CAI0065
Written evidence submitted by LMAX Group
LMAX Group is a London-headquartered, global financial technology company and the leading independent operator of multiple institutional execution venues for FX and crypto currency trading. Launched in 2010, the Group’s portfolio includes LMAX Exchange (institutional FX exchange and FCA regulated MTF), LMAX Global (FCA and CySec regulated brokers) and LMAX Digital (GFSC regulated institutional spot crypto currency exchange).
Servicing funds, banks, asset managers and retail brokerages in over 100 countries, LMAX Group operates 6 exchanges globally and trades in excess of $25billion a day. In 2021 LMAX Group sold a minority stake to J.C. Flowers & Co.
The Group builds and runs its own high performance, ultra-low latency global exchange infrastructure, which includes matching engines in London, New York and Tokyo.
Our vision is to become the pre-eminent FX and crypto currency exchange globally. Our mission is to create opportunity and deliver the future multi-asset marketplace – based on our core offering of global market access for all industry participants.
David Mercer is the Chief Executive Officer of LMAX Group. Following a successful management buyout in 2013, David has built LMAX Group into a key player in both the traditional capital markets and the crypto trading industry. A former City banking executive and currency specialist, David is an outspoken industry commentator and a long-term champion of the UK’s technology sector as well as a passionate supporter of entrepreneurship.
As a UK-based firm with a global client-base, we welcome the opportunity to contribute to this important inquiry. The crypto and digital assets industry has grown at pace, and it is encouraging to see the UK taking crypto regulation and market structure seriously. We believe that we have the solutions at our fingertips and the impetus to help the UK be a first mover globally and would be happy to discuss our thoughts further.
About LMAX Digital
LMAX Digital is the leading regulated institutional spot crypto currency exchange, run by the LMAX Group. Based on proven, proprietary technology from LMAX Group, LMAX Digital allows global institutions to acquire, trade and hold the most liquid digital assets, Bitcoin, Ethereum, Litecoin, Bitcoin Cash and XRP, safely and securely.
Today, LMAX Digital has established itself as the second largest bitcoin exchange globally, trading $2.5 billion/day.
LMAX Digital delivers complete transparency, open access and a level playing field for all crypto currency market participants, within a secure and trusted trading environment.
LMAX Digital is regulated by the Gibraltar Financial Services Commission (GFSC) as a DLT provider for execution and custody services.
Inquiry responses:
When LMAX Digital was launched in the UK in 2018, it was the first cryptocurrency exchange platform designed for institutional investors. The exchange was launched in response to the demand from our existing FX clients for institutional grade trading infrastructure to trade crypto currencies. Our objective was always to build a long-lasting, sustainable product.
Crypto currency and digital assets more broadly are a growing part of the capital markets ecosystem that cannot be wished away. Despite the recent crypto bear market, we have continued to see growing institutional participation in the asset class, whether that be through trading of crypto currency directly or investment in crypto or blockchain projects and entities.
That said, the industry is still in its early days: so far, the use of digital assets as stablecoins is significantly behind the use of them as tradeable assets, which is itself not yet a mature market. While it is interesting to speculate about whether digital assets might replace traditional payments systems, we are not convinced this is a likely development in the short or indeed the medium term. An optimistic use case would be to see them as alternative payment systems rather than as replacements to traditional currencies.
A CBDC, designed and implemented properly, could bring serious advantages to the UK. These include: the ability to make instant payments and disbursements; for businesses, a reduction in credit risk; for international commerce, the ability to settle in hours or even minutes; the increased transparency of distributed ledger technology helping tackle money laundering and tax evasion; the potential to spur an entirely new ecosystem of fintechs, all located within the UK; and, at a geopolitical level, the first-mover advantages of being among the first countries to have an internationally trusted and widely used CBDC. The benefits of a rapid settlement CBDC could quickly extend well outside of the current crypto ecosystem into the wider economy.
This has to be balanced against several downsides, which include, most prominently, the risk to financial stability should a CBDC prompt significant bank outflows at times of economic stress.
Privacy will be another key challenge related to the non-institutional use and take-up of a CBDC at a national level. Finally, there will be difficult policy decisions to be made about a CBDC’s ability to pay interest, the target customer base, the degree of centralisation of identity, and the level of transparency policymakers will be comfortable with.
