Cryptos have to go institutional #2 – NUMERATIO
Crypto assets still have a long and bumpy road ahead…
Adopting new technologies is risky and time consuming, and can be an expensive gamble. Current centralized banking legacy systems (SWIFT) and expensive structures (massive back office operations) still plague the financial industry. The advent of blockchain technology could potentially improve such an ecosystem by reducing transaction times, reducing transaction costs and reliance on a centralized transaction system therefore significantly reducing headcount costs. However, this will only work if the vast majority of the ecosystem decides to invest and adapt into this new settlements’ consortium. Nonetheless, this article relates to crypto assets and not blockchain technology, even though some people may bundle both together. To oversimplify — blockchain does not necessary require a crypto to function (simply put, it is a transactions ledger); however, most of the top 10 public crypto assets (for example Bitcoin, Ether, Litecoin, to name a few) rely on their exclusive public blockchains to record transactions and reward those who validate transactions.
In terms of novel financial products, the last time the financial industry adopted a new product was in the early 1990s with the creation of the credit default swap (CDS). These swaps were developed by one of the largest players in the financial industry (link). Fast forward to prior to the Great Recession of 2008/2009, these products mutated into an outstanding notional value of about US$ 62 trillion. On the other hand, Bitcoin, which is a peer-to-peer transaction vehicle, was created at the peak of the Great Recession outside the grasp of the financial industry and reach of any regulatory body. Its early adopters were technologists/evangelists, anarchists, and mainly retail investors. I agree that one of the reasons for its creation was to reduce the user’s reliance on the banking sector as an alternative to traditional banking but never as a substitute. Nowadays, crypto assets holders include investment firms such as Pantera Capital, BlockTower, and POLYCHAIN alongside investors such as Michael Novogratz (CEO of Galaxy Investment Partners, a crypto investment firm), Tim Draper (founder of Draper Fisher Jurvetson, a venture capital firm), and Peter Thiel (co-founder of PayPal and Founders Fund, a venture capital firm).
The road to institutionalization for crypto assets is a tough one. On one hand hardcore crypto evangelists believe in transaction privacy and decentralization/democratization of power (whereby the network confirms transactions outside the reach of the banking industry) subject to no regulatory framework. On the other hand, banks are centralized entities subject to complex regulatory frameworks designed to protect depositors. Assuming crypto asset regulation will be created on the adoption of this emerging asset class by the financial industry driven by its own clients, both sides will have to cede some hardcore ideals to ignite a new fruitful era of collaboration between both industries.
Even though Bitcoin’s price has almost reached US$ 14,000 (11) at the time of writing, representing over 250% appreciation since its yearly low around US$ 3,400, it is far from its all-time high of about US$ 20,000. Nonetheless, the current rally is structurally different to the stratospheric run in late-2017. This time around (I) there are more institutional investors holding cryptos compared to 2017, (II) regulated institutional-level grade hedging vehicles are available, (III) service providers have improved significantly to better cater to professional clients, and more. I am still quite optimistic about the asset class. Will the US$ 20k resistance level be breached this year?
Notes:
(1) I highly doubt Bitcoin futures caused the crypto market hype bubble to burst because (I) the underlying asset referenced by the futures is a single crypto asset (even though some defend Bitcoin represents more than 50% of the entire crypto asset space, now and at the time the futures were introduced) in a larger asset space, (II) open interest in these contracts was quite low compared to the market capitalization of Bitcoin at that time (1H18), and (III) the margin requirements, sometimes 5x the notional value traded, for shorting these Bitcoin futures is punitive to companies that trade leveraged products.
(2) Market capitalization of crypto assets is a statistical error when compared to the total market capitalization of traditional asset classes. This could also be an argument for its potential if adoption increases. See table below:
(3) Extract from Satoshi Nakamoto’s whitepaper: “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.” (link to the whitepaper)
(4) The vast majority of the banking industry is reluctant to deal with crypto assets by either denying the direct investment in such asset class or blocking crypto-related companies from opening bank accounts. For example, Barclays (link) and Goldman Sachs have axed plans for crypto asset trading desks. Even though the latter, through its venture capital arm, has made a direct investment in Circle (a crypto finance company), which then bought Poloniex (a crypto asset exchange). Some industry players argue that this asset class is incorrectly regulated (I agree), there are untested cases for the use of cryptos (I agree), and crypto assets could be used for money laundering (I disagree as the US Dollar constitutes the largest share of illicit transactions), amongst other things. However, the outlook for crypto assets is not entirely negative as one of the largest asset managers in the world, in this case Fidelity, has allowed some of its institutional customers to directly enter the crypto asset space (link).
(5) The top 5 richest Bitcoin addresses:
(6) Bitcoin address distributions:
(7) The Trust is a private, unregistered investment vehicle and not subject to the same regulatory requirements as exchange traded funds or mutual funds, including the requirement to provide certain periodic and standardized pricing and valuation information to investors. The Trust is not registered with the SEC, any state securities laws or the U.S. Investment Company Act of 1940, as amended (GBTC Fact Sheet).
(8) Open interest notional value of the CME E-mini S&P 500 Future versus the S&P Index market capitalization:
(9) Regulated Bitcoin future contracts’ specifications:
(10) Most crypto exchanges are lightly regulated or not regulated. For the majority of retail investors, they are one of the main points of entry to the crypto asset space. These exchanges are prone to bugs and hacks. Crypto assets lost in hacks are not guaranteed by these entities and investors can lose some to all of their investments. Investors could also lose their cold stored Bitcoin (BTC)s (their investments) if they lose the private key to their storage solution or wallet.
(11) Bitcoin prices on web sources such as CoinMarketCap (link) and Nomics (link) are calculated as aggregated prices from multiple exchanges. Crypto exchanges typically tend to offer different prices for the same crypto asset due to its user and currency base, regulatory jurisdiction, on/off fiat-to-crypto ramps, and other fundamentals that affect crypto asset prices from exchange to exchange.
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Written by: Marcos Leonardo Benvenuto (Founder/CIO at NUMERATIO)
As a disclaimer, I have investment positions in several crypto assets including, but not limited to, Bitcoin, Ether, Litecoin, and others. My holding period for most positions is over 1 month, or even more. I do not day trade cryptos so as to smooth out my price volatility exposure. Please post comments or questions below.
Published at Sat, 29 Jun 2019 00:15:46 +0000