Bitcoin is currently sobering up from the bull-run to $20,000. At the time of writing this article, the price of a single Bitcoin is trading at $6369, though we have witnessed it trading under $6000 twice in the past week, with some market analysts’ predicting it to fall further towards the $4400-$4800 range.
For investors that bought the hype and jumped into the market between December 2017 and January 2018, it must be a difficult reality to accept. It is also perhaps ironic that the crypto community is now looking towards the institutions that cryptocurrencies were built to circumvent – institutional investors, large corporations and the banks – to aid the market. The question is whether they will come and, if so, what exactly are they waiting for?
To answer this we must consider the cryptocurrency market today. There can be no doubt that the price of Bitcoin and the majority of altcoins represents nothing more than the perceived future value. Many projects represent nothing more than a white paper concept outlining how blockchain can change the way services are delivered across multiple industries.
There are relatively few projects listed on the coinmarketcap chart that have an actual working product or enough meaningful partnerships to drive change. Ethereum, VeChain, EOS, ICON, WAN and WaltonChain, present a limited selection of projects that provide institutional investors with meaningful opportunities to purchase cryptocurrencies that have a long-term value. However, as has been the case with Bitcoin, their value has plummeted from their previous highs (EOS being the exception), demonstrating a clear lack of liquidity right across the crypto market, irrespective of the news that each of these great individual projects might release.
There are two fundamental reasons why. It is not because of the lack of credentials, but due to the level of uncertainty around global regulations and the maturity of the infrastructure that services the market.
The global regulatory conundrum
Apart from agreeing on the need for strict KYC/KYB and AML regulations, there is a lack of wider and joined up regulatory thinking from major economies. This is one of the primary reasons why ‘the wall’ of institutional money has so far failed to enter the market.
Within the UK, cryptocurrencies are unregulated and while the UK treasury committee has set up a task force to gain a better understanding of the underlying technology, they have stated a relatively pro-crypto stance. They concede that ‘there is little current evidence of cryptocurrencies being used to launder money’, often a concern flagged by governments looking to crack down on the growth of digital assets. Indeed, within the UK, the Financial Conduct Authority has demonstrated little ambition to get any closer to the cryptocurrency market for fear of stifling innovation, which is a similar stance to the European Union.
Within the United States, while there is now certainty that neither Bitcoin nor Ethereum will be classed as securities, the market is still left with the uncertainty as to what other cryptocurrencies will be labelled as non-securities.
In a recent interview, the SEC chairman, Jim Clayton, stated that almost all Initial Coin Offerings (ICOs) were, in his eyes at least, securities. The idea that almost all cryptocurrencies might be perceived to have been sold on exchanges illegally is a black-swan event that investors have to consider and one that does spark fear. Many have speculated that the rhetoric of the SEC is designed to give the market time to self-regulate and to discourage those that have considered launching ‘scam’ ICOs, an area that they have been extremely active in, in recent months, closing dozens of ICO launches.
In Asia, the markets are more uncertain. The largest economy, China, has banned the trading of cryptocurrencies entirely in addition to the launching of any ICOs, fearing negative effects of money leaving its economy and concerns over money laundering and other illicit activities. That being said, the country has been the most active of investors in blockchain-related projects at a government level, mentioning the technology in its five-year plan.
Various reports provide strong evidence to suggest that their ban on crypto trading will be temporary one, an attempt to buy themselves time to whilst they consider how best to control the public interest in these projects. It is suggested that any ban they lift is limited on projects that have strong ties to the Chinese economy which would ensure projects such as NEO, VEN, WAN, TRX and QTM make for a great investment; however, until there is more certainty institutional investors will not trade based on speculation.
Japan, Singapore, Thailand, Indonesia and South Korea have all demonstrated a pro-crypto mandate; however, to date, nothing is set-in-stone. Indeed, there have actually been occasions when even government officials within South Korea and Japan have made comments within the media that has been out of line with perceived public policy. Their comments have had a detrimental effect on the price of cryptocurrencies at certain points in time, demonstrating the lack of market liquidity. With the market prone to such volatility this makes it unappealing to institutional investors to some extent who have a tendency to have less tolerance to risk.
