An Interview with DRW's Don Wilson and Cumberland's Bobby Cho
DRW is one of the leading proprietary trading firms in the futures markets. In 2014, intrigued by the emergence of Bitcoin, the firm decided to explore the potential to enter this new marketplace by leveraging its trading experience and infrastructure.
DRW established a separate company called Cumberland that specializes in providing liquidity for large trades. Cumberland currently has about 10 people working out of DRW offices in Chicago and London, with support from many areas of the parent company. It does business with a wide range of customers from all over the world who want to buy or sell cryptocurrencies, and it sources the liquidity for these trades from within the over-the-counter market and from trading platforms in various parts of the world.
In this interview, Don Wilson, the founder and CEO of DRW, and Bobby Cho, the head of Cumberland, describe the challenges of finding liquidity in a highly fragmented market and the approach they take to managing the risks of doing business on these trading platforms. They also describe an increase in the number of institutional investors coming into the cryptocurrency market, and they predict that this will drive the trading platforms to adopt the types of best practices commonly seen in more established markets such as futures exchanges. They also comment on the underlying utility of these cryptocurrencies and what they would like to see from the regulators.
MV: Let's start by talking about the formation of Cumberland. Why did DRW decide to go in this direction?
WILSON: One of the exciting things about being at DRW is that I encourage people to bring up new ideas. Early on in Bitcoin’s existence, there were a couple of people at DRW who were really excited about it. We started having a dialogue in 2013 about why this is important and interesting and how it might change the world. One outlook was that Bitcoin is exciting because of the distributed ledger, which is a much more efficient way of tracking ownership of things and enables you to do so in a decentralized manner. Our thinking was that sooner or later people would want to use Bitcoin for this characteristic, and the next step was, okay, therefore what? What can we do here?
One view we had was, well, we should buy Bitcoin because people will want it for this characteristic of enabling the instantaneous transfer of value, and there will be all sorts of uses for that. Another thought was to start a company focusing on using distributed ledger to make the settlement of traditional financial instruments more efficient. Another thought was that we could set up a desk and start trading Bitcoin.
In the end, we couldn’t agree on what the right approach was, so we decided to do all three. We started Digital Asset Holdings, which is focused on making traditional financial instruments settle more efficiently by using distributed ledger technology. We bought Bitcoin. And we set up a trading desk in 2014, which became Cumberland, to provide liquidity in Bitcoin.
MV: So what exactly does Cumberland do and what's the profile of your customer base?
CHO: Cumberland is one of the largest OTC liquidity providers in the cryptocurrency space. Basically, we offer institutional-size liquidity to market participants. They range anywhere from cryptospecific funds and businesses to hedge funds, brokers, family offices and venture capitalists. We also manage an inventory of different cryptocurrencies for our own account in order to run our trading business and manage the risk appropriately. And we look at different opportunities in the space, such as selectively participating in ICOs [initial coin offerings] that come across our desk.
MV: Are you tapping DRW’s expertise in running a market making/liquidity providing business, or is it a purely standalone thing?
CHO: We leverage a lot of the best practices that DRW has put in place during the last 25 years and apply those to the operational risk management that we do at Cumberland. The cryptocurrency market is at a very grass-roots level of development. There is no defined set of market standards. In fact we are trying to help create those standards across a number of different activities. And the best place to start is to leverage what DRW has learned from previous experience.
MV: What's the balance between exchange trading and OTC trading in the cryptocurrency market?
CHO: The bulk of our presence in the market is on the OTC liquidity-providing side of things. There is a huge imbalance in liquidity and trading volumes between exchange trading and OTC. On any given day, exchanges are reporting anywhere from $200 million to $250 million traded in a 24-hour period. OTC trading is not reported anywhere, but I’d imagine that the OTC market is larger than that number. A lot of the OTC trading happens because of the lack of liquidity on the exchanges.
MV: What size transaction becomes difficult or expensive to do on the exchanges? Is there a threshold where people say it's better to go OTC?
CHO: It really depends on the day and the liquidity on the exchange. Our minimum trade size is $100,000 and our average trade size is well north of that number. When you think about anybody that’s looking to put a sizeable amount of money in the market, whether it’s $1 million, $5 million or $20 million, they’re used to dealing with a U.S. counterparty and having the ability to transact with someone who is doing it on a daily basis, not wiring funds overseas to an exchange that may end up crediting those dollars in five to 10 business days.
