A Spring Awakening For Institutional Crypto

News, Opinion | June 20, 2019 By:

The brutal “winter of crypto,” where cryptocurrency trading volumes plunged by as much as 85 percent from a January 2018 high, has been enough to dampen the enthusiasm of even the most ardent supporters of disruptive digital assets. However, industry sentiment is that the freeze may have melted, with the green shoots of spring sprouting up and perhaps piquing the interest of sophisticated investors.

Regulation Welcomed

Many in the sector agree that greater oversight could be a catalyst for more institutional investors entering crypto, and there is now support for moves to regulate the sector. Recent action by Hong Kong regulator, the Securities and Futures Commission (SFC), to introduce a new regulatory framework for exchanges is an example of moves to tighten up the crypto space. Under the proposed scheme, crypto exchanges will only be able to deal with institutional investors as part of a move to better protect the public. This plan however has received a mixed reception from local industry players, who may be used to less oversight.

But for serious, legitimate market participants regulatory clarity is desirable. Those less scrupulous players, who may be shirking security best practice or puffing up trading volumes, are those that are actively wanting to stay in the dark. The Securities and Exchange Commission itself currently faces a conundrum, with questions about the appropriate level of oversight, understanding that over-regulation could stifle innovation, but not doing enough could put investors at risk of having their digital assets stolen or misappropriated.

The sector should welcome clearer regulation, not only to protect investors but also because it may safeguard against industry participants themselves making large investments into infrastructure or technology, only to find out later that the solutions are non-compliant or illegal.

Custody No Longer a Stumbling Block

A lack of properly regulated custodial solutions has in the past inhibited the widespread adoption of crypto as an asset class, but now institutional-grade custody solutions have arrived, with many more predicted to join.

In 2018 Fidelity became the first big name to enter the crypto custody space when it announced it was launching a separate company called Fidelity Digital Asset Services. That same year Coinbase Custody officially opened for business with its first customers being crypto hedge funds, exchanges and Initial Coin Offering (ICO) teams. Intercontinental Exchange (ICE), the owner of the New York Stock Exchange, in April announced its cryptocurrency trading platform Bakkt had acquired Digital Asset Custody Company (DACC), a crypto custodian services company.

Settlement Systems Still Lacking, But Optimism Remains

While there have been advancements in crypto-focused custody, concern remains about the lack of prime brokers and settlement systems for crypto trading. The current model where a trading counterparty is also the custodian of the assets required for the transaction remains inherently risky. The possibility for assets to be stolen if there is a security breach remains a key barrier preventing more institutional investors entering the space.

Connectivity and API offerings are still of poor quality and require institutional investors to run multiple web interfaces at once in order to trade. Additionally, most crypto exchanges still do not leverage the FIX protocol, meaning there is still additional work to be done in order to create better connectivity.

Despite these challenges, we at Caspian are upbeat about the long-term future of crypto, particularly Security Token Offerings (STOs). We believe that the ability to digitize what were previously illiquid assets like private equity or collectables is certainly getting a lot of mindshare, and it will be interesting to see how important they become.