The currently dominant blockchains have anonymity and zero trust architectures with no central authority as a principal design point, however the downsides of this approach are that there is no recourse in the event of theft of funds, loss of private key or account access or even basic recallability in the event of a simple mistake.
The degree of anonymity embodied in current crypto currencies is unlikely to be attractive for a CBDC. However, one of the key attractions of CBDC as a widely used payments and disbursement system is the fact that distributed ledger technology allows for far greater transparency around flows of money and individuals’ transactions. This has its advantages – for instance, it helps tackle tax evasion, detect illicit activity, and can combat many types of fraud by providing a retrospective transaction audit trail.
This may exacerbate existing problems around digital inclusion as well as creating a market for new technology to disguise illicit activity. Conversely, if the CBDC is designed less for public use and more for, say, international settlements and inter-institutional trade, this eliminates the problem of uneven take-up but does set limits to the potential effectiveness of a CBDC across the UK’s financial ecosystem.
If this approach ends up being the one taken, there is a real opportunity here to help level the financial playing field by reducing the structural advantage of the larger institutions, who have the balance sheet to deal with the significant settlement credit risk caused by delays in the current financial system – this could be game changing.
At a technical level, the key decisions will be about whether to create a bespoke technological platform, or use an existing model, given the important financial stability requirement to be able to control the size of the money supply.
At a practical level, there are will also be key trade-offs to balance. If the focus is to be on private as well as on institutional users, there are fundamental choices to be made about security, privacy, and digital inclusion.
There could be considerable upside in undertaking a staggered institutional trial to better understand the practicalities of CBDC adoption, similar to those trials undertaken with banks to test the European Currency Unit (ECU) during the formulation and establishment of the Euro during the 1980’s. LMAX Group would be pleased to take a lead role in such a trial to assess the value and application of a CBDC.
The greater transparency afforded by increased blockchain transactions will not be universally welcomed and there will be a political as well as a practical need for effective regulatory oversight. In the fast-moving space that is crypto, Governments will also have to balance the desirability of getting into the CBDC space early with the possibility that post-launch refinements may be needed, as well as considering whether privately issued stablecoins may confer similar benefits while eliminating key risks.
Expertise within the UK Government has grown from a standing start, and we still believe that within Government and regulators, the cadre with expertise in crypto-assets is relatively small.
We also believe that the conversation within Government about whether crypto is to be feared, tolerated or embraced remains ongoing, and this has led to mixed messaging around the extent to which the UK wants to be a key player in the crypto industry.
We think the setting of new competitiveness objectives for regulators marks a decisive step forward for the UK, but, without a firm timeline, it remains to be seen when these new objectives will take effect and the impact that will have.
Given that crypto is here to stay, it would be most beneficial to take a longer-term view and establish a robust market structure with well-considered regulation that preserves market integrity, protects consumers and promotes confidence in a nascent industry that could provide a real opportunity for the UK to lead.
These assets are growing considerably as an investment class. The next step would be bringing them further into the wider economic ecosystem, including by having a flourishing trading infrastructure, so that in the long term there is little difference seen between so-called traditional markets and crypto markets - which we are seeing increasingly converge.
Crypto-assets open up the door to investment in currencies where deflationary economics drive price appreciation and decentralised mechanics unlock direct, 24-7, unincumbered access to a global network. Crypto-assets are designed to recognize monetary value (NFTs included) in a digital world growing at exponential rates. This translates to new innovation and amazing growth potential. We also believe the emergence of this new asset class offers the opportunity for investors to further diversify portfolios into an alternative investment class. As far as risks go, we see regulatory uncertainty as the primary risk. Market participants require a clearer regulatory framework in order to feel like they can operate effectively and confidently within the space.
Crypto assets offer the opportunity to move money without a trust and across borders almost instantaneously, thanks to blockchain technology. In order to have the confidence to move funds in a trustless way, it is critical that technology offers the solutions at scale that make such transactions truly compelling, meaning the rewards far outweigh any risks.