MV: Given how fragmented the marketplace is, do you see big discrepancies in prices from one trading venue to another, and does that create opportunities for companies like Cumberland to buy on one, sell on the other, and profit from the difference?
CHO: Yes, the prices can vary wildly, but I'd say the market is pretty efficient at pricing in the differences in fees among the exchanges, in how they are structured, and the jurisdictions where they are set up.
WILSON: One of the reasons you see these variations is that some of the exchanges have aggregate daily withdrawal limits. They will only wire out a certain amount of dollars in a day, and once they reach that limit, you can no longer get dollars out. At that point, there could be price divergences, but you are limited in how much you can do. They look like arbs, but actually there are constraints that cause these things to trade at different prices.
" Basically, we offer institutional-size liquidity to market participants [ranging] from cryptospecific funds and businesses to hedge funds, brokers, family offices and venture capitalists."
Bobby Cho
Head
Cumberland
MV: How many exchanges is Cumberland connected to?
CHO: Currently there are over 200 exchanges. But how many have liquidity? Maybe a handful. We connect to any exchange that has meaningful volume.
MV: What about security and safety? As you know, there have been a number of situations where exchanges were hacked. How do you cope with that risk?
CHO: We take a very methodical approach to how we analyze onboarding with an exchange. A lot of what we try to do here is risk management, and we take that as the lens when we look at an exchange. Liquidity is obviously a very important statistic for us, but we also look at the customers who are trading on that exchange and consider whether we want to be part of that venue. That’s very important, and overlooked by a lot of folks.
You also have to understand the longevity of these businesses. A lot of these exchanges are venture-backed start-ups. We try to get a sense of just how much money they are putting toward the business and what the future business plan looks like.
Next we go into connectivity. Each exchange is going to have different connections and different APIs and a different way for us to consume data. Then, obviously, as you mentioned before, there are the issues around wallet security and getting comfortable with their internal processes and procedures and making sure that they’re implementing best industry practices.
MV: How do the APIs and market data feeds compare to what you see in other markets?
"Will many of these ventures fail miserably? Yes, probably. But will some of them be wildly successful and change the world in really important ways? Probably yes."
Don Wilson
Chief Executive Officer DRW
WILSON: There’s a lot of room for improvement. Especially when the market gets busy, there are significant delays in getting fills and market data. In the futures space, we’ve seen a continuous evolution, and the exchanges have moved to a more deterministic and predictable matching process, which is really healthy for the marketplace. I’m sure that as these exchanges mature and more institutional exchanges get launched, the situation will improve.
CHO: One example is that some of the exchanges don’t provide streaming data. So we’re constantly pulling the data on a periodic basis. Another example is that, due to the lag in market data that Don spoke about, much of the data that you’re looking at may or may not be stale. So you may be acting on something that is just not real.
WILSON: It could be also that you get a fill and there’s a massive delay in the notification, anywhere from 90 to 120 seconds long. Think about that. On a traditional exchange, we’re measuring things in microseconds and a handful of milliseconds of latency on a matching engine is viewed as really unacceptable. A millisecond is a thousandth of a second. And here, we’re talking about delays of a hundred seconds. The order of the magnitude is different.
MV: Why is that a big deal?
WILSON: If you’re working orders across multiple exchanges, because you’re trying to accumulate a position and you don’t really know where the liquidity is going to come from, you could easily get fills in multiple places and not know about it. Then, when you get the fill message from one exchange, and you go to cancel your order in the other, you find that you’re already filled. So you wind up buying more than you had intended. That's one of the reasons why market participants who are trying to trade larger size would rather just call Cumberland and transact.
Another thing about the exchanges is that we spend a lot of time understanding how well they are run. If it’s an exchange that has meaningful volume, we may decide that we want to transact on that exchange even if we’re less comfortable with their operations. In that case, we try to minimize the amount of money that we hold at the exchange, whether that’s in dollars or in crypto. And we view any money that we put there as having some chance of disappearance. So for us, it’s kind of an "eyes wide open" approach, and we view that as a real cost of doing business in this market.
MV: Do you see a trend toward these exchanges adopting standards?
CHO: I think they will start to implement some of the best practices that are seen in the traditional markets, whether they’re circuit breakers or other types of things. I do see it going that way, especially as we start to see institutional flow on the exchanges. When Cumberland started in 2014, the people who were most heavily involved in trading were Bitcoin-specific businesses or individuals, such as payment processors, wallet providers, early adopters and miners. That has started to shift over the last six to 12 months. With the run up in price and the overall media coverage of Bitcoin, there are a lot more traditional folks that are getting involved in the space. You are seeing the emergence of cryptocurrency funds. I think the latest stat I saw was that over 50 cryptocurrency funds have been started this year. That will continue to change over time.
