The Crypto Market Will Pay With Decentralization For Liquidity
As we wrote earlier, Fidelity Investments has announced the launch of the new subsidiary that will provide custody and trade execution services for digital assets to institutional investors. It may be an indicator of the new trend as more and more big financial institutions are moving into the industry offering new products and services to their customers. It seems that the fiat space has stopped to satisfy their business needs to the fullest extent, but why? Why does the traditional financial business want to get into crypto and what will the crypto community get in turn from their entrance? Will they be able to attract stubborn institutional investors who are still hesitant to put their money in digital assets?
We decided to ask the Financial Markets Analyst and Consultant Ed MENDEVIL to find out the answers to these questions and figure out what the market changes we should expect in the future.
BNT: Why have financial organizations decided to start offering services on the crypto market at the first place?
ED: First of all, their clients are asking for it. In fact, back in 2017, at the height of the crypto bubble, clients of large banks were asking to pour money into crypto. According to various reports, investments in digital assets accounted for 2% of clients portfolios, and companies saw these movements of large chunks of money to the crypto market and ICOs. The inflow of $7 bn in 2017 alone was enough for institutions to begin investing in crypto, which was done mostly through OTC markets, buying and borrowing BTC and ETH from third party trading desks like Genesis Global Trading, which reported about providing hedge funds and other firms with crypto loans on the total sum of $553 mln since March. Financial institutions like making money both by capturing it and on returns. And crypto has returns from 1X into the 1000X. Just wait till the next bull run!
Editorial Note: The first financial instrument with a cryptocurrency as an underlying asset was bitcoin-futures introduced by Chicago exchanges CME and CBOE in December of 2017. It was a kind of invitation to the market for institutional investors since it allowed to hedge risks of price changes. That event caused the winter boom when prices jumped up by 80%, although it appeared to be a successful speculation for some investors on positive news rather than the entrance by institutions. The majority of capital inflow was made by retail traders, but why? The terms of the bitcoin-futures turned out to be not very appealing as both exchanges set margin rates of 35-40% and contracts were cash-settled, which implied a slow process of transferring funds through intermediaries. Moreover, derivatives still bore high risks considering poorly regulated legislative environment.
Therefore institutions have not got deep into the crypto via bitcoin-futures since winter of 2017/2018 and the statistics just proves this statement. The highest daily volume of 12,878 contracts on the CME platform for a total of 64,390 BTC (1 contract - 5 coins) or $530 mln, and on the CBOE - 7,138 contracts (1 contract - 1 BTC) worth $58.3 mln occurred on July 24 while the total market capitalization was $141.6 bln, which means that the biggest contribution the futures have managed to make to the market value was only 0.4%
While the expectations of the crypto community were high, futures failed to affect significantly on the industry increase and as a result the bearish trend began
BNT: How did the market decide to recover from the collapse so as not to lose the institutional interest?
ED: After the bubble, the crash and ICO craze there was a clear need for scrutiny and regulatory framework. Low and behold, came the SEC and the idea of security tokens. 2018 saw STOs becoming a reality. It is said, that 2019 will be the era of STOs, as the SEC has repeatedly indicated that many utility tokens can be considered securities and most ICOs are in fact, securities. The CFTC has also said that utility tokens, are effectively commodities. Thereby setting the scene for STOs to enter the market and replace ICOs. That being the case, it’s the natural move for large institutional banks to want to participate and control the soon to be regulated crypto market.
Editorial Note: ICO craze resulted in projects having attracted investments in the amount of $6.5 bn during 2017 and $13.7 bn in the first half of 2018. However, approximately 80% of ICOs turned out to be scams and their utility tokens did not bear any value. Regulators are also having negative sensations about projects’ tokens, for example, the SEC openly says that they haven’t seen a true “utility”.
As more investors are becoming savvy, stopping to invest in just great ideas with no working business-models and real products behind them, the market started to develop another method of attracting capital and the concept of security tokens arouse. While ICOs remind more of crowdfunding, STOs is very similar to traditional fundraising as ownership of tokens provides a vested interest in a company’s stock, liabilities and profits and determines investors’ rights. This new financial product should be of higher interest to sophisticated investors since not only the concept of traditional securities is reproduced and it is more about investing in valued assets rather than obtaining “utilities” of ICOs, but also STOs satisfy regulatory restrictions, which adds to their security and therefore their value.
Security remains the decisive issue when it comes to investing in digital assets according to Greenwich Associates Survey. While 70% of surveyed executives of more than 140 organizations, including hedge funds, investment banks, asset management and brokerage firms, believe in the further development of cryptocurrencies, growing amount of money stolen during hacking attacks - $927 mln in the first three quarters of 2018, and lack of qualified depositories are still deterring holders of large capital to put significant sum of money into crypto assets.