There are many compelling use cases for DLT in the financial services sector. These include optimisation of customer KYC practices through the sharing of information between banks and institutions about existing and prospective customers, the facilitation of much faster payment processing on account of real-time verification of transactions, the drastic improvement of clearance and settlement mechanisms to allow for near instantaneous, cheap transfer of money across international borders, and greater financial inclusion.
Across the board, we’re seeing institutions, including leading global banks, having to respond to increased demand from their customers to offer cryptocurrency products. Customers are realising that among all the other reasons to gain exposure to the asset class, digital assets offer the potential to dramatically reduce costs through faster and more automated processes and settlements.
The evolution of Defi is exciting - particularly because it brings together both traditional capital markets and the crypto market, and, in turn creates a much better utilised payments system and capital efficiency. We believe that global capital markets can provide customers with unfettered market access through a frictionless marketplace – this will be possible by combining positive aspects of both traditional capital markets and crypto as well as large institutions contributing to it – whether its provision of credit to crypto trading counterparties or contribution of market data for valuing Defi tokens. LMAX Group is at the forefront of this. We contribute to the Pyth network which is built on Solana. The Pyth network will become the oracle of capital market valuations going forward with relatively low latency.
As macroeconomic forces push institutions to engage with the crypto currency markets, viable DLT use cases are steadily emerging. For instance, CBDCs are a popular topic in central banking circles, with governments in Sweden, Singapore, and the EU trialling them, and there is interesting work being done around the issuance of gilts using DLT. DLT is also making its way in capital markets, reducing settlement risks and offering greater visibility.
As discussed above, we think there has been growing consultation and outreach, especially in recent months and years, albeit from largely a standing start. As a general point, as governments consider regulatory frameworks, they must not overlook the wider economic opportunities that the crypto ecosystem presents.
In the UK, we believe that the Government has the opportunity to create a leading position globally in the crypto currency industry by setting effective regulatory standards.
With the right framework in place the UK can reap the rewards of being the go-to destination, generating jobs, growth and tax revenue whilst cementing London’s position as a leading global financial centre, attracting talented innovators and investors.
London has established itself as a global financial services centre with the ability to attract demand for tradeable instruments and provide highly efficient processes for their trading, clearing and settlement. The city remains the world's largest foreign exchange centre and we believe that crypto currency is a natural extension to that stronghold. The UK absolutely has a role to play as a global home of crypto investment and there is a significant opportunity to lead the market, foster innovation and benefit from the jobs created and tax revenues that come with that.
However, an effective regulatory framework is absolutely key. The current lack of regulatory determinism is causing a blockage. That needs to be resolved in order to unlock the wall of institutional money that we know is coming.
Regulation provides critical rules and boundaries for the industry, but the right balance needs to be struck between over- or under-regulating to avoid quashing this nascent asset class in its critical developmental years, or at the other end of the spectrum, risking the UK’s reputation through lowering standards. We believe that the appropriate regulation can be implemented that both protects market participants yet encourages this embryonic sector without stifling growth. The right framework will provide significant economic benefits if applied fairly and consistently.
Within this system sandboxes will continue to be important, as will constant dialogue between regulators and the crypto currency industry with a degree of political oversight.
Whilst we are purely an institutional exchange, we welcome visibility around the risks for retail investors as it can only increase the understanding of the benefits of crypto as part of a healthy financial system. When considering consumer protection, which is of course important to the development of the crypto industry, a distinction also needs to be made between sophisticated and unsophisticated investors. The former, which includes institutional investors, are able to take a rational assessment of risk and see it as a legitimate – albeit less mature and more volatile – asset class, and this should be reflected within regulation.
We believe that as a global financial centre, with the ability to attract global demand for tradeable instruments and to provide highly efficient processes for their trading, clearing and settlement, the UK has a role to play as a global home of crypto investment. There is a significant opportunity to lead the market, foster innovation and benefit from the jobs created and tax revenues that come with that. However, an effective regulatory framework is absolutely key to that.
Policymakers and regulators must have a full understanding and be clear on industry strategy, what they are regulating and why. Only then can the UK reap the rewards that come with an effective framework including innovation, technology, job creation and ultimately taxes.
With regard to the nature of regulation itself, regulation provides critical rules and boundaries for the industry but the right balance needs to be struck between over- or under-regulating to avoid quashing this nascent asset class in its critical developmental years, or at the other end of the spectrum, risking the UK’s reputation through lowering standards. It is a fine balance to strike, to create regulations that protect market participants and encourage this young sector without stifling growth; but the right regulation will provide significant economic benefits if applied fairly and consistently.
