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Illusions: How The Crypto Market Centralized Itself

05 November 2018 13:18, UTC
Anastasia Ermolaeva

The largest banks have previously praised only the blockchain technology and criticized virtual currencies, but now they are entering the market by offering their products and services with the biggest focus on institutional investors. "Banks are nothing but servitors. They should service cryptos as well as fiat and move to whichever people want. They make commissions on what people use. Providing services for customers is all they should care about and provide it in the best possible manner”, - says our expert, the top-manager and partner of the crypto venture fund Nithin EAPEN.

Competing with crypto companies for investors’ capital, brands, that have been proving their high level of expertise year after year, can use their influence in the traditional financial sector as their competitive edge. When making an investment decision, the holders of large capital allow risks in the amount of 2-5%, so it is natural if they first consider proposals from more reliable and experienced financial institutions rather than the products of companies that exist on the market at best for several years. If the investor faces a choice between an offer from Fidelity Investments, a company with a 72-year history, that manages assets with a total value of $7.2 trln, or from a blockchain company founded yesterday, roughly speaking, it is likely that even with higher commissions the investor will prefer the first organization.

In our recent exclusive interview the Financial Markets Analyst and Consultant Ed MENDEVIL predicted the collapse of the digital economy decentralization. The expert believes that 80% of the US crypto market will be under the control of traditional financial giants. Our other expert, the venture specialist Ethan PIERSE agrees that traditional corporations will take the bulk of the financial opportunities on the crypto market. "The history of FinTech has shown that financial institutions are bad at innovation. So startups/scale-ups will out-innovate financial institutions unless those institutions can out-capitalize them. Many of those startups are B2B focused and providing services to financial institutions, so a lot of FinTech innovation in large companies is actually white-labeled or acquired startup innovation”, - the expert believes.

Indeed, most blockchain projects are startups. The development of new technologies and solutions requires significant resources, and young companies have to raise capital from outside in order to have the opportunity to scale their business. In addition to ICO, more traditional fundraising formats are used in the crypto world, which can be much more attractive for institutional investors, because they imply participation in the share capital, and not the purchase of utility tokens, the value of which is often not secured by anything. One of these formats is venture investment. Receiving a share in the capital of a startup, a venture investor, if desired, can influence on the strategy and direction of the business. Consequently, all crypto projects, which have resorted to external financing, are in some way centralised and controlled by traditional business.

On October 18, it became known that the cryptocurrency startup BitGo, that provides services of digital assets storage and processes 15% of all bitcoin transactions in the world, has completed the series B round and managed to raise $58.5 mln. The last capital input was made by the venture investment company of Mike NOVOGRATZ Galaxy Digital Ventures, and Goldman Sachs, one of the largest investment banks in the world and one of the most interested and active in the crypto market representatives of the traditional financial sector. The total investments by both companies amounted to $15 mln.

According to BitGo statements the raised capital will be allocated to the development of the wallet that will store the assets of institutional investors of a total worth of $1 trln. Interestingly, in August, there were rumours that Goldman Sachs itself is developing a custodial service for institutional investors. Representatives of the company did not confirm, but did not refuse this information:“In response to client interest in various digital products we are exploring how best to serve them in this space. At this point, we have not reached a conclusion on the scope of our digital asset offering”. Perhaps the bank is really working on its product, and now they can spy technological solutions from BitGo. We can assume another scenario in which the financial giant will eventually increase its share in the capital of the startup and eventually acquire it.

However, it is important to note that not all banking institutions are ready to become venture capitalists, as this type of investment involves high risks. A venture investor gives capital to innovative teams, that seek to anticipate the future, so there is no guarantee that the project will be successful. Moreover, banks are under great pressure from regulators and if they decide to invest in a project, the risks of such investments should be minimal.

On obtaining a share in startups’ capital by venture investments the opportunities to subdue the crypto business for the banking sector do not end. The most linear way to increase its influence on the market is the acquisition of smaller and weaker players. “I think the real question is will legacy financial institutions such as large banks, Wall Street or technology companies enter the Bitcoin/crypto exchange space. I believe the answer is definitely “yes”. We have already begun to see this with the purchase of Poloniex by a consortium of players like Goldman Sachs and Circle”, - points out our expert, the consultant of institutional hedge funds and bitcoin enthusiast Michael GRAUB.

The increase in prices in the second half of 2017 provoked a growing number of new users on the crypto exchanges, including Poloniex, to which the exchange was not ready. Moreover, the company operating in the US had to keep up with the new regulatory requirements, which concerned the tightening of KYC and AML rules at the end of last year, and therefore had to bear growing expenses to comply and implement the new principles. Unable to cope with all the increased costs at the same time, the top-managers were forced to sell the exchange for $400 mln in February of 2018 to Circle, whose shareholder is Goldman Sachs.

Why did the Circle need a cryptocurrency exchange? Although the company's main product is the Circle Pay mobile payment app, it also operates an over-the-counter cryptocurrency trading platform for large investors, with a minimum order of $250,000. For its new investment application, Circle Invest, the company needed a crypto exchange, whose clients can be smaller investors and traders, and the purchase of Poloniex came just at the right time. The exchange acquisition helped to expand the audience and functionality of the new Circle product, the full launch of which took place in the first half of 2018.

It turns out that crypto investors only benefited from such consolidation, because at the output they received a better product - the application does not charge fees for trading, and digital assets can be bought by connecting a bank account to an app account. Moreover, the exchange acquisition by traditional business saved the project. Otherwise, Poloniex customers could have lost not only their favorite trading platform, but also their assets, because in case of bankruptcy the company may not have fulfilled all its financial obligations.

The rescuer of another crypto exchange was the Belgian investment company NXMH, the subsidiary of the South Korean game company NXC, which on October 29 acquired 80% of Bitstamp's capital. Although the founder of the largest crypto exchange in the EU, Nejc Kodrič, who retained the post of General Director, insists that the company did not experience financial problems, and the sale took place solely due to the desire to expand the business on the world arena, he still sold only part of his share, keeping only 10% in the total capital. Moreover, he reported a 60-70% reduction in trading volumes since the beginning of the year.

If we combine the shortage of revenue streams with the fact that the exchange faced the problem of a hacker attack in 2015, which resulted in the theft of 19,000 BTC ($5 mln at the time), it becomes clear that the founder of the project is dissembling, and the financing of the company was necessary. Not only the exchange gained additional investments, Bitstamp obtained the opportunity to strengthen its position on the Asian market, especially in South Korea - the home country of its parent company, as well as to exchange experience, technology and developments with other crypto exchanges Korbit, which NXC acquired last year.

In the next article, we will explore another way that financial giants can use to increase their influence in the crypto sphere.

But by now it already becomes clear that the centralization of the crypto economy is not an impending threat, but an already existing reality. The idea of a fully decentralized market is unlikely, as any young industry requires capital for further development. And it can obtain this capital from traditionals, which are increasing their presence on the promising emerging market, not only independently developing and launching new products, but also financing crypto companies, which, due to the instability of the industry, may face financial difficulties. All that traders and investors should really care about at the end of the day is the quality, efficiency and reliability of the product offered to them.