MV: How about the geographical balance of trading? How has that shifted?
CHO: I think the U.S. leads and will continue to lead on the liquidity side of things. But you’re starting to see a shift to greater trading in places like Japan and Korea, which is directly correlated to the efforts that are happening on the ground in those regions. By that I mean real dollars are being put to work towards cultivating cryptocurrency businesses and adoption and technology growth. A prime example are the banks in Japan that have venture capital arms investing money into companies to help cultivate that business in Japan. That is directly impacting the volumes coming out of those regions.
MV: There’s been a lot more press coverage the last six months. The price has skyrocketed. Are we in the midst of a bubble?
WILSON: I think it’s fair to say that there are a lot of characteristics of the market that appear to be bubble-like, if you look at, for instance, the ICOs. There are companies that are putting out not very well-written 10-page white papers, and on the back of that, raising millions of dollars for not very welldefined tokens. The willingness of the market to fund these ventures, to me, is a little bit indicative of a bubble. But on the other hand, staying with the ICO space for a minute, some of these ideas are really interesting. They are leveraging the new technology to do things in a totally different way and the ability of this technology to move value in an almost frictionless way, and they are using the tokens as financial incentives to create an ecosystem around their ideas. Will many of these ventures fail miserably? Yes, probably. But will some of them be wildly successful and change the world in really important ways? Probably yes. So is Bitcoin on its way up from $4,800 to something ten times higher, or is $4,800 going to be the all-time high and it's headed back to zero? I have no idea, but I would say that there’s probably more upside than downside.
MV: We have talked a lot about Bitcoin. But Cumberland is active in lots of cryptocurrencies, correct?
WILSON: That’s accurate. But if you look at the market capitalizations of the top coins, you see that there is a really fast drop-off. There’s Bitcoin, Ethereum, and Ripple, which is kind of a special case. Then it starts to really fall off. With the exception of Ripple, our volumes are probably pretty proportionate to the market cap.
CHO: Just going off of what Don said, currently Bitcoin market cap is about $80 billion. Ethereum is about $35 billion. I think the next one is somewhere in the $9-$10 billion range. So liquidity starts to drop off and just general interest starts to drop off. And again, there’s a new cryptocurrency or multiple cryptocurrencies being born every single day.
MV: Do you feel like the risk/reward is right to provide liquidity in those more obscure currencies?
CHO: You have to think about risk management. With cryptocurrencies, you have to have the proper risk controls around wallets. These technologies change every single week, so you have to maintain those wallets and make sure they’re up to date. And with everything in cryptocurrencies, it just differs wildly. Unlike with equities where there are firms acting as qualified custodians, there aren’t bona fide custodians out there for every single cryptocurrency. Managing your own wallet and the private keys associated with that wallet comes with inherent risks.
MV: Is there also an issue with illegal activity? Is there the potential for some currencies to be preferred by people engaged in activities that they want to conceal from the outside world?
WILSON: Early on, there was this false perception, held in part by people who were doing bad things, that if they transacted in Bitcoin, somehow they could get away with it. That notion is totally flawed because, of course, the ledger provides a history of every single transaction that ever took place. A lot of those people were found out and some of them went to jail, and in some cases governments auctioned off their Bitcoin holdings. I think that people now understand that using Bitcoin and Ethereum to purchase illegal goods or services is probably not a very good idea.
MV: What would be the right stance for regulators observing this space?
WILSON: First, do no harm. Second, there are some opportunities to provide clarity on certain issues. For instance, around ICOs, if the SEC [Securities and Exchange Commission] were to provide some guidance about what constitutes a security and what doesn’t, that would be very helpful for companies that are trying to raise capital in that space.
MV: Is there also an opportunity to be more proactive? For example, the Commodity Futures Trading Commission recently issued an approval for LedgerX's application to list options on Bitcoin.
WILSON: That’s right, and that’s exciting. If and when an ETF is approved, that will provide the market with another important tool for people to access the space. So, yes, there will be lots of interactions with regulators as this market evolves.
MV: What’s your thought on the potential for cryptocurrency derivatives to gain some traction?
WILSON: Certainly, for the major coins, there’s an opportunity. Obviously, right now, the coins are pretty volatile so the margins are going to be pretty high. But I definitely think that there’s opportunity in that space.
