Secure Institutional Trading in Crypto

Institutional Challenges in Crypto Trading
Exchange-based models have undoubtedly been the norm when it comes to digital asset trading, including crypto trading. And yet, these models come with various pitfalls that make them quite unfavorable for large-scale, institutional traders.

Standard trading via exchanges often requires asset managers to surrender complete control over their funds to their liquidity provider. Trading in this way generally offers asset managers little to no insight into how their funds may be utilized. What’s more, trading on centralized exchanges does nothing to address the issue of counterparty risk, leaving user funds in jeopardy in the event of exchange mismanagement or failure.

Institutional traders using exchanges can also face extended settlement periods on their transactions, limiting their liquidity and making it difficult to react to market developments in a timely fashion. Not to mention that centralized exchanges are prime targets, and have previously fallen victim, to hackers and other malicious actors. If that wasn’t challenging enough, institutions trading on public exchanges must also deal with regulatory scrutiny and concerns around frequently changing compliance requirements.

While exchange-based models present significant challenges, other entry-level investment options like crypto ETFs and proxy stocks such as MicroStrategy are not without their own shortcomings. Crypto ETFs offer exposure to digital assets but come at the cost of flexibility. Investors are bound to the operating hours of traditional markets, forfeiting the ability to trade 24/7/365—an essential feature of the crypto ecosystem where markets never sleep. This time restriction can prevent investors from responding to rapid price fluctuations in the highly volatile crypto space, resulting in the loss of profits.

Similarly, investing in certain companies’ stocks as a proxy for Bitcoin comes with dual exposure: the price of Bitcoin and the company’s financial health and management decisions. Poor corporate strategy, operational missteps, or broader issues within a company’s business model can amplify risks, making this approach an imperfect substitute for direct cryptocurrency investment. Unlike native crypto assets, these vehicles add layers of complexity and vulnerability, diluting the direct benefits of digital asset ownership.

As we enter a new market cycle with increasing digital asset values, institutions need more efficient and transparent solutions that allow them to securely manage large transactions, protect their digital assets from counterparty risks, and govern their digital assets at scale without surrendering control.

The Transition from Legacy Financial Models to Digital Asset Infrastructure
Since its inception, the crypto market has followed the models established for traditional
financial markets. Early crypto trading happened through P2P transactions on public forums and P2P exchanges before eventually moving to centralized exchanges.

While these traditional financial models had some benefits in terms of speed and cost, they are ultimately ill-suited for digital assets, carrying with them several risks. Participants must practice flawless self-custody or find qualified digital asset custodians to avoid major counterparty risks. Then there is the difficulty in ensuring the best possible prices via market aggregation—a necessary regulatory requirement in many jurisdictions—and the usual friction and costs linked to moving digital assets from one provider to another.

Crypto trading has advanced since its rudimentary beginnings, with vast improvements to
custodial solutions and tools for maintaining regulatory compliance. Most notably, the rapid development of Decentralised Finance (DeFi) has given rise to countless decentralized trading options, reducing reliance on third-party intermediaries. Even so, for matters of liquidity, convenience, perceived security, or regulatory compliance, most transactions still rely heavily on centralized exchanges.

Centralized exchanges, while pivotal in onboarding newcomers to crypto, often replicate the same hierarchical and opaque structures found in traditional finance. By centralizing control and custody of funds, they stand in stark contrast to the core ethos of crypto: decentralization, transparency, and user sovereignty. This alignment with legacy financial models can create friction for institutions seeking to embrace the unique benefits of blockchain technology, rather than simply adapting it to fit outdated paradigms.

Many of today’s trading platforms, be they centralized or decentralized, are increasingly
inadequate for institutional requirements. They subject users to inefficiencies in trading
processes and asset pricing, as well as attracting significant fees. Most critically, these platforms often fall short when it comes to securing users’ digital assets.

