The future of blockchain might come wearing a suit and tie, but I’m okay with that.
As mentioned in my last article, I came here for the technology, I stayed for the community and ideology. Thus, it’s been difficult to pinpoint how I really feel about the current direction of the blockchain space. The retail market has been beaten to hell. I don’t have proof of it, but judging by the two occasions DOGE has increased by 100% in the past 30 days I’d guess that market manipulation hasn’t gone anywhere. The past months have been arduous for most cryptocurrency investors, Bitcoin and Ethereum have both plummetted in price. Despite a wave of recent good news, the market remains in a downtrend- almost as if it’s waiting for something.
Over the past few months, I’ve learned a lot about blockchain, financial markets, and the nature of money. If you read some of my earlier writing, I was a little more aggressive with my ideology. As I’ve begun to work more deeply in the space, and meet people from walks of life I never thought I’d be crossing paths with, I’ve learned that it’s not quite as black and white as I thought.
An Institutional Entry Point
Imagine that you’ve been standing on the sidelines watching the cryptocurrency market for the past couple of years. While those who invested around December of last year might be reeling from their capital losses, the market can look quite appealing at these levels if you haven’t found an entry point yet.
I’m of the belief that institutional investors will spur the next bull run in the cryptocurrency market. Whether it be through directly investing in the market, or through pushing forward new developments like Bakkt, Bitcoin ETFs, and Coinbase Prime.
The longer this bear market carries on, the more the stage is set for institutional investors to enter. We just need to knock down a few barriers for them first.
Barriers to Entry
It’s been difficult for institutional investors to enter the market even if they’re interested in doing so. Bitcoin and cryptocurrency as a whole are looked at within a spectrum of diverse opinions, coming from hedge funds, banks, family offices, and the like. Either they’re all aboard the band-wagon, or they think that same wagon is heading towards impending doom.
One of the reasons institutional investors have been slow to enter the market is a lack of infrastructure. There are services they require that the average investor doesn’t, and some of these services don’t exist just yet. If they do exist, they aren’t in a regulated environment, which makes it difficult to invest when you’re handling a large amount of capital, often belonging to several different people who have entrusted you with their funds.
Blockchain and cryptocurrency are in their technological infancy, they’ve barely been around for a decade. As it matures, it’s starting to draw more and more interest from institutional investors — as a result — the infrastructure and products they need to safely invest in the space have started to arise.
These elements that help lower barriers to entry for large investors bring an exciting outlook to the future of blockchain.
As infrastructure is built, more and more investors will feel safe investing.
As new investment vehicles are created, new pools of capital will be able to flow into the crypto market.
Institutional investors are gearing up to bring on the next bull-run, and by the looks of the products they’ll have at their disposal, it could be a big one.
I initially wrote this as an intro to an article on BAKKT, but it got quite lengthy so I’ve split it into two — the next article will go into how these services and products set the stage for BAKKT, and what it actually is.
Understanding Institutional Investment Vehicles In Cryptocurrency
Let’s focus on 4 key areas. For the sake of simplicity, think of Custodian services as infrastructure, and derivatives, investment funds, and ETFs as products.
- Custodian Services:
- Investment Funds;
- ETFs; and
The lack of trusted custodian solutions in cryptocurrency has been a significant roadblock for institutional investors hoping to enter the space. Think about how nerve-wracking it can be to handle the security of your own assets — multiply those assets value by 100–10,000 and imagine how much more concerned you’d be.
Custodian services are services that hold and secure your assets. In the case of crypto, this can get quite complicated. There are high levels of risks as custodians are honey-pots for hackers, and extreme measures need to be taken when protecting a large number of assets. The lack of regulation around the space also makes it difficult for would-be service providers to create solutions.
The traditional finance world and its inhabitants have little experience in cryptocurrency custody. To be fair, the concept of custodial services for cryptocurrency has only been around for a few years — even the experts in this field are still learning as they go.
There has been some movement from large financial institutions towards providing these services, but a decisive leader has yet to appear. Bank of America filed a patent for cryptocurrency custody solutions and Northern Trust Corporation (a company with over $1 trillion USD in assets under management) has announced they’re working on a solution, but it won’t be available for another 12 months at least.
Although a pressing issue, there are solutions being developed. Coinbase, a well-known crypto exchange, has been working on a custodian service that will place 98% of funds in cold storage and offer criminal insurance to cover the 2% that is stored online.
Coinbase was founded in 2012 and has never been hacked, making it an obvious contender for preferred service providers when institutional investments begin entering the market. To bring this service to life, Coinbase partnered with ETC (Electronic Transaction Clearing), a registered broker-dealer and member of FINRA. The partnership between Coinbase and ETC bridges the gap between traditional finance and cryptocurrency worlds by ensuring that the custodian service will fall under standard SEC regulations. The issue with custody in crypto isn’t so much a lack of solutions, but a lack of trusted and regulated solutions — making this partnership big news for the industry.
They’re also facilitating institutional trading through their new platform called Coinbase Prime.
If the largest companies in the space are dedicating their time to creating investment vehicles and infrastructure for institutional investors, then that’s probably what’s best for the market.
Created by the team behind Ledger Nano S hardware wallets, Ledger Vault promises “End to End Security” independent of third-parties, meaning that investors keep control of their own private keys.
Ledger has established a strong reputation in Crypto Security through selling millions of Ledger Nano hardware wallets. Ledger Vault opened up early access last May, they’re currently going through testing with a small batch of customers to iron out any remaining kinks before their full product launch.
Possibly one of the most interesting custodian solutions available, Xapo Vault is an actual vault — as opposed to Ledger Vault, which is just, well, a name.
