As the cryptocurrency landscape continues to evolve, the acting CEO of BitMEX’s parent company, Stephan Lutz, in an interview, suggests a shift in the operational model of exchanges, particularly regarding their internal market-making teams.
Lutz believes that the rise of high-frequency traders (HFTs) and proprietary trading firms can effectively replace the need for internal market makers, ensuring liquidity and bridging gaps in the market when there are imbalances between buyers and sellers.
In BitMEX’s own journey, its internal trading entity, Arrakis Capital, has transitioned into a limited role as a treasury desk. Lutz sees this as a natural progression for crypto exchanges in a market with a greater number of institutional liquidity providers and more mature companies. The distinction between treasury functions and internal teams operating like hedge funds becomes crucial, with indicators such as the separation of client and house funds, access to data that could facilitate front-running, and the ability to manipulate markets on the exchange.
Regulatory scrutiny and the future of internal trading teams
The recent regulatory pressure and scrutiny faced by exchanges with internal trading teams have led to a closer examination of their operations since the fall of FTX last year. Lutz emphasizes the importance of distinguishing between benign internal trading teams and those that resemble hedge funds, like Alameda Research.
To differentiate between the two, Lutz identifies key factors such as the separation of client and house funds, access to data, the ability to move markets on the exchange, and fee structures. Exchanges with low or no transaction fees may raise red flags, indicating their primary goal of attracting trading flow for market-making purposes, according to Lutz.
As the cryptocurrency industry evolves, the role of internal market makers is being reevaluated, with a shift towards relying on external liquidity providers.