Traditional investors, including pension funds, are financing crypto brokers that allow hedge funds to make riskier bets on volatile digital assets. For one, the retirement plan of US defense contractor Lockheed Martin continues to support crypto prime broker Hidden Road despite some high-profile collapses in the industry last year, according to a report from the Financial Times.

What is Hidden Road?

Based in London, Hidden Road is a cryptocurrency brokerage and credit network for institutions. Last year, the company raised a $50 million equity investment from Citadel Securities, Coinbase, and other investors, Hidden Road, positioning itself as a leading player in bridging the gap between traditional investors and the digital asset market.

Hidden Road, which initially concentrated on foreign exchange offerings before venturing into the realm of digital assets, offers a potential lifeline for the crypto market at a time when the industry is facing a credit crunch and declining trading activity due to recent scandals (such as the collapse of crypto exchange FTX).

The company has secured regulatory licenses in the UK, Netherlands, and Singapore, attracting major market makers like Flow Traders and Virtu Financial. Notably, Hidden Road does not trade assets, which addresses concerns about potential conflicts of interest.

Prime brokerage, a popular method of leveraging trades in mature markets like stocks, relies on traditional prime brokers within Wall Street banks to extend credit to hedge funds, family offices, and high-frequency traders. However, these traditional brokers can face significant losses if a hedge fund fails to repay their borrowed funds.

This risky investment strategy is causing concern among experts. Andrew Urquhart, a finance and financial technology professor at Henley Business School, said that if “my pension fund said we’re going to get into crypto, I’d be very worried about that.”

Hidden Road’s Approach to Financing Raises Concern

Hidden Road’s unconventional approach to financing, which relies on outside investors rather than employing a proprietary repayment structure, has raised some concerns. A prime broker operating in this way may mean “they don’t have a proprietary interest in the repayment,” Cyrus Pocha, a partner at Freshfields, said.

Furthermore, executives within the industry have expressed concerns about Hidden Road’s size, as its balance sheet is in the hundreds of millions rather than the billions typically held by banks. In a significant market downturn, Hidden Road’s balance sheet may not withstand the pressure, potentially requiring investors to contribute additional capital.

“I have to look at it from an arm’s length distance to be comfortable. They’re intermediating credit with a pretty thinly capitalised balance sheet,” said the head of one crypto exchange, adding: “To be taken seriously they need to have a significant degree more balance sheet behind them.”

It is worth noting that Hidden Road employs risk management strategies, such as charging an “exchange risk spread,” to protect against the failure of a trading venue. After the exchange’s collapse, the company also fully reimbursed customers who utilized its services and traded on FTX.

However, previous attempts at prime brokerage models in crypto have not always been successful. The collapse of companies like Digital Currency Group’s Tradeblock and Genesis’ lending unit are some more notable examples.

“It’s completely empty, the whole [crypto] prime brokerage, institutional broking space is wide open,” said Gautam Chhugani, senior analyst of global digital assets at Bernstein. He also acknowledged the difficulty of managing the volatility associated with cryptocurrencies.

The cryptocurrency market has had a tumultuous year. Spot crypto trading volumes have dropped by more than half, plunging to $515 billion in July compared to $1.2 trillion during the same period last year, as reported by CCdata.

The market downturn also delivered setbacks and financial losses to many pension funds. The Ontario Teachers’ Pension Plan, with $190 billion in assets, lost its investments in FTX, while CDPQ, managing $300 billion, faced losses in its investment in Celsius.

This article originally appeared on The Tokenist

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