Bitcoin And The Consequences of Institutionalization

Innovation, Investing | September 5, 2018 By:

Bitcoin was created amid troubled times. The financial crisis of 2007/08 led to a five years long recession that had people questioning the ability of centralized governments to provide economic stability. Distrustful of traditional financial institutions, the idea of a currency for the people captured the imaginations of many. Bitcoin was the epitome of that vision. It was the poster boy of the ‘cypherpunk’ movement, advocating widespread use of strong cryptography and privacy-enhancing technologies as a route to social and political change – a means to curb the powerful corporations and crony capitalism, once and for all.

Approximately a decade since bitcoin’s invention, things have taken a very different turn. What once represented a way for anarchists, libertarians, and liberals to fight back against a clearly ailing financial system, bitcoin is now on the brink of being adopted by the very institutions it was built to fight against. For the ideologues that were there for bitcoin’s incipient years, that sea-change might feel like an expedient betrayal – and they would be right. But bitcoin has matured in a way that even its founder certainly couldn’t foresee.

Bitcoin has forged a whole new financial system. While in the grand scheme of the global financial system, it still has a relatively small market cap, its market is still more than large enough for financial institutions to take notice. If the client demand is there, which it is, then institutions have every right to meet that demand – and many already are.

Things were set in motion last year, when leading exchanges CME Group and Cboe Global Markets launched future trading for bitcoin. Earlier this year, investment giant Goldman Sachs followed suit, by offering crypto futures trading. Most recently, Intercontinental Exchange (ICE), the owner of the New York Stock Exchange (NYSE), announced that it would list physically settled bitcoin futures contracts and form a new company with a mission to make bitcoin a mainstream financial asset.

Crypto now occupies a significant part of the asset management market, with roughly $3.5 billion – 5 billion in play. The number of crypto hedge funds has grown from just 20 in 2016, to 175 in 2017, to well over 300 now. Multiple prominent figures in the space are optimistic that cryptocurrencies are here to stay, and even Soros Fund Management is now reportedly planning to launch crypto trading, in spite of George Soros’ original dismissal of the asset.

Firms like Soros Fund Management and Goldman Sachs are far from outliers in the world of finance. According to a recent survey from Reuters, one in five financial institutions are considering trading cryptocurrencies within the next 12 months. That’s a noteworthy shift from 2017, when bitcoin and crypto were derided by the financial world as a scam and an avenue for criminality. Financial institutions may be saying one thing, but they’re doing quite another, and there will be fast followers now that Goldman and ICE have put the wheels in motion: very few want to lead, but everyone wants to be next in line.

The big question now is, what will be the consequences of this institutionalization? There are a number of possible answers.

Since institutional investors demand a stronger level of security, custodial services will need to be tightened. So too, will regulation: hedge funds can’t simply invest their clients’ funds in the same free-and-easy manner as a retail investor. Clients want ways to invest in crypto while still being covered by the same protections offered by more traditional markets. With higher volumes under trade, liquidity will also be affected – as will volatility – although it’s unclear in what way: the market may become more volatile as block trades take place, or indeed less volatile due to the improved liquidity.

While the impact may still be up in the air, one thing’s for sure: big money is becoming increasingly interested in bitcoin and other cryptos. Regardless of whether this leads to price rises in the short term, it’s worth remembering that in the long term, this is all good for the space. It gives the market much-needed legitimacy, drives regulation, and promotes higher security standards – all of which will help cryptocurrencies to prosper in the years to come.