Besides Coinbase Custody, Lloyd’s insurance of Kingdom Trust cold wallets, Fidelity Investments became one of the first influential financial organizations that started to offer highly secured custodial services, which imply keeping digital assets in physical repositories, that are not connected to the Internet. Moreover, cold storage is planned to be geographically distributed, which minimizes the risk of hacking. Experts believe that the industry will start to receive significant capital infusion in the first two quarters of 2019 as the tests of the new platform will be finished and it will begin to fully operate by this time
BNT: Do you agree that security of digital assets is one of the main concerns?
ED: Everyone understands that for liquidity to be present, financial investors require insurance and custodial services. It’s a double edge sword really. For one, custodial services are hard to come by – unless you have big pockets and rub elbows with lobbyists. Which of course, large banks do. This makes it easy to acquire insurance for their own exchanges and platforms and makes it easier to become the custodial services for all the other smaller retail crypto exchanges and platforms. That said, yet another front for them to control. Nevertheless, if you want to see Bitcoin break the 12k mark with enough liquidity to sustain that level, then you need custodial services, because regulatory agencies need insurance for their retail and accredited investors. As an example Goldman Sachs once looked down on crypto and now has a custodial service specifically for Ethereum tokens. With great insurance, comes great interest and a free pass into crypto.
Editorial Note: Financial giants try to recreate the infrastructure of the traditional economic sector that is familiar to institutional investors. Not only they develop custodial and insurance solutions, but also work on more secure financial instruments, which eliminate the need for investors to personally hold virtual coins. Derivatives such as digital assets receipts by Citigroup, which are similar to ADRs, and crypto swaps by Morgan Stanley are just ones of the list.
If investors may find these derivatives quite an attractive option, the crypto community may significantly suffer from popularization of these financial instruments. Almost every derivative, except options, which give the right, contains an obligation to buy or sell a product. Hypothetically each financial liability should be secured by real assets. However, the history and a mortgage crisis in 2008 in particular show that often security does not cover a half of the debt. In 2008 the notional amount of derivatives was up to $600 trln, while the value of real assets was estimated at the mark of $600 bn, which means a coverage of only 0.001% of derivative debts.
Institutional investors are the main holders and investors in derivatives in the traditional financial industry, and if they decide to join the crypto movement, part of their investment in digital assets may be made at the expense of their borrowed capital. With no need to directly hold coins when investing in digital derivatives there may be a situation when part of financial liabilities on the digital market will be secured not so much by virtual coins as by other debt obligations. Therefore, a tight correlation between the hitherto independent crypto market and the traditional financial industry may be built
BNT: What is the correlation between the traditional economy and the crypto sector? Is there any motivation for financial companies conquering new markets that is rising from the current state of the global economy?
ED: There is an economic uncertainty. The economic climate is increasingly volatile. Many analysts believe we are reaching a point in the market, that will start to pivot. In actuality, the markets have been crashing around the world, and the US is the last holdout, which will eventually catch up to other breaking economies like China, and others in Asia and Europe. We've seen the systemic break down in other minor economies like Argentina, Turkey, Venezuela, Greece. I think the difference now is it won't be just one market, but it will be a domino effect of internally cracking markets like we see in the cyclical markets of the emerging economies. There is a lot of bliss right now, that's for sure, but with China’s housing crisis, the Yen weakening, the Pound and the potential Brexit backlash, which in turns affects the Euro, it can potentially take the world into a giant recession.
Why does this matter? Well, financial traditional companies know this, and expect the majority of retail traders, and small but still important institutional companies to move into safe havens. And somehow, they’ve realized, crypto will be a safe haven for many investors. And they are setting up both, a financial institutional way to participate and seek refuge, and a retail method that is compliant and robust enough to capture the masses of retail traders moving from emerging markets, equities, for example, into crypto markets. It will be a huge transfer of wealth and these companies are going to make sure that they are there to catch a large chunk of that wealth. JP Morgan, once called crypto a fraud, and now is seeking to acquire a large share of the retail crypto investment with their new platform.
Editorial Note: Herewith it is difficult to call cryptocurrencies safe havens for investors. Since the winter craze investors, who stuck to the hodl strategy, have already lost near 70-80% of their money. Although Bitcoin has recently reached its multi-month bottom level of volatility and during the last week performed almost as stable coin, slightly fluctuating on the level of $6,500, in case of big money coming drastic price alterations may take place. The SEC’s decision on bitcoin-ETFs is highly expected in the beginning of 2019. However, if the hype turns out to be bigger than a real readiness of investors to put money in this derivative as it happened with bitcoin-futures, the market may face a high volume of speculations, failure to strengthen new positions and a dramatic drop once again.