When it first started, many of us heard about the first Xapo Vault location, carved into a Swiss mountainside. Since then, they’ve upgraded their security to include several vaults spread out across the globe. This helps prevent capital losses due to natural disasters in specific locations. The vaults boast “human and automated guards”, which sounds terrifying.
Owned by the Winklevoss brothers, Gemini is a crypto exchange that has applied for a Bitcoin ETF (so far it has been rejected). Although temporarily rejected by the SEC, they are still working on bringing an institutional grade investment vehicle to market.
What are Derivatives?
Derivatives, specifically futures and options contracts are speculative and leveraged trading vehicles, usually reserved for institutional investors. Owning a derivative differs from owning a cryptocurrency because derivatives don’t represent any actual ownership of an asset, they represent speculative value derived from the performance of the underlying asset.
For example, if I buy a $10,000 Bitcoin futures contract, I’m not buying $10,000 worth of Bitcoin, I’m buying a contract that’s worth $10,000, that will increase or decrease in value depending on what direction I bet the market is moving.
The global derivatives market is estimated to be worth around $540–1200 trillion of represented underlying assets. The capital used in derivative markets is mostly derived from institutional investors, who currently don’t have a method to invest in Bitcoin or other cryptocurrencies. Crypto derivatives give capital the ability to flow out of the derivatives market and into the crypto market.
Available Crypto Derivatives
A potential use case for these futures is the ability for miners to hedge against the market. If they fear the market will begin to go down, they can purchase futures to protect themselves if the price of Bitcoin goes down, and their mining operations become far less profitable than usual (as we’re seeing with Bitmain at this point in time).
Some of the first methods for institutional investors to take part in Bitcoin trading were via investment funds. Investment funds like GBTC sell shares in their fund and tie their shares to a certain amount of Bitcoin in value. Unfortunately, due to there being a fixed supply of shares available, the price of these shares don’t always match up with the price of Bitcoin.
EXCHANGE-TRADED FUNDS (ETFs)
What are ETFs?
An Exchange Traded Fund (ETF) invests in a group of underlying assets or derivatives so that people who buy ETFs don’t have to actually own an asset to benefit from its’ price movement.
ETFs come in different shapes and sizes, they can use leverage and operate inversely to the asset their tied to, or operate as a normal stock.
Bitcoin ETFs have been getting a lot of attention in the media lately as a couple different players in the crypto space have started to bring them forward for approval by the U.S. Securities & Exchange Commission (SEC). So far, all of the ETFs brought forward have been rejected, which is disappointing given the potential increase in market size an ETF can bring. Just yesterday the SEC delayed the decision on whether or not to approve certain Bitcoin ETFs. The decision has been pushed back to late December as the SEC hopes to uncover more information.
“Some believe that a cash-redeemed bitcoin investment instrument like an ETF is the lever that will finally open the bitcoin market to large scale entry, particularly by institutional investors who have not yet made the jump.” — Crypto Coin News
BAKKT — Digital Asset Exchange
The owner of the New York Stock Exchange (NYSE) recently announced that he’s working on a federally regulated marketplace for digital assets such as cryptocurrencies. The exchange, called Bakkt, will aim to be a globally regulated ecosystem for digital assets. To add to the excitement, they’re launching Bakkt in partnership with companies such as Microsoft, Starbucks, and the Boston Consulting Group.
Microsoft is contributing to the project through Azure, their cloud computing solution. On the retail side, Starbucks is going to be the flagship retailer, allowing customers to convert cryptocurrency and other digital assets to U.S. dollars in Starbucks stores. Curious about what other digital assets Bakkt might decide to include? Think about reward points, which are in a way cryptocurrencies themselves, they just exist in a closed loop I.e. once you convert to Starbucks points, you can’t convert back to your base currency. Through Bakkt, and its partnerships with companies like Starbucks, we will have a digital asset exchange that allows us to trade rewards points, air miles, gift cards, cryptocurrencies, and tokenized assets (amongst many more).
This is both important and incredibly exciting for the cryptocurrency market. As we’ve learned, much of what holds institutional investors back from entering the space is a lack of infrastructure. They aren’t willing to compromise the security or efficiency they have in traditional markets in order to trade a shiny new Bitcoin. Most exchanges also lack the liquidity required for a pool of institutional investors to partake, there simply isn’t enough trading volume for their orders to be filled. While the precise solution hasn’t been discussed, Bakkt claims that it will increase liquidity as part of its efforts to spur adoption of cryptocurrency amongst institutions and retail investors. Bakkt will also reduce volatility within its platform by allowing cryptocurrency investors to hedge against it
The formation of Bakkt is the most exciting piece of cryptocurrency news I’ve heard in a long, long time. Not only will this serve as an institutional trading platform to usher in family offices, hedge funds, and other institutional investors — it will also increase adoption of blockchain amongst retail investors, with a user a friendly platform and trust established through the credible names involved.
The Future of Blockchain
While the development of custodian services, Bitcoin ETFs, and crypto investment funds are exciting to learn about. Bakkt is a game changer. The other investment vehicles and infrastructural developments are aimed mostly at institutional investors, while Bakkt will both facilitate capital influx from these institutions, as well as create a credible platform for a new wave of retail investors to join in on the crypto-fun.
I for one, can’t wait for the day I’m sitting at my laptop trying to trade Bitcoin against Virgin Airline miles (I notoriously never by flights until the last minute, my only recourse will be to beat the market). Or the thought that some day soon I might be able to hide my funds from market volatility with gift cards instead of Tether (gross).