Crypto's Capital Efficiency Conundrum: The Missing Primitive of Clearing

Instant settlement has become a hallmark of cryptocurrency markets, enabling fast and secure transactions without the need for intermediaries. However, this approach also introduces capital inefficiencies that could hinder the market's growth.

Built on the principles of atomic settlement, most crypto markets finalize each transaction independently, without considering the broader network of participants. This leads to a situation where firms are forced to continuously move and pre-fund capital, even when their net exposure is close to flat.

According to Ethan Buchman, founder of Cycles Protocol and co-founder of Cosmos, this problem arises from the absence of multilateral netting in cryptocurrency markets. Traditional financial systems use clearinghouses to reconcile and net obligations before settlement, compressing large volumes of transactions into smaller net flows.

The Depository Trust & Clearing Corporation is an example of a clearinghouse that acts as a central counterparty, managing settlement risk and allowing participants to offset their obligations. This approach has been used in various forms throughout history, including in Yugoslavia and Slovenia during periods of economic stress.