‘Traditional’ equities trading has undergone massive transformation over centuries. The evolution of how trades are conducted reflects technological advancements, market demands, and the need for efficiency. From the establishment of stock exchanges to the emergence of electronic communication networks (ECNs), the journey from disruption to adoption paints a clear picture of the changing landscape. Today, these evolutions are being mirrored in the digital asset markets, where institutional-grade exchanges and ECNs are emerging as disruptors to incumbent exchanges.
Crypto exchanges: centralized, vertically integrated models
Crypto trading began primarily on centralized exchanges (CEXs), where exchanges serve multiple roles: price discovery, order matching, and custody of user funds. While convenient, this vertically integrated model raises several risks.
The most prominent risk in CEXs is the conflict of interest between trading and custody. Because exchanges hold user funds, they can use these assets for their own purposes, such as funding proprietary trading activities or lending them out in lending markets. Users often have no visibility into how their funds are used, creating significant counterparty risk. This model has led to several high-profile exchange collapses and liquidity crises, eroding trust in CEXs.
The requirement for pre-funding trades further complicates matters. In CEXs, users must transfer assets into the exchange before trading, tying up capital and creating inefficiencies. If a user wishes to move assets between exchanges to arbitrage price differences, the time taken to transfer funds can result in missed trading opportunities.
The emergence of institutional ECNs
Electronic Communication Networks (ECNs) allow participants to trade directly with each other, bypassing the need for a centralized exchange. They match buyers and sellers automatically, leading to reduced transaction costs and faster trades. In recent years, institutional-grade ECNs have entered the digital asset market to cater to the needs of institutional investors. Firms like TP ICAP, Rulematch, AsiaNext, Crossover, EDX, and Finery Markets are applying the same principles that made ECNs successful in traditional markets. These platforms provide institutional investors with a more secure, efficient, and transparent trading experience.
Unlike CEXs, these new entrants do not require users to pre-fund accounts. Instead, they focus on price discovery and order matching, leaving asset custody to third-party custodians. This horizontal structure—separating trading from custody—eliminates conflicts of interest and frees up liquidity. Institutions can now trade without worrying about the risk of their assets being used by the exchange for other purposes.
By removing the requirement for pre-funding, these digital asset ECNs are able to offer faster execution times and greater capital efficiency. This is a significant departure from CEXs, where delays in transferring funds between exchanges often lead to suboptimal trade prices.
Market infrastructure gaps in digital assets vs. traditional markets
One of the critical areas where digital asset markets still lag behind traditional markets is in post-trade settlement infrastructure. In traditional markets, the introduction of central clearing houses and delivery versus payment (DvP) mechanisms helped reduce counterparty risk and ensure that trades were settled securely. The lack of such infrastructure in digital asset markets has left participants exposed to greater risk.
For example, in the FX market, decentralized liquidity providers match buyers and sellers, but settlement processes are often facilitated through trusted intermediaries, ensuring that both parties receive their assets without delay. In digital asset markets, where settlement often relies on trust between counterparties, the risk of settlement failure remains high.
This is where the Fireblocks Network was built to create a layer of trust and suite of products to manage the risks associated with digital asset transfers. Most recently, Fireblocks Off Exchange was launched to provide a technology-based approach to address a critical missing piece of post-trade infrastructure. By mitigating (rather than transferring) counterparty risk, institutions can securely transfer assets between their own, as well as custodian accounts, and trading venues without pre-funding, facilitating more efficient use of capital.
Integrated to institutional ECNs, Fireblocks can be used for secure, real-time settlement for trades. Institutions can now trade on these ECNs without tying up capital prefunding accounts, leading to greater liquidity and faster settlement times.
Potential impact by regulation
Regulation and industry bodies have played a critical role in ensuring the stability and transparency of traditional financial markets. Organizations like the SEC and BIS have enforced standards that reduce systemic risks, promote transparency, and protect investors. In traditional markets, frameworks such as the Basel Accords and the Dodd-Frank Act have been instrumental in regulating OTC derivatives, centralized clearing, and segregation of client funds. These regulations have significantly mitigated conflicts of interest and improved market efficiency. Applying similar oversight to the digital assets, particularly to CEXs, could have a transformative effect. It would address key issues such as the misuse of customer funds, lack of transparency, and insufficient custody practices, making the digital asset market safer for both retail and institutional investors.
In digital assets, although industry bodies have been established, they’ve yet to have a direct impact on best practice or standards within post-trade in the same manner as regulatory bodies or an equivalent to the BIS, notably to separate trading and custody functions. This would reduce conflicts of interest inherent in vertically integrated CEXs, where user funds are often used for proprietary activities. Centralized clearing and settlement systems, and OES, could be encouraged, similar to the role they play in traditional finance, reducing counterparty risk and improving capital efficiency by removing the need for pre-funding trades. Increased regulation and industry cooperation could help unlock institutional participation in digital asset markets, fostering a more mature and transparent ecosystem.
Shaping the future of digital asset trading
The evolution of trading from informal face-to-face transactions to the rise of structured exchanges and electronic communication networks has set a precedent for how markets can adapt to technological advancements and changing demands. As the digital asset market continues to grow, the lessons learned from traditional financial systems are proving invaluable, crisis included.
Institutional-grade ECNs are emerging as viable alternatives to CEXs, promoting greater transparency and efficiency. By separating trading functions from asset custody, these platforms address critical risks associated with the vertically integrated models of traditional digital asset exchanges. OES technology enhances this shift by beginning to fill the gaps in post-trade and inefficiencies of pre-funding, facilitating a more fluid trading experience but the market still lacks a standardised practice to unlock further benefit. As the digital asset landscape continues to evolve, embracing the best practices of traditional finance, alongside innovative technological solutions from digital assets, will be pivotal. By building a more transparent, efficient, and secure trading environment, the digital asset market can better position itself for sustainable growth and broader adoption. This transformation is not merely a reflection of market trends but a critical step toward realizing the full promise of technology advances digital assets contribute to a modern financial ecosystem.
