Since the price of crypto assets spiked dramatically in 2017, many have been predicting that a wave of institutional money is going to come into the cryptocurrency market, bringing with it a flood of change.
However, speakers at Profit & Loss’ Forex Network London event argued that the “institutionalisation” of the crypto markets will play out differently than many envisaged and that some crypto-focused firms have been targeting the wrong client base.
A fundamental reason for this, explained Max Boonen, CEO of B2C2, a cryptocurrency liquidity provider, is that there is a common misconception regarding the operations and structures of large institutional financial services firms.
“People talk about a firm like BlackRock as being a large institution, but they don’t really understand what BlackRock is. At the end of the day, firms such as this get so big because they pool a lot of money from retail investors. These firms aren’t going to come into the crypto markets and try to build a business where there’s no demand, so actually the next wave of institutional money has got to come from retail demand. We must not forget that it’s going to come from the ground up,” he said.
Boonen pointed out that some major cryptocurrency exchanges have launched with great technology and systems in place and yet volumes remain low because they’ve pitched their businesses to the wrong client base.
“I think that they misidentified the end-user. They thought that they were going to cater to high speed prop trading firms, and those firms are going to come, but they will come to this market because there’s an underlying volume there, they cannot drive it themselves,” he said.
Justin Slaughter, a partner at Mercury Strategies agreed with these comments, stating: “I think the fundamental mistake that a lot of us made was assuming that the pick up that was done by retail compared to the original techie heads was going to be mimicked by institutional players.”
He added that the process of internal approval at large financial institutions to get involved in the crypto markets has also proven to be slower and more fraught than was originally anticipated.
However, David Mercer, CEO of LMAX Exchange Group, which operates LMAX Digital, the institutional crypto currency exchange, expressed optimism that major financial institutions, and in particular large banks, will inevitably come to form part of the crypto ecosystem.
“Every bank on The Street is utilising blockchain today. Look at JP Morgan, they have JP Morgan Coin for internal use, how long do you think it will be before that moved from being an internal coin for their own customers to an external one? How long do you think it will be before Goldman Sachs or State Street have a coin?”
Mercer argued that blockchain technology is set to revolutionise the plumbing of capital markets and that in order to deploy this technology there needs to be an asset attached to it, regardless of whether that asset is any of the cryptocurrencies that are available in the market today.
Boonen, who worked at Goldman Sachs before founding B2C2, agreed that once the economic incentives are high enough, the banks will get involved in the crypto markets.
“One thing we’ve already learnt is that, for a sufficient amount of money, the banks will come,” he said.
Boonen added that it was widely known that when the price of bitcoin and other cryptocurrencies was on the rise in 2017 that Goldman Sachs was looking to launch a crypto NDF, and that other banks had similar initiatives underway, but that these plans got shelved once the price of these assets started reversing in 2018.
He continued: “The reality is that they didn’t stop because they stopped believing in this market. I think that if the price goes back up, let’s say it goes to $10,000, then there is a business for them, and at that point in time they won’t be able to come into this market fast enough.”
Barriers to adoption
Yet, despite agreeing that the entrance of large institutional players into the crypto markets is inevitable, the speakers also identified some of the current barriers to this happening.
For example, Mercer described the problems that LMAX Digital had when it engaged a major audit firm to look over its business. The firm had to limit the scope of the audit because it was unable to verify the cryptoassets being held by LMAX Digital as a regulated custodian, which Mercer claimed was nonsensical given that every cryptocurrency transaction is on the blockchain, which is itself immutable.
While this creates a friction point for financial institutions wanting to participate in the crypto markets, Mercer said: “Those big organisations will eventually just have to get over that line.”
Slaughter, meanwhile, said that while the traders at financial services firms might be keen to participate in the crypto markets, it’s the lawyers and compliance staff at these firms that are likely to slow things down and delay the shift from internal crypto projects to external ones.
Although compliance is a burden for some firms in the crypto market, with Boonen revealing that at one point compliance staff accounted for 30% of B2C2’s headcount, the panellists agreed that regulation is not a key challenge.
“I believe that the regulatory framework that we have in place right now works,” said Boonen. “For example, if you offer a crypto CFD then it’s a financial instrument under Mifid and we’ve got the right licenses to trade it, there’s nothing special about that product under the regulations. Once you figure out what regulation applies then it’s easy.”
Mercer concurred that regulation is not a problem for firms active in the crypto markets, but highlighted that many firms have concerns regarding anti money laundering (AML) provisions.
“The issue is not regulation, it’s just AML. Personally, I think it’s easier to track a bitcoin than it is a euro in your pocket. So when the banks say ‘How can I prove that a coin hasn’t been in a suitcase?’ I push back and say ‘How do you prove that this euro or that dollar hasn’t been at a race course or in a suitcase?’,” he said. “That’s actually the sticking point right now and at some stage they’re going to have to make that leap.”
Boonen also highlighted AML as a barrier to the adoption of cryptocurrencies by banks, stating that they are reluctant to touch these assets because “they have been bitten many, many times” by AML requirements.
“They don’t want to take the risk at the moment. But this is really something that could transform the market overnight,” he said.
Slaughter contended that the problem facing crypto is not regulation, per se, but rather a general lack of technical literacy around cryptoassets.
“Lawyers are trained and graded on how well they can put a peg into an existing hole, you’re not credited for novelty. You get credit for finding ways to establish that something is following a precedent, and for regulators it’s the same. They hate the concept of novelty,” he said.
Calling back to Mercer’s suitcase full of money metaphor, Slaughter continued “You’re absolutely right. Cryptocurrency is infinitely more traceable than a suitcase full of euros or dollars. The problem is, the comparison point for AML KYC people is credit cards or bank transfers. They don’t want any dollars, but they also don’t want a reduction of the establishment they understand so well.”
Credit Still Missing
Generally, the panel argued that the necessary infrastructure is in place for institutional market participants to trade crypto assets.
However, Mercer highlighted one major component of the current financial systems that is still missing from the crypto-space: credit.
“Everyone’s dancing on the edge of this issue, talking about things like stablecoins, but what they’re really saying is that they don’t trust the counterparty to send them the bitcoin after they’ve sent their dollars. It’s old fashioned PVP, we need some credit there,” he said.
Mercer claimed that the banks will eventually come into the crypto markets and provide this credit before adding, perhaps somewhat tongue-in-cheek, that if they don’t then LMAX will start doing so.
He commented: “The banks will come and they will solve this credit issue. And if they don’t, then we will, because at the moment people are asking LMAX Digital to solve that problem for them. So if there has to be an LMAX Bank then so be it, watch this space!”