. You're referencing BTC transaction fees in USD, not in BTC (satoshis).
(https://lnkd.in/esWDVjbU)

This paper expands on the point nicely:
Determination of Transaction Fees in the Bitcoin Network.
(https://lnkd.in/ehwCjSzv)
To save reading the 21 pages of this paper a crude summary would be:
i) BTC transaction fees are charged in BTC (satoshis).
ii) If BTC dramatically ramps up in price – the relative USD value of BTC transaction fee also jumps – but if our unit of account was BTC – there would be no such spike. (as evidenced by figure 2).
iii) Be aware of block size (basically, if you don’t have enough transaction to fill a block, even zero fee transaction will get written).

Ordinals (aka BTC NFTs) also make up a piece of the puzzle.
(https://lnkd.in/eBxG8wVU)

The iPhone price variance also highlights why institutions (asset managers) are interested in BTC and why sell side institutions want to support their customers getting price exposure to this asset class. Note well, price exposure does not mean operational risk exposure (like steal my keys!).

I found the Acuiti Q3 2023 Crypto Derivatives Management Insight Report interesting. It confirms the polarisation of crypto-natives and TradFi (along the lines we would expect). It also confirms both the need for prime brokerage services and how TradFi is recognising this.
(https://lnkd.in/e-iK2Zip)
#acuiti

For those that are enjoying the RWC - WooHoo! The Wallabies may be going home after 15 days, but I'll still be enjoying the games. For some the Ryder Cup is also on. Regardless, whatever your leisure, may it be a pleasure.

If you can't measure it, you can't manage it.

 

Note: This post was originally published on LinkedIn in Sept 2023.

Measure it, manage it. It's a mantra I often use. Measuring things allows us to mitiage, remediate, calibrate, communicate, be transparent etc.

Earlier this week I read a LinkedIn post from HM Treasury. It struck me because of the message (Endometriosis - of which I was unaware) and the courage of the presenters. The awfulness of no diagnosis or mis-diagnosis. Not knowing how or what to measure can lead to dreadful outcomes.
(https://lnkd.in/ewMM_auf)

But sometimes we can measure too much. I found this piece by Vera Cherepanova an interesting take on transparency. Likewise, with DLT we often get "captivated by magical thinking that transparency will solve all our problems." Sometimes mandatory reporting is not what we want - it is what we are reporting.
( https://lnkd.in/eM3wUe6P).

Like most control frameworks, ours also incorporates industry best practice. I picked up this BIS paper on CCP non-default losses and thought I would find a nice list of all the items to check for. But if fact, it is most often common sense and experience that tells us what to look for. Our experiences are what gives context to what we are measureing for.
"Scenarios and assumptions concerning potential losses are commonly informed by expert judgment from both internal and external subject matter experts given the inherent challenges of modelling potential losses in what are low-probability, high-impact events with limited historical data." (2.1.2 p8).
(https://lnkd.in/ezJH2wT3),

Measuring things also means that we need to act or re-act.
"If a sense of urgency is both necessary and detrimental, this results in a dilemma. Management must simultaneously create pressure/urgency and refrain from doing so.....the problem is that urgency invokes a prevention focus. A prevention focus favors upholding current standards, risk aversion and error avoidance, something that is highly efficient in creating a faster set response. However, it is not sufficient in situations where new, creative solutions are needed."
https://lnkd.in/eyj_f8Nz

Sometimes, none of the above matters. Clarity, purpose and conviction clearly project the path forward. The project path and trajectory is clearly defined. Who cares who invented the scales?
Just Do It! Get at it!
This is the beauty of T-Cup: Think Clearly Under Pressure. (Clive Woodward's words in preparing England to win a world cup).

By whatever measure, whatever your leisure, may it be a pleasure.

The blindfold, sword and scales all have a role to play.
https://lnkd.in/eieWVC8a

FTX: CEX - DEX, TradFi - DeFi, Reg - Unreg

Note: This post was originally published on LinkedIn in Sep't 2023

FTX is back in the news this week. It was a nice write up in FT Alphaville that caught my attention. But as ever, some of the best insights are in the comments.
(https://lnkd.in/eQD5eJ2n)

What is starting to emerge is a more comprehensive picture of the assets held - circa US$7byn.
That is some market overhang, which in turn raises the questions of liquidity and transparency (information leakage).
There is also a variance in the quality of these assets - with only some US$560 million in BTC.
(https://lnkd.in/e6s7WNxy)

FTX is worried about information leakage and they need this pre-approved.
(https://lnkd.in/eQ6KHc_H)

What struck me about this, was in equity markets we had the debate about Dark Pools in 2017. (https://lnkd.in/e9QUw3sJ).
And we took our learnings from it in 2020. (Liquidity shifts, if you push it out of the Dark, onto the CLOB, it migrates to the closing Auction - kinda like a stress ball, squeeze one place, it'll pop up elsewhere).
(https://lnkd.in/e6rAczm8).

There is growing maturity in liquidity and how it is reported in crypto markets.
(https://lnkd.in/ePpYdNdw).

So all this gets me thinking about the learnings from TradFi that we cast across into the emerging digital (crypto) markets. Crypto natives have done a lot - but so has TradFi. Right now there feels like some polarisation between the two camps, but I believe this will converge.

There is also an interesting read out from WFE (TradFi) on a review of crypto-trading infrastucture. What this report is silent on, is latency and through-put. There is a (I would say material) difference between the resilience and capacity of regulated TradFi systems and the unregulated CEXs of the world.
(https://lnkd.in/et9cn6bE).

