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News
Coinbase CEO calls out “really sketchy behavior” at the SEC: Fireworks have erupted from the SEC ever since Gary Gensler took office in early 2021. After a quiet, laissez-faire season under the Trump administration, the US securities regulator has quickly adopted an aggressive stance across its many jurisdictions. We’ve talked about the ongoing US equities battle between Gary Gensler & the market-making community over PFOF. Gensler makes aggressive comments both privately & in public, industry leaders call it politically motivated & inaccurate, and tension builds for inevitable court battles/rule changes down the road.
The cycle seems no different in crypto, although with a few added complexities. On the evening of September 7th Coinbase CEO Brian Armstrong shared his recent tussle with the SEC over the exchange’s upcoming launch of a crypto lending service. When Coinbase tried to brief the SEC on their launch plans, they were told to scuttle the project because “lending is a security”. When asked for more guidance supporting this claim, regulators gave none. Coinbase came away from the conversation a bit puzzled; competitors already had lending products open for public use and weren’t seeing the same level of SEC scrutiny.
My guess is the tussle will make its way to the courts at some point, which will put another spotlight on the age-old question - what the heck is a “security”?
The SEC said Bitcoin was not a security in 2018, that it was a commodity & therefore under the CFTC’s jurisdiction. In 2021 Gensler hinted that stablecoins were likely securities & should be regulated as such. The CFTC has muddied the argument by implying that stablecoins are merely extensions of their underlying assets, which are closer to commodities than securities. Both agencies are clearly fighting for regulatory turf & influence as legal precedent is formed, which is where Coinbase comes into the equation.
In my opinion, I think the SEC does have a reasonable argument to regulate crypto lending as a security. However, I hope their posture can shift from an aggressive, stifling stance to one of clarity & support for companies like Coinbase looking to innovate with crypto out in the open.
Cboe and EuroCCP Debut New European Derivatives Market: I love it when new futures exchanges launch. It’s a big deal when a large, sophisticated exchange tries to enter a new market; we don’t get those very often. Apart from the excitement & interest exchanges work to build in the new venture, a flood of detailed data is made available about their launch strategy, if you know where to look.
An exchange’s core value-add is its liquidity. Exchanges can’t build this themselves, so they incentivize market makers to trade on their platform and provide it for them. How exchanges incentivize market makers, then, can be considered their true value-add.
CBOE’s European derivatives exchange launch this week came with some updated reports about their market maker incentive programs. Most programs have the same elements - rewards a participant can receive from the exchange, and rules the participant must follow to win these rewards. Here are the details in CBOE’s case:
Quoting Obligations - Participants must have liquidity available for CBOE’s markets during certain times of the day (most of the London trading session), for a certain amount of volume (at least 5 contracts per market), and maintain a certain level of market quality (0.025 - 0.5 index points). Meeting all these requirements will give participants a performance score, which will be used to assess the rewards they can receive.
Rewards - Participants with high performance scores can win a wide array of rewards, from deep discounts on trading fees to completely free trading. In addition, participants can use scores to compete for what CBOE calls a “Monthly Stipend Pool” of ~$10K per month & 10% of CBOE’s revenue in that market. While complex, these rewards can add up to material amounts, making incentive schemes an integral part of a market-maker’s trading strategy.
We’ll quickly be able to see whether these incentive schemes work as intended. If trading volumes are robust at launch it means there’s enough liquidity to support the retail & institutional traders interested in these new products. If not, CBOE may have to tweak these programs to get more market makers on board.
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Other Stories I’m Reading
Virtu Financial CEO says pay for order flow benefits retail investors
FTX strikes ambassador, equity deal with NBA star Steph Curry
Tesla plans energy trading desk as company expands renewable power projects
US fund filings show CME taking bite out of LCH swaps share
State Street to Buy Brown Brothers Harriman Investor Services for $3.5B
Chart Of The Week
The last few months of exchange volume reports have made it overwhelmingly clear - Tradeweb has become a serious threat to MarketAxess’s dominance in the corporate bond market.
Pre-COVID MarketAxess had the greatest share of electronic corporate bond trading by far. Both MarketAxess & Tradeweb grew share at a similar pace, with gains coming from the secular analog-to-digital transition taking place among global bond trading desks. Between 2018 and early 2020 both exchanges gained ~400 basis points of market share each:
(Source)
After COVID the dynamic emphatically shifted in Tradeweb’s favor. While MarketAxess share is more or less flat since the start of COVID, Tradeweb’s share is up +1,000 basis points:
(Source)
Why is this happening? I have two theories. One - MarketAxess has said in the past that their market share is more exposed to volatility than competitors. When chaos strikes, they get a bigger slice of the market. When markets are calm (which they’ve been recently) traders look elsewhere for liquidity.
Two - Tradeweb has now built enough features across its platform to reach a turning point in its value proposition to customers. Net-spotting - the ability to execute a corporate bond trade & a US Treasury trade at the same time - helps Tradeweb’s UST customers save money & time. Portfolio trading helps ETF liquidity build electronically. These and other new features are attracting more voice bond traders to the screen, and they’re now choosing Tradeweb over MarketAxess to make their transition. It’s not that Tradeweb is stealing MarketAxess customers - they’re just getting nearly all of the incremental growth in electronic trading. If it continues for much longer I think we’ll start to see MarketAxess get more aggressive on pricing or other initiatives to defend its growth runway.
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Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, NDAQ, COIN and VIRT. I am also long Solana.