The Need for Off-Exchange Trading Solutions
Since the collapse of FTX, institutional traders have become more aware of the counterparty risks involved with entrusting custody of their digital assets to a centralized exchange. This led to institutional traders moving to more secure custody solutions, with many institutional traders and investors moving funds into self-custody solutions or to regulated digital asset custodians.

That being said, additional difficulties arise when it comes to trading with digital assets secured
this way. These include the challenge of ensuring liquidity without compromising security, as self-custody solutions often create operational inefficiencies. Traders must navigate delayed access to funds due to complex multi-signature governance, which can slow down decision-making and execution speed. Additionally, ensuring seamless integration between custodial solutions and crypto trading platforms can be cumbersome, requiring advanced infrastructure and additional costs to maintain connectivity.

Off-exchange solutions combat this by offering institutions a way to engage in digital asset trading while still keeping control over the digital assets used for trading. What’s more, they offer additional benefits such as real-time pledging of digital assets, minimized exposure, and faster
settlement cycles.

As the value of digital assets rises, providing institutional traders with more diverse trading opportunities, the crypto trading industry can expect to see an increase in demand for solutions that balance liquidity, security, and efficiency, while maintaining institutional-grade compliance standards.

Why Secure Hardware-Backed Systems Are Needed
It’s important to note that institutions looking to protect their digital assets cannot simply settle
for any self-custody technology or unsafe custodians. Indeed, when it comes to securing digital assets, hardware-backed technology should be used, as it offers the most reliable option when it comes to security.

Hardware-backed technology systems utilize hardware security modules (HSM), which protect the institution's cryptographic keys in an offline, tamper-proof environment. Such systems can even provide institutions with a set of Personal Security Devices (PSDs), enabling operators to clear and approve their interactions at every step. Thanks to this design, important operations such as executing transactions occur in this secure offline environment, protected from any potential security threats.

In contrast, software-only solutions put cryptographic keys at risk on your device or in the cloud
because they are not designed for secure cryptographic operations. This exposes them to malicious attacks including hacks and malware. While exchange-based solutions can leverage secure hardware technology to protect their clients’ digital assets, they require blind trust—forcing you to delegate your digital assets to a third party, without visibility into how they are safeguarded.

Hardware-backed, off-exchange trading systems are a superior option, allowing institutions to trade confidently with minimal risk, keeping visibility, security, and control over their digital assets while ensuring compliance and capital efficiency.

Above is an illustration of the Ledger Enterprise Tradelink architecture; a secure off-exchange trading technology enabling seamless institutional trading. It provides access to qualified custodians, collateral management solutions, and multiple crypto-exchanges allowing real-time settlement and crypto collateral pledging. During the trading cycle, digital assets remain safeguarded by the qualified custodian of the trader's choice and secured by Ledger’s industry leading Ledger Vault security. Tradelink empowers institutions to trade efficiently without compromising the control or safety of their digital assets.

The Future of Secure Institutional Trading
The transition in how institutions engage with digital assets trading is ongoing. From P2P to centralized exchanges, to decentralized exchanges, each development brings the industry closer to a more secure, efficient, and trustless decentralized trading environment.

Off-exchange trading, like that powered by Ledger Enterprise TRADELINK, is the latest step towards that goal, offering institutions a highly secure trading environment more closely catered to their commercial needs. Thanks to emergent platforms that empower institutions to stay in control of their digital assets while trading, we can expect to see many more businesses incorporating crypto into their wider asset management and investment strategies.

This article was written for educational purposes and doesn’t constitute advice.

Ledger Enterprise is a hardware- and software-based technology company enabling businesses and institutions to store, self-custody, and manage their digital assets and power their web3 operations. Ledger Enterprise is a technology company and not a financial services provider.

About the Author
Article authored by Leonard Korkmaz- Senior Product Marketing Manager at Ledger & Sebastien Badault - Executive VP, Enterprise Revenue at Ledger.