Financial institutions adopting a renegade technology intended to do away with them is quite ironic. However, various developments over the past month indicate that the institutions are coming for your cryptocurrency.
Whether it is something to be bemused, excited, or alarmed of depends on what an individual wants out of the blockchain technology and digital currencies. What is apparent is that there will be an awkward and intensified clash of cultures between crypto land hodlers and Wall Street pinstripes.
While an influx of institutional funds may drive up cryptocurrency prices, the clash foretells more volatility and uncertainty for at least a little longer.
A significant development came with a report two weeks ago that Fidelity will launch a trading service for digital assets. The world’s sixth largest fund manager announced a project designed for giant institutional investors’ trading demands in which they will offer services like “institutional-grade custody.”
For the believers of Bitcoin’s “be your own bank” philosophy, the concept of third-party custody is contradictory to crypto’s “trustless“ ideals.
It was inevitable though. If corporations—hedge funds, brokerages, and banks, first, then non-financial firms, second—are to enter the cryptocurrency economy, the compliance, risk management, legal, and insurance demands they live under almost necessitate them to pass off the risk of owning those assets to outside custodians.
Also, an increasing amount of crypto holdings worldwide is in the custody of third-party operators, regardless if it is at centralized crypto exchanges that comingle client assets with those of others or with custodial wallet providers like Coinbase.
The notable difference is that such types of services are already being developed for hedge funds and other professional investment companies by heavily regulated enterprises like Fidelity. Custodial banks such as Northern Trust and State Street are also working on administering similar services.
Moreover, several providers that started as crypto firms have earned regulatory status as qualified custodians, enabling them to pursue compliance-sensitive institutional investors as clients. These include Coinbase which recently received a similar qualification from the NYDFS and BitGo which received a charter from the South Dakota Division of Banking last month.
Meanwhile, the Intercontinental Exchange (ICE) is preparing to launch the new Bitcoin futures trading service Bakkt in December. The main difference with the futures contracts launched by both the Chicago Board of Options Exchange and the Chicago Mercantile Exchange is that Bakkt’s will be for physical delivery instead of only a cash-based settlement. In turn, it will require custodial and other services.
The race to service institutions comes as the mania for ICOs has waned due to the drastic downturn in token prices attached to decentralized apps. That was mainly because of a regulatory pushback from the SEC after commissioners argued that majority of, if not all, ICOs were in breach of securities registration policies.
The new buzzword “STO” is now emerging in the ICO’s place. It is the concept of a security token offering. In many respects, STO is way less revolutionary than ICO. Many ICOs purport to be selling “utility tokens” with governance structures that include a unique crypto economic model for incentivizing and rewarding specific behavior throughout decentralized networks. On the contrary, STOs are the crypto-based version of traditional assets like equity and bonds.
The distributed ledger technology consortium established by giant banks, R3, is already referring to security tokens as the “third blockchain revolution.”
It is somewhat ironic that a group founded by Wall Street companies, which scoffed at the ICO market’s absurd hype in 2017, is now using a language which could be regarded as hyperbolic. STOs could have a huge impact especially regarding smart contracts helping to manage cap tables more efficiently and possibly bypass underwriters in the direct issuer-to-investor model.
However, traditional investment companies and other accredited investors participating in primary securities markets will mostly feel the impact. It might make raising capital cheaper and introduce new models for doing so with institutional investors.
Huge, regulated entities offer new trading and custodial services in preparation for the anticipated influx of new securities that utilize the blockchain and smart contracts to manage transfers of various traditional assets. All are aimed at the expected arrival of institutional investors into the world of cryptocurrency.
Holders of Ether, Bitcoin, and other digital assets that might already receive massive incoming orders from these deep-pocketed investors sometimes salivate at the thought—mainly because they expect a rise in prices.
Despite all the efforts to fit the square peg of digital currencies into the round hole of intermediary-managed capital markets, there is an inherent contradiction that would be difficult to reconcile.
Wall Street types love talking about cryptocurrency as a new asset class to add next to commodities, bonds, and stocks in their clients’ portfolios. But, while various early-adopting retail players are still dominating the crypto community, such “asset class” is going to behave differently from others.
That is because when an individual purchase Ether, Bitcoin, or other pure cryptos, they are not only acquiring a claim on a company’s equity or a real estate, they are buying into an idea.
That idea is backed by an enthusiastic community and supports a paradigm that would witness the similar intermediating institutions eliminated from the economy.
It would be challenging for Wall Street analysts to grapple with that contradiction. There will be lots of surprises which could create volatility.