Michael J. Casey is the chairman of CoinDesk’s advisory board and a senior advisor for blockchain research at MIT’s Digital Currency Initiative.
The following article originally appeared in CoinDesk Weekly, a custom-curated newsletter delivered every Sunday exclusively to our subscribers.
The term “institutional crypto” sounds like an oxymoron. There’s something quite ironic about financial institutions adopting a renegade technology that was designed to do away with them.
Yet a string of developments this past month suggests that – to put it bluntly – the institutions are coming for your crypto.
Whether this is something to be alarmed, excited or bemused by, depends on what you want out of cryptocurrencies and blockchain technology. Do you want fully independent control over your assets, a more efficient and inclusive global economy, or just to get insanely rich?
What is clear is that, for a time at least, there will be an awkward and increasingly intensified clash of cultures between the pinstripes of Wall Street and the hodlers of crypto land.
And while an influx of institutional money may at some point drive up crypto prices, that clash portends more uncertainty and volatility for at least a while longer.
An important development came with the news two weeks ago that Fidelity will offer a digital asset trading service. The sixth-biggest fund manager in the world announced a project catering specifically to the trading demands of large institutional investors in which, most importantly, they will provide services such as “institutional-grade custody.”
For believers in the “be your own bank” philosophy of bitcoin, the very idea of third-party custody is contradictory to the “trustless” ideals of cryptocurrency’s origins.
But this was inevitable. If corporations – banks, hedge funds and brokerages, first, then non-financial enterprises, second – are to participate in the crypto economy, the legal, compliance, insurance and risk management demands they live under almost require that they pass off the risk of holding such assets to outside custodians.
And let’s face it, an increasing amount of the world’s crypto holdings is in the custody of third-party operators, whether it’s with custodial wallet providers such as Coinbase or at centralized crypto exchanges that comingle customer assets with those of others.
A key difference is that these kinds of services are now being developed for hedge funds and other professional investment firms by more heavily regulated firms such as Fidelity. Custodial banks such as State Street and Northern Trust are also working on delivering similar services.
At the same time, a number of providers that started as crypto companies have earned regulatory status as qualified custodians, allowing them to also go after compliance-sensitive institutional investors as clients. These include BitGo, which received a charter from the South Dakota Division of Banking in September and Coinbase, which only last week received a similar qualification from the New York Department of Financial Services.
Meanwhile, the Intercontinental Exchange, or ICE, which owns the New York Stock Exchange, is preparing to launch Bakkt, a new bitcoin futures trading service – likely in December, the company said last week. The key difference with the futures contracts that were launched late last year by both the Chicago Mercantile Exchange and the Chicago Board of Options Exchange, is that Bakkt’s will be for physical delivery rather than merely a cash-based settlement. That will, in turn, require custodial and other services.
Goodbye ICO, hello STO
This race to serve institutions comes as the mania for initial coin offerings, or ICOs, has waned on account of the dramatic downturn in the prices of tokens attached to decentralized applications. That was in turn mostly due to a regulatory pushback from the Securities and Exchange Commission, after commissioners argued that most, if not all, ICOs were in breach of securities registration rules.
Now, a new buzzword is emerging in the ICO’s place: the “STO.”
This is the idea of a security token offering. In many respects, it is far less revolutionary than an ICO. Most ICOs purport to be selling “utility tokens” whose governance structure includes a unique cryptoeconomic model for rewarding and incentivizing certain behavior within decentralized networks. STOs, by contrast, are a crypto-based version of more traditional assets such as bonds or equity.
Still, R3, the distributed ledger technology consortium founded by large banks, is already calling security tokens the “third blockchain revolution.”
It’s perhaps a little ironic that a group founded by Wall Street firms, which scoffed at the absurd hype in the ICO market last year, is now using language that could also be deemed hyperbolic. Still, it’s true that STOs could have a big impact, especially in terms of smart contracts helping to more efficiently manage cap tables and, potentially, bypass underwriters in a more direct issuer-to-investor model.
To be clear, though, the impact will mostly be felt by traditional investment firms and other accredited investors who participate in primary securities markets. It might make it cheaper to raise capital and open up new models for doing so with institutional investors.
But it’s not really about democratizing finance, as the ICO phenomenon, with its direct reach into retail markets, was purported to be.
Institutional framework, non-institutional model
There’s a pattern to all this: new custodial and trading services being offered by large, regulated entities, all in preparation for an expected influx of new securities that use smart contracts and blockchain technology to manage transfers of more traditional assets. All are aimed squarely at the expected arrival of institutional investors into the crypto world.
Holders of bitcoin, ether and other crypto assets that might now receive a flood of incoming orders from these deep-pocketed investors sometimes salivate at this idea – essentially because they expect prices to rise.
That might be the case, but this is not going to be a smooth ride.
One reason is that, for all the efforts to jam the square peg of cryptocurrencies into the round hole of regulated, intermediary-managed capital markets, there is a fundamental contradiction that won’t be easy to reconcile.
Wall Street types like to talk about crypto as a new asset class, one to add next to stocks, bonds and commodities in their clients’ portfolios. But for the time being at least, while early-adopting retail players of varying size still dominate the crypto community, this “asset class,” if it can be called that, is going to behave in a very different way from others.
That’s because, for now at least, when you buy bitcoin, ether or other pure cryptocurrencies, you’re not just buying a piece of real estate or a claim on a company’s equity, you’re buying into an idea.
And that idea, one that’s supported by a very motivated, enthusiastic—if not always rational – community, supports a paradigm that would see these very same intermediating institutions removed from the economy.
I feel Wall Street analysts are going to have a hard time grappling with that contradiction. There will be a lot of surprises. And surprises create volatility.
Making a deal image via Shutterstock.
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