BNT: So, financial institutions are coming because of the FOMO and not willing to miss out new opportunities to increase their influence and capital?
ED: Yes, this is my assessment. I think this is how big banks work. They must always be on top of the financial pyramid in order to have control over the monetary policy and cash flow. So, it’s only fitting that Fidelity roll out their version of crypto products, exchanges, and services. It’s the only way to win the wealth of crypto investors. Yes, Fidelity isn’t doing this because they believe blockchain to be the best technology in the world, or because they want the people to benefit from a crypto economy. It’s strictly to capitalize on the investor money – on THEIR platform using their terms under micro regulation. They did it with the dot.com boom and the internet, they will do it again.
Editorial Note: Before launching a new subsidiary Fidelity carried out their own survey, the results of which are also proving the institutional interest. 70% out of the 905 surveyed companies, which manage assets of $29 trln worth, showed their interest in cryptocurrencies. Even though it is too early to talk about real investment decisions and real capital coming to the market, if we just assume that surveyed companies with a positive approach to crypto assets manage $20.3 trln and may allocate at least 1% of their investment portfolios for digital financial instruments, the capital inflow to the industry can reach up to $203 bn. This infusion by only surveyed companies may double the market as the current capitalization amounts to $203 bn as well.
As for Fidelity, there are assets of $7.2 worth under their management right now. Besides acquiring new clients, with new services the company might start managing another $50.4 mn in digital assets purchased by their already existing clients
BNT: Traditionals have found a new source of income. But will the crypto market indeed benefit from the entrance of financial giants?
ED: Some may say, we will all make money regardless. That may be the case to a certain extent, and within a certain timeframe. But ultimately, if there is control of the supply, there is control of the crypto economy in the US. And this will ONLY serve to redistribute wealth. From the bottom of the crypto economy, back to the top of the pyramid, ensuring the wealth gap continues. And it’s no surprise that all these traditional banks, financial institutions, and hedge funds are commingling to enter the market at the same time. With names like Fidelity, Goldman Sachs, Bakkt, ICE, American Retail Group, Interactive Brokers, State Capital, FlexFx, JP Morgan rocking out institutional grade exchanges, custodial services, and for the first time ever retail products.
BNT: Is there any specific methods financial organizations use to attract investors’ capital in their crypto products and what are they?
ED: Well, have you noticed all the ‘new’ ways to invest in equities – whereas you no longer need to be an accredited investor, or have a min requirement of $25k to enter a trading platform? There are gimmicks like first 100 free trades, and no minimum needed, mobile and automated investing apps. It’s their way of attracting the retail investor money – which in this new millennium has reached an all-time understanding of the importance of investing. People are awake! And yet, they are catching this new type of a retail investor, savvy and informed. And now, they intend to do the same with crypto retail investors.
BNT: And does the crypto business try to compete with these traditional companies and what do they do to acquire institutional investors?
ED: The crypto business community is attempting to also break into the institutional investor market with setups for derivatives exchanges, custodial services, EMS, and OMS systems, as well as the influx of crypto companies such as Sharespost, Totle, NordFx, Blockchain Terminal, Conibase Pro, Gemini, Simex, Poloniex (Goldman Sachs), tZero, etc. and their own custodial services.
BNT: Please, share your forecast for the future of the crypto market.
ED: I think, traditional banks will essentially control crypto in the US. Investors will eventually have to become accredited to participate on their platforms. And finally, the blockchain world will be left in a chokehold where 80% of blockchains will have commercial ownership, thereby killing the ‘decentralized’ synopsis of the blockchain technology. I know, how dramatic I am being. The same thing was said when I attempted to be the voice of reason in 2017 to avoid a lot of ICOs, that regulation would shut down Bitconnect, and to create an investment strategy. One year later, some of the investors lost about 60-80% of their money and now are seeking help from financial consultants. On the upside, Fidelity and the other traditional banks and institutions will provide the market with a lot of liquidity. The questions is, which side of the trade will YOU be on. In 2017 and early 2018 CME and CBOE, JPMorgan and Interactive Brokers shorted everyone else. I’m guessing, Fidelity knows the strategy they will be using to maximize profits too. Will you?
BNT: We at Bitnewstoday.com will, for sure, continue following the further developments of the market, preparing its analysis for our readers and introducing expert opinions and views on the industry as you have shared with us today. Thank you!ED: It was my pleasure. Thank you!
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