The Citadel Securities Paradigm Shift
Plus: A new OpenSea killer, Coinbase M&A, and more
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Citadel Securities Announces $1.15 Billion Investment from Sequoia and Paradigm: Another day, another wave-making headline from the most successful & scrutinized market making firm on Earth.
Citadel Securities has sold ~5% of the company to venture capital firms including Sequoia & Paradigm and will be adding a Sequoia partner to its board. The deal marks the firm’s first outside investment since forming in the early 2000s, valuing Citadel Securities at ~$22 billion.
There are a TON of implications from this announcement. First, a $22 billion valuation seems light for a market making operation of CitSec’s size. The firm made nearly $7 billion in revenue & $4 billion in EBITDA in 2020, and likely made even more in 2021. Surely Griffin could have negotiated a higher price for the crown jewel he’s been building for 20 years, right?
Then again, achieving exit liquidity for Ken Griffin doesn’t seem to be the goal of this transaction. Griffin is already one of the richest people in the world and doesn’t necessarily need another $1.1 billion in his bank account. There has to be something else, some other angle that would warrant the first outside investment for such a closely held firm.
Let’s look at the finer print of the press release - particularly the below comment from Paradigm (emphasis added by me):
“Citadel Securities has developed software and algorithms that have driven substantial improvement to market structures for the benefit of institutional and retail investors everywhere,” said Matt Huang, Co-Founder and Managing Partner of Paradigm. “We look forward to partnering with the Citadel Securities team as they extend their technology and expertise to even more markets and asset classes, including crypto.”
Sequoia & Paradigm aren’t just VCs - they’re VCs with heavy involvement in crypto, funding numerous web3 & blockchain startups at the forefront of a rapidly evolving (and sometimes overplayed) industry. Ken Griffin has talked about his cautious interest in crypto & his desire to enter the space when regulation becomes more clear - I’m willing to bet this announcement marks the start of Citadel’s serious foray into crypto market structure. Combining the tech & trading expertise of Citadel Securities with the resources & reach of two top crypto VCs creates a powerful partnership to extract value out of the already crowded crypto space. Trading a decent valuation for access to this partnership may seem like a good deal in Griffin’s mind.
By extension, this deal means that more serious crypto regulation is likely not too far away. Griffin’s crypto cynicism was apparent only four months ago when he spoke about Bitcoin at a Chicago conference. Something must have changed between then and now for him to change his mind. Does he know something normal market spectators don’t?
Coincidentally, we saw a tweet cross the wire from Congressman Tom Emmer about incoming crypto legislation a few hours after Citadel Securities’ announcement:
To be clear, Citadel Securities entering the crypto space is a big deal. The firm is a top market maker in US equities, options, fixed income and ETFs, giving it an unparalleled view of institutional & retail order flow across the globe. Applying the data, infrastructure & $100 million algorithms developed in its core business to crypto would extend that network effect & help it capitalize on opportunities other firms may not see or be able to profit from. Other firms like Jump Trading & Alameda Research have multi-year head starts in the crypto trading arena - will Citadel’s TradFi dominance be enough to catch up?
This deal carries more market structure implications than Griffin’s budding interest in crypto. There have long been rumors of Citadel Securities pursuing a public offering at some point; this deal could mean an IPO may now be coming sooner rather than later. This makes even more sense considering the historic COVID volatility & retail trading bonanza that has pushed Citadel Securities revenue to record highs. An IPO in the next year would allow Ken Griffin to achieve exit liquidity for all or parts of the business at a favorable valuation, likely much higher than the $22 billion given to Sequoia & Paradigm. A public Citadel Securities would be at worst extremely entertaining, and at best a great source of market structure information & potential alpha.
We’re only two weeks in & already 2022 looks to be just as exciting of a year for market structure as the two chaotic years before it.
*P.S. - if you’re looking for more info & analysis of Ken Griffin, Citadel & Citadel Securities, I recently published two long-form paid posts on the pair of companies & their journey to the top of market structure. You can find Part 1 here and Part 2 here. Thank you for reading!
Coinbase announces acquisition of derivatives exchange FairX: One of the most profitable trades of the last few years has to be applying & winning approval for a CFTC-registered derivatives exchange.
