The Darker The Market The More It Needs Sunlight

There are a lot of nooks and crannies in capital markets.  Exchanges only trade the big ones.  I think it’s important to note that matching trades is super simple.  You can go out and buy a crude automated trading system off the shelf and a simplistic one is not that hard to build.  The trick is when the trade is made how do you report it?  How do you account for it?  How do you margin it?  How do you make sure both entities on each side of the trade perform?  How’s the security of the exchange?

These are huge issues.  Bitcoin exchanges have been ripped off causing people to lose money.  I went to a presentation of a new Bitcoin exchange once.  I asked two questions.  How do you margin and how do you clear?  The margin was accounting margin and the exchange made it so the traders assumed all the counter-party risk.  I don’t know if it ever got off the ground or not but it was clear to me that there was going to be trouble.

In this latest period of market volatility, one thing should have become very clear to average investors.  They cannot pick tops, and cannot pick bottoms.  If you were an active trader you might have made money but the probability was high that you lost.  Passive traders lost money too. But, they had less stress and paid no commissions.  Over time if you are bullish on America the passive traders will get their money back.

It is not just cryptomarkets that are dark.  Plenty of traditional markets are dark too.  Humans gravitate to marketplaces.  It’s been in our DNA since we were created.  Just read the study Economics of a POW Camp and that idea might resonate with you.

One of the companies WLV invested in, CFX Trading, brings sunlight to a dark marketplace.  I was telling a VC about it out here in California and he was laughing at the mental picture of a small group of guys emailing and using a phone to trade.  But, that’s how a lot of markets around the world work.  I know people trading at CFX and they are making 8%-14% on their money every year.  That’s huge.

However, it’s not “free” return. You have to do a lot of homework and the market isn’t super liquid right now so only a buy and hold strategy works.  CFX got a break with the new tax law as the return on these instruments received better tax treatment than they did previously.   The more players you get into a market though, the more liquid and shorter-term speculation will become a part of the market. That’s the grease that gets the wheels turning and allows the market to service more people at a cheaper cost.  Spreads narrow.  The end result is the entire marketplace gets bigger and more efficient as people gravitate to it.

This is one promise of blockchain.  It can bring some sunlight into markets like this which is why I remain bullish on the sector.  It will create marketplaces where none existed before.