What is Prime Broker? How does Prime Broker work in crypto?

According to Fidelity Digital Assets, over 40% of institutional investors in the United States and Europe are currently investing in digital assets, and 60% believe digital assets have a place in institutional investor portfolios.

Lack of experience and connections in a volatile market can make cryptocurrency investing challenging. Particularly, in light of recent crypto meltdowns such as 3AC’s default and Voyager Digital Ltd’s bankruptcy, real-time asset management for investment firms has become more critical than ever.

Key insights: 

• Prime Broker provides a variety of services including cash management, borrowing/lending, short-selling support, market insights and regulations, finding new investors, and more.
• Prime Brokers serve hedge funds, large-scale investors or institutions while Brokers serves individuals. Profits are generated through services fees, interest rates or by using clients’ funds for investment.
• Each Prime Broker has various requirements and fees. To transact with Prime Brokers, financial institutions usually need to have a minimum account size ranging from $500,000 to $50 million.

What is Prime Broker? 

Prime Broker is a package of services including securities lending, leveraged trade execution, cash management, etc. They are provided by investment banks and other financial institutions to hedge funds and other large investment clients who need to borrow stocks and bonds as well as money to buy stocks and bonds.

Prime Broker acts as an intermediary between hedge funds and two significant sets of counterparties:

• Pension funds and other institutional investors with shares to lend (for the ultimate aim of short selling).
• Commercial banks with money available for margin loans.

The establishment of such departments traces back to the 1980s.

Prime Broker assists their clients with large-scale investment transactions, as well as providing specialized services such as short-selling assistance, research access, and keeping them up-to-date on regulatory issues.

Some big Prime Broker in the traditional finance could be mentioned are Goldman Sachs, Morgan Stanley, Merrill Lynch, UBS, Credit Suisse…

What is Prime Broker in Crypto? 

Prime Broker in the crypto space is a set of tools and services provided by AMMs, crypto exchanges, liquidity providers,... to make trading easier. Prime Broker's customers usually are large-scale investors, institutions, hedge funds or Venture Capitals.

Prime Broker is necessary as many large investment organizations have large sums of money to invest but lack the internal resources to manage the investments on their own. Matrixport, among many others, is an example of a crypto-native prime broker. The company currently serves over 500 institutions worldwide, providing margin lending and crypto trading accounts that are securely linked to CeFi and DeFi.

Other Prime Brokers in the crypto space including Hidden Road, Wintermute, Finansiv, Nexo, BitGo, Troy Trade, Quantreq, Tagomi, Caspian…

How does Prime Broker work in Crypto? 

Prime Broker offers a variety of services to assist their clients in executing trades and managing digital assets, including:

• Custody: Working as an institutional-grade custody for digital assets. Custody supports settlement requirements for trade executions, transaction processing, and same-day settlements in some occasions.
• Market Making/OTC: Providing two-sided liquidity for buyers and sellers.
• Borrow/Lending: Offering access to obtain cash to increase their leverage. They also help their clients with "short selling", which is when investors borrow stocks to sell them. Prime Broker charges a loan fee for this service. The total cost includes both the borrowing fee and any interest agreed upon in the contract.
• Derivatives: Providing liquidity across crypto derivative markets, including pricing and structuring highly unusual derivative contracts for clients.
• Expand Capital: Prime Broker can provide "capital introduction" services, which include setting up meetings and presenting to those who may be interested in investing in a fund.
• Research: Providing data, analytics reports, market insights… requested by its customers.
• Regulatory Consultant: Helping clients keep up with all regulation updates.
• Cash management: Collecting and managing client’s cash flows. Effective cash management is critical to any business's stability.

Prime Broker units can earn handsomely from a variety of sources, including overall fees, transaction commissions, and lending charges. The interest rate spread between their borrowing and lending operations also benefits Prime Broker significantly.

Each Prime Broker has its own set of fees. They also charge different rates based on a client's transaction volume, the number of services used, and so on.

Prime Brokers can also use clients’ collaterals for their own investments. This is known as "rehypothecation". In many circumstances, fund partners agree to let their collaterals be used in exchange for a fee reduction.

Comparison between Prime Broker and Broker? 

A Broker is a person or institution who facilitates the purchase or sale of assets, such as stocks and bonds for an investment account. Typically, the amount of assets necessary to trade with a Broker is between $50 and $200,000.

A Prime Broker is a large institution that offers a variety of services to other large institutions, such as cash management, securities lending, and risk management. The assets necessary to trade with Prime Broker might range between $500,000 and $50 million.

Conclusion

Prime Brokers are establishing the foundation for the next stage of digital asset evolution, which is shifting away from speculation and toward asset management by assisting their clients in investing, managing money, borrowing assets, broadening their connections…

Due to the market's size and maturity, there is yet to be full-prime offerings for digital assets. As a result, more firms from traditional markets, including established Prime Broker providers, are anticipated to enter the digital asset industry over time.

Learn more: What is Risk? Risk measurement methods in finance