Cryptoassets have disruptive potentials, but institutionalization is necessary for them to reach this potential, according to a report from Big Four auditing firm KPMG.
The researchers use cryptoassets as an umbrella term for referring to cryptocurrencies, security tokens, and utility tokens. Also, according to the researchers, “Institutionalization is the at-scale participation in the crypto market of banks, broker-dealers, exchanges, payment providers, fintechs, and other entities in the global financial services ecosystem,” adding that this level of institutionalization is the next growth step for cryptoassets.
KPMG expects institutionalization in the following areas. Cryptoasset and token generation, which includes platforms related to cryptoasset issuance, ICO sales venues, mining, airdrops, and collateralization. Emerging companies are expected to lead the institutionalization in the cryptoasset generation area.
The firm also expects institutionalization in the area of financial instrument development including derivatives, ETFs, investment trusts and related financial instruments. Legacy financial institutions should be the institutionalization agent here, according to KPMG.
Institutionalization is also needed in the areas of trading services, asset management, retail, payments, and services (coin ranking, data provision, advisory, tax and legal services.) Both legacy and emerging companies will facilitate the institutionalization of these cryptoasset industries.
Finally, both emerging and legacy institutions need to take responsibility of establishing trust in cryptoassets.
How Much Institutionalization Has Cryptoasset Space Seen?
Driven by investor demand for avenues to benefit from the boom that the cryptocurrencies experienced over the last few years, the cryptoasset generation sub-industry is one of the most advanced areas of the crypto industry. There is no shortage of token generation platforms. A few of them include Angelist’s Coinlist, Republic, an equity crowdfunding platform, Coin Factory, and KICKICO.
However, given the legal uncertainties around ICOs, it’s unlikely that the ICO generation area will witness any significant participation from traditional institutions. It’s the security token generation space that is likely to witness meaningful institutional participation. So far, there is little (known) participation from traditional institutions in security token generation. According to the information available on the website Security Token Network, which monitors development in the security token space, Indiegogo appears to be the only non-blockchain company that’s built a system for issuing security tokens. The closest thing to security token generation from a traditional institution is JPMorgan’s patent filing to use blockchain to generate security tokens.
The table below lists some available security token issuance platforms developed by both incumbent and emerging companies.
The aforementioned report outlined at least five requirements and challenges related to the development of security tokens. Some include regulatory uncertainty, the need for establishing complaint electronic trading platforms and the need for complaint clearing, settlement and custody solutions. It’s a possibility that traditional institutions are prioritizing solving these challenges over developing security token issuance platforms.
Financial Instrument Development
For crypto assets to go mainstream, especially for investors, there is a need to develop various financial instruments based on the generated cryptoassets. The aspect of developing financial instruments is one of the more important areas for the participation of legacy financial institution. Here are a few reasons for that. First, investments are a major way projects are funded to achieve growth, which creates the need for a more structured and transparent way to invest in crypto projects. Second, legacy financial institutions have the world’s biggest investor within their networks, which means that the easiest way to draw new investors into the crypto space is to have traditional financial institutions participate. Third, traditional financial institutions have the most robust infrastructure (systems, organization, data, licenses, etc.) required to develop financial instruments that inspire investor confidence.
So far, most of the crypto financial instrument developments has been related to futures. There are currently futures products from CME Group Inc., one of the world’s largest developers and operators of derivatives and futures exchanges. CME has filed, at least, two patent applications for derivative products related to cryptocurrency.
The Chicago Board Options Exchange, or CBOE, also a major derivatives exchange, also offers bitcoin futures. The futures offered by these two derivative exchanges are accessible in the traditional financial markets.
In addition, Intercontinental Exchange, or ICE, is developing a bitcoin futures product via its crypto trading platform. As a reminder, ICE is the parent company of the popular New York Stock Exchange. Nasdaq, another major stock exchange, is also working on its own bitcoin futures, scheduled for a market launch during this half of 2019.
There is, however, emerging developers of financial instruments such as Crypto Facilities and BitMEX. The former is a Financial Conduct Authority-regulated provider of crypto derivative trading, with listings including futures contracts for bitcoin, ether, bitcoin cash, litecoin, and ripple.
Other than futures, there’s currently a regulated exchange-traded product, or ETP, developed by Amun AG in Switzerland. What’s more, the world’s first regulated crypto mutual fund, developed by First Bloch Capital, has also launched in Canada.
There are also a few emerging crypto companies that offer investors access to fund investment. A few notable players in this space include Coinbase, y-combinator-backed CoinBundle, Digital Currency Group, through its Grayscale Investment subsidiary, BitWise, just to name a few.
Again, regulatory uncertainties are limiting the participation of incumbent financial institutions in the development of crypto investments products. The CEO of BlackRock, an investment management firm, with roughly $6.44 trillion in asset under management, said last year that his company will only develop EFT products when the crypto industry become “legitimate”
Institutionalization In Crypto Trading Services
With over 200 crypto exchanges, per the data provided by crypto trading data provider CoinMarketCap, crypto trading is about the biggest area of the cryptoassets industry right now, although it’s still a relatively small market. That is because a larger part of the current crypto trading space is designed with retail traders and investors in mind. According to Coinbase, which also contributed to the KPMG study, the current retail-focused nature of crypto trading is keeping institutional investors from entering the market en masse.