The picture, I do like. The associated video I can't really recommend, but what it does show, is the huge conflicts of interest that exist in unregulated CEXs.
(https://lnkd.in/egvRTQHP).

Meanwhile, there is a Rugby World Cup on. Already the Wales / Fiji and France / Namiba games remind us of the unique nature of these events. For those that follow the code - enjoy! But whatever your leisure, may it be a pleasure.

CBDC, substitution, FSB, stable coins, Covid

Covid = COronaVIrus.
A corvid is a bird.
(Copied from Twitter)

Been a while between posts. No apology for that. Lots of news to digest.

This week, I had the pleasure of attending a 'Breakfast Briefing'. Of course the topic that lured me was crypto. The panel was almost painful. I felt frustrated as they hopped between topics. To one observer, it looked like the crypto industry had made no progress in the last 2 years. I disagree. Crypto is great and crypto is here to stay. It is not when or if, it is how we will embrace it.

Last week-end, on a Sunday, I got a nice BIS email with an update on CBDC. (Central Bank Digital Currency).
https://www.bis.org/quarterlyreviews/index.htm
It takes an in-depth look at the world of payments, including CBDC (from p85, the report in total runs over a 100 pages).
I do like Central Bank papers, they are clear, argued, and outline their premises and assumptions. (The panel I attended,  did not). With this clarity, this 'unpacking' of things, comes clear disambiguation. Clarity of terminology has been lacking in the crypto world from the outset, and in that regard, it is not much better today. Disambiguation is one of my crypto themes.
Given the current interest in Stable Coins, I gave it a read, but I confess, I didn't find it that great.
My problem was with the underlying assumptions. Do I really want access to CeBM (Central Bank Money v's CoBM, Commercial Bank Money?). Yes for high value / wholesale, no for retail. What I do want is certainty and finality. I want recourse and to have that, I expect a governance framework for dispute resolution. Hey, things go wrong. I don't really care, so long as we can put it right. It's when there is no recourse there is outrage and indignity.

I am also a big fan of Distribution. And one thing in the paper really resonated with me:
"When it comes to achieving resilience, neither a DLT-based system nor a
conventional one has a clear-cut advantage. The vulnerabilities are simply different.
The key vulnerability of a conventional architecture is the failure of the top node, for
example via a targeted hacking attack. The key vulnerability of DLT is the consensus
mechanism..."
p93.

Exactly this, crypto is new, but not to be feared. So often what we do is just a substitution or transfer of risk. CCPs do not eliminate counterparty risk from the system, they concentrate it and mitigate it. It is a transfer of risk and it works well. We understand it.

All is not lost however. There is a further article "On The Future of Securities Settlement" from p67, with a nice round up of the various Central Bank initiatives in the annex on p81.

FSB Chair’s letter to G20 Finance Ministers and Central Bank Governors: February 2020

https://www.fsb.org/2020/02/fsb-chairs-letter-to-g20-finance-ministers-and-central-bank-governors-february-2020/

There are a couple of important themes coming out of this (of interest to me):

1. So-called ‘stablecoins’. The FSB is resolved to quicken the pace of developing the necessary regulatory and supervisory responses to these new instruments. It will issue a draft report on regulatory issues and possible responses for public consultation in April.

2. Cross-border payments. Recognising the importance of efficient and inclusive payment services for global growth, the Saudi G20 Presidency has requested the FSB to coordinate the development of a roadmap for improving cross-border payments. The FSB will deliver this roadmap to the G20 in October.

I've been trying to get people into the mindset that Fiat, is just another piece of inventory. We DvP one thing versus another, IvI or Inventory v Inventory. This terminology is also TvT (Token v Token) or DvD (Delivery v Delivery). If we can get that T, to be a 'stablecoin' with CeBM backing, WooHoo! We're so much closer to DvD. (Ultimately, I'm a DvP model 3, hybrid guy, but very happy to start w/ DvP model 1).

I also firmly believe crypto has a major role to play in the facilitation of cross border payments.

I am still unsatisfied with the risk management of transactions while they're in the mem-pool awaiting the next block write, but I am very encouraged by some of the things to address that.
As a final generalisation I don't feel nearly enough is being made of "you see what I see" on a DL (Distributed Ledger), nor the ability to enrich a DL.

I think that's enough of a rant for today. Please welcome me back to your inboxes.

Whatever your leisure, may it be a pleasure!

We all love the Irish, and many of us rugby too.
Given the context of Covid, the Italians play on, but they cancel spectators (contagion risk).
The Irish, cancel the game, but welcome the spectators.
I expect Covid to jump 400% in Ireland next week.

Congrats to the Aquis Team.
https://www.thetradenews.com/aquis-gets-go-ahead-2-7-million-nex-exchange-takeover/

Indian Central Bank may seek to defer the inevitable
https://www.financemagnates.com/cryptocurrency/news/indian-central-bank-to-appeal-against-top-courts-decision-on-crypto/

EU Tax Havens.
This is a well laid out data set.

https://ec.europa.eu/taxation_customs/sites/taxation/files/eu_list_update_18_02_2020_en.pdf 

Delighted Spitting Image makes a return...
...with regular weather updates from our roving reporter Greta Thunberg
Brilliant.

Good old bats. The ultimate incubator.
https://www.sciencealert.com/deadly-viruses-always-seem-to-start-off-with-bats-here-s-why-they-re-patient-zero