Often said is how revolutionary Blockchain technology is. Seldom heard, however, is how it affects traders’ performance targets and objectives. Now, granted, 10 minutes, the average time for Bitcoin to be transferred f rom one entity to another is vastly superior to traditional flow methods. For traders, however, the reality is starkly different.

Leaving Bitcoin and cryptocurrency on an exchange is fraught with pitfalls that most readers will know well by now. It’s become commonplace to hear of exchange hacks on an annual basis. Some exchanges have a better track record than others. But all are targets as cryptocurrency is one of the largest financially hackable bounties in the world.

Traditional asset managers have rules to play by. There is good reason why regulations require third-party custodians. But for institutional traders looking to trade Bitcoin at high velocity this proves to be challenging at best.

Basic math
Hardcoded into Bitcoin’s network is the mathematical goal that transactions are confirmed and settled within a ‘Block’, on average, every 10 minutes. But a great deal can happen in that time frame in crypto. Price swings can be so volatile that the network faces multiple jams with people sending their Bitcoin to exchanges for sale. This bottleneck results in much longer times for blocks to be solved and trader accounts to be credited accordingly.

Compounding this delay is the fact that most spot market exchanges require at least three block confirmations before account funds are released and free to trade. That means, on average, a minimum of 30 minutes before traders can actually execute. This poses a serious problem for traders looking to go in and out of a trade as fast as possible.

The options for traders aren’t plenty. The first option is to take on considerable counter-party risk by leaving their cryptocurrency on exchanges with the hopes and trust they will not be hacked – a solution unlikely to bode well with regulators in the future. The other option is to accept potential time delays that would lead to either steep losses, missed buying opportunities or worse, margin calls that would be too late to be met resulting in liquidations even with small amounts of leverage considering the volatility Bitcoin has become so accustomed too.

Always waiting
Blockchain data helps understand the potential risks and opportunity costs posed when relying on the Blockchain. Even on the least volatile of days, confirmation times can be painful. On volatile days, they’re decapitating (see charts below).

Figure 5: Time taken to confirm 3 blocks on 19th May 2021 (Spot market conf. req)

Figure 6: 2 Oct 2021: Bitcoin’s least volatile day in 2021 - 3 Confirmations time (min)

Figure 7: Bitcoin % Loss/Gain from time of decision to sell to being able to after three confirmations (Based on actual block time confirmations)

To put this in financial perspective, the time between the decision to sell, for example, and the time when a trader would be able to actually sell post-confirmations can be steep and upwards of 15%. And even with price rebounds, the likelihood of achieving intended sell targets is only a little higher than zero (see charts above).

Tools, not returns
A recent survey highlighted that institutions are most concerned with custody of Digital Assets. The irony is that institutions have more robust tools in their arsenal than the retail crowd. Solutions have been built and continuously evolve not only for safe storage, but for the active participation in an ecosystem that provides high yields in various financial products that have developed over the past few years in the decentralized arena.

What will accelerate the adoption of the space isn’t actually the promise of high returns alone, but the understanding and application of the right set of tools.

The reality is that institutions will in all likelihood maintain a traditional mindset when entering the ecosystem that still suffers from loose regulatory guidelines. In essence, the rules will remain the same trickling their way into the digital asset space.

Clearer skies ahead
As more institutions enter the space, so do their requirements when looking at solutions. And contrary to the aforementioned survey, institutions have options on the table that would both eliminate counter-party risk and bypass Blockchain limitations by accessing vetted exchange networks such as ClearLoop.

Such networks allow large traders to instantly access exchanges at the same time without prefunding requirements. This effectively shifts volatility into an opportunity rather than a risk as traders would have an unfair advantage of accessing cross-market liquidity at times when the Blockchain network is jammed.

Such off-chain real-time settlement networks are a benchmark standard within traditional finance and it’s only reasonable that institutions have the same level of capability within the digital asset world. This is why such networks continue to grow and onboard both investors and exchanges. It’s a mutually beneficial relationship.

Obligations
Beyond the considerations that regulations or even self-imposed institutional restrictions would require custodians as seen in the traditional asset marketplace, there are other tick boxes that need to be met.

‘Best Execution’ practices require brokers to act in the best interest of the investor. Unfortunately, with the Blockchain being so unreliable in settlement finality and fees adding up during volatile periods, institutions will have a hard time meeting the regulatory obligation.

Ready when you are
The Blockchain has certainly changed the perception of what might be considered valuable. New opportunities pop up at a fast pace within the crypto ecosystem. Central banks have taken notice. Hedge funds have taken notice. Family offices have taken notice. But institutions need a set of tools that allows them to participate within a well-defined traditional ruleset, and these tools are now here.

This article is from The Wealth Mosaic's WealthTech Views Report: DLT & Blockchain 2022. Access the full report here