There are many Islands trying to take advantage of the market uncertainty. Cyprus, Malta, The Cayman Islands, Bermuda and Gibraltar are examples of countries launching an ‘open-for-business’ approach towards digital assets, the latter of which has opened up a cryptocurrency exchange called The Gibraltar Blockchain Exchange (GBX). This exchange has been created for the purpose of attracting Institutional Investment, while they look to become the first country in the world to issue a set of regulations for ICOs.
Whilst these crypto friendly islands do not make much difference to those people living in countries such as China, they do incubate innovation, providing the market with time to build products and services that will help the market mature. While this might be the case, such a misaligned approach to regulation is obviously disconcerting.
It is, perhaps, to the detriment of governments who have failed to recognise that the underlying technology of cryptocurrencies has proliferated the need for hard borders. It would be more helpful for institutional investors if they recognised this opportunity and considered a way of harmonising regulations in order to drive global trade. Today, this is purely aspirational when we consider that most countries to date cannot make a decision as to how cryptocurrencies should be traded within their own borders.
Market infrastructure requirements
Institutional investors are also put off by how difficult it is to navigate through the cryptocurrency market. The user experience and user interfaces of almost every touch point within this industry is awful. It is likely one of the reasons why there has been a lack of wider retail and institutional adoption.
An individual’s Bitcoin address is a unique 51-digit number that can only be accessed using a private key. If you were to lose your private key, or if someone was to steal it, you lose your funds. As a decentralised network it would be impossible for an institutional investor to get regain their funds as there is no central authority that can investigate matters further, such as a bank might do, when there are instances of fraud on your current account. It is for this reason that institutional investors do not want to have responsibility for owning their own private keys. Their preference would be to pay custodians to take over that responsibility on their behalf.
Unfortunately, the crypto industry has a lack of custodian service providers from traditional custodian banks, making this market a risk too far at present. Indeed, while there are service providers available, the vast majority are new players without the reputation of more traditional custodian banks.
Furthermore, they also retain far less working capital making it impossible for them to cover losses should a client’s private keys be stolen while in their custody. Indeed, we must remember that hedge funds are entrusted by pension funds, endowments and additional large-scale investors to ensure their money and investments are safe. It is impossible for them to make any guarantees that this is the case in the current market.
It is, however, important to recognise that there are efforts underway to change this. Earlier in 2018, Nomura, launched a custodian service through their partnerships with Ledger, a security and infrastructure provider for cryptocurrencies and Global Advisors, who specialise in investment management for Bitcoin. This week (July 2) Coinbase, the cryptocurrency exchange, also announced they have accepted its first deposit and is now ‘open for business’. Their service will initially be available to institutional clients across the US and Europe and is set to be extended into Asia before the end of 2018.
While these are all positive developments, we also need to recognise that the current exchanges used by investors are not suitable for the needs and expectations of institutional clients. Many of the exchanges are prone to hacking: BitThumb, Mt. Gox and Coinrail just some recent examples of exchanges that have lost billions of dollars’ worth of cryptocurrencies. Other exchanges, such as Kraken, have been subjected to a prolonged DoS attacks from November to December 2017, while Bittrex and Binance had to close their doors, unable to facilitate the sheer volume of transactions taking place between November 2017 to February 2018 just from retail investors.
Such poor infrastructure adds to the concerns of volatility. Coupled with a lack of investor protection it makes for a difficult market for institutional investors to enter.
Until we see better infrastructure and clear direction from the regulators, we will undoubtedly see institutional money continue to sit on the sidelines. The launch of Bitcoin ETFs might change this to some extent, but ultimately, I believe we will need to see further clarity from regulators and services from custodians before these new products enter the institutional market.