We are supportive of regulation that continues to mature with the asset class without stifling growth or blocking off opportunities. With regard to start-ups, we are strongly supportive of sandboxes, which have been a success story and it is gratifying to see that an increasing amount of companies using them are in the crypto space.
Ultimately regulation is the best way of protecting consumers and preventing economic crime, and we take this seriously in the products we offer. Only the most liquid and established crypto currencies are offered through LMAX Digital: Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), Ripple (XRP) and Bitcoin Cash (BCH) against USD, EUR, JPY, GBP and SOL (Solana) USDC.
Trading is available 24 hours a day, seven days a week, and governed by similar rules and principles as LMAX Exchange’s FCA regulated MTF (Multilateral Trading Facility). This ensures the exchange operates with best-of-breed security, compliance, KYC and anti-money laundering policies and procedures, and market participants are treated equally regardless of status, size or activity levels.
The LMAX Digital KYC policies and procedures are in compliance with the UK Financial Services Commission (FCA) and FATF standards. In addition, the KYC program is also compliant with the Gibraltar Financial Services Commission (GFSC) Distributed Ledger Technology (DLT) Provider regulation.
LMAX Digital has had the AML program since its launch in May 2018. The AML program is compliant with the Gibraltar Financial Services Commission regulatory requirements as well as with the UK FCA and FATF standards.
At a global level, the Global Financial Action Task Force and its internal standards for AML has been robust.
The UK is currently in a unique position with its blend of regulatory talent, innovative financial sector and supportive policymakers. We also have the advantage of a less fragmented regulatory landscape than our immediate financial competitors, notably the US. This may not always remain the case and the market does not stand still.
The fragmented approach to crypto regulation to date has driven uneven levels of adoption and in Europe, France and the UK have taken supportive approaches to date.
Further afield, the Monetary Authority of Singapore (MAS) has been on the front-foot in terms of implementing a favourable regulatory and tax infrastructure for crypto-assets and by utilising blockchain technology in many areas of its economy. Whilst MAS has been bullish on the potential of crypto and blockchain, it has also introduced guidelines on how firms can advertise crypto products to protect the interests of retail investors. It has sought public feedback on its regulatory proposals that aim to establish Singapore as a responsible global crypto currency hub, with strong corporate governance, regulatory and risk-management capabilities.
With any developing industry, common terminology and treatment can be incorrectly applied in a generalist manner. MAS has examined the features and characteristics of each digital token, to determine the applicable regulatory requirements, a process which we thoroughly support.
The Singapore government's approach towards cryptocurrencies is one that is adaptive, continually evolving and consultative.
Crypto-assets are inherently global and borderless in nature and will require cooperation in the creation of the standards and framework across the globe or at least in the major economies and financial centres. Looking forward, each upcoming regulatory agreement should be created with the macroeconomic impacts in mind.
LMAX Group sees huge potential in the innovation of the technology industry to address and mitigate crypto’s impact on climate change. Our ongoing engineering focus is on how to reduce the sector’s environmental impact whether by providing a platform for emerging green currencies or in working together to find solutions to achieve net-zero emissions.
Matching trades on an exchange removes bitcoin transactions on the blockchain, therefore centralised exchanges are very energy efficient. At LMAX Group, we operate in renewably powered datacentres and can therefore do many thousands of transactions for the energy of one bitcoin transaction. Hundreds of thousands of bitcoin transactions in a centralised exchange like LMAX Digital may result in only a handful of net settlements on the bitcoin blockchain per day.
Due to our proprietary technology design, the more transactions we do, the lower our energy footprint per transaction is. We don't build on bitcoin and don't see it as a future technology platform. We popularise and develop blockchains which are proof of history, the most power efficient. For example, a transaction on solana costs the same energy as three google searches.
We also are aware of the 'displacement argument' that says that bitcoin's use of renewable power means it is not available to reduce the overall carbon footprint of power generation. However, until reliable grid scale energy storage is deployed, much renewable power is currently curtailed/wasted and could be used for mining.
September 2022