If you were able to start a company with the intention of launching an exchange, hire the right lawyers & ex-regulators to manage the licensing process & survive long enough to get approved, sizable returns would be waiting for you just around the corner.
First it was LedgerX, a struggling derivatives exchange that got bought out by FTX for an undisclosed but likely multi-million dollar sum. Then it was ErisX, an exchange in a similar circumstance which CBOE purchased in late 2021. Then Crypto.com bought Nanex and the Small Exchange for over $200 million. Then Coinbase most recently joined the party, inking a deal to buy Chicago-based FairX for an undisclosed sum. These deals all share the same story - a small exchange with no popular products, no customer base, no immediate path to profitability, but CFTC registration, get bought out for many millions of dollars to jump-start a crypto exchange’s derivatives buildout.
Where are these deals leading? Crypto exchange heavyweights want to supplement their cash-cow spot businesses by offering futures products to US retail & institutional clients. The hope is that the combination of spot & futures markets under one roof will help provide margin offsets to customers & attract market share away from both competing spot exchanges & CME, the dominant crypto futures platform in the US today.
I’m skeptical that these derivatives units will make much progress the way exchange buyers might hope. CME’s lead in crypto derivatives is formidable, and in my opinion, nearly insurmountable. If any of the challengers have a shot to compete, my pick would be FTX given its overseas futures success & expertise. Coinbase has no derivatives business to speak of prior to its FairX buy & gets most of its revenue from retail. I’m not confident a retail crypto futures business will get much traction without institutions present as well. In my opinion, Coinbase would be better served focusing on its NFT marketplace launch given the asset’s overlap with retail & much higher revenue capture.
Regardless, I’m excited to see the US derivatives space set for some fireworks in 2022.
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Other Stories I’m Reading
Chart Of The Week
LooksRare NFT Marketplace Goes Live: A fascinating exchange battle has quickly heated up in the NFT space that I want to make sure you’re following.
LooksRare, a startup NFT marketplace launched by a team of anonymous developers & touted as a potential OpenSea Killer, launched on January 10 to a surprising amount of fanfare. LooksRare isn’t the first exchange to try and disrupt OpenSea, but it looks to have the best chance of challenging the NFT king of any that have tried so far. Successful startup exchanges in TradFi and crypto employ a number of tactics to take market share:
They incentivize top traders to abandon incumbent exchanges for their own, either with equity in the exchange itself or attractive rebate programs.
They undercut competitors on fees.
They create new technology that gives customers alternative ways to trade.
In the case of a retail exchange, they market in more unique & intense ways than competition.
In its first week of operation, LooksRare has already engaged all these tactics with encouraging success:
The exchange launched a $LOOKS native token & airdropped it to anyone who traded 3 ETH (~$11,000 USD) or more on OpenSea between June & December 2021. $LOOKS holders can stake their token to earn a portion of LooksRare’s trading fees, making the exchange a community-owned, Web3-esque entity compared to the more centralized OpenSea. If LooksRare succeeds, so do staked $LOOKS holders.
LooksRare charges a flat 2% fee on all NFT transactions, lower than OpenSea’s 2.5% fee:
LooksRare unveiled a new NFT order type - the “Collection Offer” - that allows buyers to set a price where they’re willing to buy any NFT from a certain collection. This is something OpenSea doesn’t offer & allows buyers to set passive buy orders on the exchange’s order book, which should improve volumes & liquidity over time.
LooksRare seems to have partnered with every major Crypto Twitter profile in existence to spread awareness - dozens of high profile accounts on Twitter have voiced their support for LooksRare, their distaste for OpenSea & their ownership of equity in the exchange itself. Influencer marketing isn’t the sole path to retail crypto exchange success, but in sufficient size & scope, it can make a real difference.
Despite a number of technical glitches at launch LooksRare volumes have begun to build serious momentum. The below chart from January 11 shows hourly LooksRare volume surpassing - then tripling - OpenSea’s volume in a surprisingly short amount of time:
Even though most of this volume is likely wash trading to capture $LOOKS rewards, the sheer amount of volume attracted in such a short amount of time is very encouraging.
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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 and VIRT. I am also long Solana.