Bigger traders could get involved in bitcoin, potentially giving the currency a boost. People promoted bitcoin at a booth at a Las Vegas technology convention in January. PHOTO: GETTY IMAGES
By BRADLEY HOPE And MICHAEL J. CASEY
April 5, 2015 2:50 p.m. ET
Some of the U.S.’s biggest proprietary traders and investors are testing the waters for a bigger move into bitcoin, giving a potential boost to the fledgling virtual-currency industry.
While still cautious of becoming exposed to “cryptocurrencies,” some of the firms, which trade with their own money on their own behalf, say they see potential for big profits in trading bitcoin as more investors enter the market and financial-services firms use the currency to streamline transactions.
Their involvement could help reduce volatility in the market for bitcoin, which has struggled to gain legitimacy in part because of concerns about wild swings in its price.
Among the companies at the forefront of this move is DRW Holdings LLC, a high-frequency trading firm in Chicago founded by former options-pit trader Donald Wilson in 1992. DRW is a founding investor in a new bitcoin financial-services firm called Digital Asset Holdings that launched last month. Cumberland Mining & Materials LLC, a DRW subsidiary, has “begun to experiment with cryptocurrency trading,” DRW said.
Other firms with large proprietary trading groups also appear to have an appetite for greater exposure to bitcoin.
Citadel Securities LLC in Chicago and KCG Holdings Inc. in Jersey City, N.J., were among a small group of firms that have offered bids to buy shares of the Bitcoin Investment Trust since it listed last month on the OTC Markets, a platform typically used for trading shares of smaller companies that aren’t as heavily regulated as stocks listed on exchanges.
The trust holds bitcoin in a fund that issues shares to wealthy investors accredited by the Securities and Exchange Commission.
KCG spokeswoman Sophie Sohn said that in addition to the engagement with the trust, her firm is “actively exploring various opportunities related to” bitcoin. Citadel said it was not involved in Bitcoin apart from the bids offered for the trust, a spokesman said.
Wedbush Securities, another firm that has made offers to buy shares of the trust, saw it as “a good place to get your feet wet” with bitcoin, said Gil Luria, a payment analyst at the Los Angeles-based investment bank.
Launched by an unidentified software coder in January 2009, bitcoin is a digital currency that is created, or “mined,” by computers.
Advocates believe it will transform how people buy and sell goods and transfer money across the globe. But its rise has been plagued by concerns about a lack of security, criminal usage and price volatility. While it is accepted by an estimated 100,000 merchants world-wide, its use by mainstream consumers remains limited.
Investment in bitcoin and related digital currency-based businesses has surged in recent months, in part reflecting bets by venture capitalists and other investors on several noncurrency uses for the technology that underlies bitcoin. Various applications are under development that aim to strip out middlemen from the financial system and enhance record keeping and transparency in the broader economy.
One persistent problem for the bitcoin market is it can be hard to trade because there aren’t enough buyers and sellers at exchanges. Executives at those exchanges have sought to persuade high-frequency trading firms to begin making markets in bitcoin, trading-firm executives said.
In market making, a trading firm offers both bids and offers for an asset so that investors always have a willing party with which to trade. The trading firm tries to capture the spread between the bids and offers, buying at a slightly cheaper price and selling at a slightly higher price.
Ari Rubenstein, co-founder of Global Trading Systems Inc. in New York, said his team is looking at how to trade bitcoin but is waiting for regulators to give a signal that they approve of it.
“No one has an idea if bitcoin is going to take off and be unbelievable, but everyone agrees it has that potential,” he said. “But we are still weighing the risks of getting involved.”
Until now, New York broker-dealer SecondMarket Inc., a pioneer in trading alternative securities such as private-company shares, has been the largest institutional market maker.
The firm, which launched the Bitcoin Investment Trust in 2013, said it has traded almost 800,000 bitcoins valued at more than $300 million since its founding.
While there has been a higher level of interest in bitcoin from institutional investors, including hedge funds and proprietary traders, there are still a number of challenges for the market to overcome before those players can get more heavily involved, said SecondMarket director Michael Moro.
“One is that at a $3.5 billion market cap, it is still a small place for traditional large money institutional guys to make markets,” he said. “Two, liquidity is scattered” across exchanges in Hong Kong, Europe and the U.S.
For firms to get more engaged in trading bitcoin directly on a large scale, it will require more sophisticated exchange infrastructure and regulatory certainty, said Charles Cascarilla, chief executive officer of ItBit Pte. Ltd., a bitcoin exchange.
“They are all very interested, but it comes down to having some kind of regulatory clarity as well as to the technology available—whether you have something they feel is trustworthy, whether you have a big enough capital base, whether you have good enough technology,” he said.
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