Until There are Clear and Present Regulated Guidelines Cryptocurrency will Not be a Robust, Legitimate Asset Class
There is and has been talk on The Street about financial institutions adding crypto services to their offerings, raising new funds for digital currencies, and even launching dedicated trading desks.
But until institutional investors have a regulated, full featured trading exchange with diverse sets of spot and derivatives products, their adoption will move slowly and cautiously, and crypto will continue to fall short of being the robust, legitimate asset class that it can be.
Institutional exchanges for cryptocurrency represent a multi-billion-dollar whitespace market.
Various institutions, including Intercontinental Exchange (ICE) parent company of the NYSE are vying to get such venues up and running. But some of the exchanges in development today face significant regulatory barriers,, and may be held back until they solve such complex issues like securities custody and settlement.
The Big Q: What are institutional investors to do since many want to make meaningful moves in the cryptocurrency markets now?
The Big A: Let’s see…
In many ways, cryptocurrency would not exist without the early adoption of retail speculators and entrepreneurs. And this came at a huge cost, because building an asset class “retail first” ignored the largest consumers of mature asset classes: traditional institutional capital. As these investors and speculators provide liquidity for consumers, stabilize prices and drive innovation around valuation.
The large financial institutions demand levered products aka derivatives, highly reliable infrastructure hosted in Wall Street data centers, and compliance features that fit in with their existing trading desks.
This is why institutional investors are challenged to accept and adopt existing retail focused cryptocurrency exchanges, and that is because they were built retail-1st.
Trust is a Key issue for institutions, as many retail exchanges are unregulated and based offshore.
As 1 analysts I read said, “Cryptocurrency needs better “rails” in place to turn it from an asset class into a capital class. But it is ‘here to stay'”.
What’s needed to make crypto a capital class is to allow physically delivered forwards, or the delivery of the actual asset after the expiration of a trading contract. This will be instrumental for getting institutional investors into cryptocurrency, but the existing infrastructure has problems delivering this.
The Chicago Mercantile Exchange (CME) and the Chicago Board Options Exchange (Cboe) have started down this street by offering financially settled forwards for Bitcoin (cash settled in lieu of physical Bitcoin).
But, because of the thin liquidity in the underlying spot markets, these contracts are subject to manipulation at settlement and distrusted by institutional venues.
Daily volumes in August averaged just over 30,000 Bitcoin equivalent on CME and 5,000 on CBOE .
Notably, Bain Capital Ventures joined OKCoin USA to lead a $15-M Series B in Seed CX, a licensed cryptocurrency exchange to offer institutional trading and settlement for both spot and CFTC-regulated derivatives. This company will give institutions access to the levered products they want, with settlement functionality, including physically delivered forwards on its platform.
Soon, 2 parallel worlds will form to support the cryptocurrency asset class, they are:
- A centralized system that mirrors the traditional financial system, but with many friction points removed, creating an on-ramp of fiat (paper) into the cryptocurrency world.
- A decentralized, trust-less replica of the centralized system with protocols built to support each independent function.
One cannot exist without the other and both can flourish together.
There is benefit in cryptocurrency assets and services that fall into the 2nd, i.e., the decentralized, category, because they offer an alternative, non-fiat (paper) way to store value and conduct business without reliance on the competence and ethics of sovereigns and central banks, an idea that will gain more appreciation.
Central banks in the developing world can harm national economies if they cannot overcome systemic shortcomings and stem inflation or devaluation.
This is why some companies are developing stable-coins whose value is less prone to fluctuation, in one case pegging the value of a digital coin to the USD. A decentralized digital currency like this can protect a society from the fallibilities of its own central bank.
Decentralized money markets built with blockchain will also be of great benefit to the developing world, as they will enable people to lend, borrow and earn interest on their crypto assets without the burden of counter-party risk.
There is plenty of opportunity to create new ways for the hundreds of millions of unbanked and under-banked people to join the global economy.
Decentralized cryptocurrencies can help people worldwide.
Do not expect cryptocurrency as an asset class to fully develop until institutional investors come off the sidelines and into the main game.
These investors want is a centralized, trusted venue for trading this new form of Money.
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