“Institutions have a different set of requirements than retail consumers and need to see a focus on compliance, transparency, and governance to comfortably use and transact with crypto,” chief compliance officer Jeff Horowitz and VP, finance Eric Scro, both of Coinbase, wrote in the KPMG report.
However, following discoveries of how blockchain and cryptocurrencies can disrupt legacy industries, there’s a growing interest from institutional investors, which creates a need for trading systems that speak to their needs, as stated above. Institutional interest is now driving the development of complaint and transparent trading systems. A host of emerging crypto exchanges including Coinbase, Gemini, Circle, Seed CX, and Caspian have developed institution-grade trading platforms.
Given that majority of institutional investors are in the same network with legacy financial institutions, large financial corporations are also investing massively in building robust trading infrastructure. Unlike in the case of financial product developments where institutions are directly creating instruments, traditional institutions are building trading services indirectly, by either setting up a different company or investing large amounts in crypto trading start-ups. For instance, American Express (AMEX), a financial services corporation, invested in crypto trading service Abra in 2015. Beyond investing in Abra, American Express added functionality for funding Abra accounts with AMEX cards.
American e-retailer Overstock.com launched a subsidiary, called tZero, for the trading of security tokens. According to the retailer, tZero is fully compliant with security laws and it seeks to take the traditional investment world to the blockchain. The token trading platform recently won a patent for integrating legacy trading systems to crypto exchanges.
Before the end of last year, Nasdaq and Fidelity Investment, an asset manager with about $2.5 trillion in global asset under management, invested ErisX, a cryptoassets trading services targeted at both retail and institutional investors.
Institutionalization In Asset Management
Last year, Ethereum prices tanked and analysts attributed the significant drop to the panic selloff by ICO project who were trying to secure the value of the crypto funds that they raised. Still, some project suffered a loss to their crypto holdings. The problem? Leaders of ICO projects are mostly tech entrepreneur without asset management expertise. Given that speculation is what drives the price of cryptocurrencies, there’s a need for asset managers who understand the workings of financial markets. In addition, for mainstream investors to enter the crypto space, especially the ones who are less knowledgeable about financial markets, an easier, simpler and safer access to cryptoassets is required. This sort of simplified access can only come from asset managers.
Majority of the developments in the financial instrument area overlap with the developments in the cryptoasset management space. Just about every company developing non-futures products have assets managements features on their platform.
One of the most notable moves in this area is from Fidelity Investment, which announced the launch of a digital asset management platform last October.
According to KPMG, incumbent institutions should dominate crypto asset management space, especially with fund management, arbitrage and custody services. But incumbent asset managers, with the exception of Fidelity, are yet to publicize their plans for cryptoassets management. It’s worth noting, though, that an asset management industry publication, The Trade, reported that wall street asset managers are working on their own funds, citing an unnamed asset manager, who attributed the slow movement of managers toward offering cryptoasset management services to the lack regulatory clarity from global policymakers.
The reluctance of incumbent asset managers, coupled with the need for asset management in the crypto space, is seeing the birth of emergent crypto asset managers — Coinbase, Bitwise, CoinBundle, First Bloch Capital, etc. Financial regulators in Switzerland also approved crypto asset manager Crypto Fund AG last year.
Institutionalization in Retail and Payments
The bitcoin whitepaper, published at the time of bitcoin launch, revealed that the first cryptocurrency was created to facilitate peer-to-peer payments. While the crypto space has since evolved from the simple idea of P2P payments to a whole new class of assets, payments remains an important part the crypto evolution. Following the heightened attention that the development of financial products received last year, Ethereum creator Vitalik Buterin pointed out that financial products will only help pump crypto prices, while developments that make it easier to spend crypto is will fuel actual adoption of digital assets.
I think there's too much emphasis on BTC/ETH/whatever ETFs, and not enough emphasis on making it easier for people to buy $5 to $100 in cryptocurrency via cards at corner stores. The former is better for pumping price, but the latter is much better for actual adoption.
— Vitalik Non-giver of Ether (@VitalikButerin) July 29, 2018
Unlike in other areas of the cryptoassets industry, there is huge institutional participation in the development of crypto retail and payment products. In the retail e-payment space, companies including MasterCard, Visa, PayPal, Square, Facebook, American Express, just to name a few, are all investing heavily in developing crypto payments technologies.
To understand the extent of the crypto payments development, consider that MasterCard, reportedly, has the third-largest blockchain-related patent applications worldwide with 80 patent filings as of September last year. Visa and PayPal had 24 and 20 patent applications respectively. Last year, Square won a patent for a payment network with the capability for merchants to accept payments in any currency, cryptocurrencies inclusive.
In the cross-border payment space, big banks including HSBC, Royal Bank of Canada and ANZ bank, JP Morgan, Bank of America and several others are all developing blockchain or crypto powered cross-border payment systems. Ripple is a big part of the cross-border payment solutions that banks are developing. Ripple CEO told CNBC last year that “dozens” of banks will start using its blockchain products this year.
Pure play remittance companies like Western Union, MoneyGram, Ant Financial and UAE Exchange are all building cryptocurrency or blockchain bases remittance products. MoneyGram and WesternUnion already have some level of relationship with ripple. Ant Financial recently partnered with financial institutions in Malaysia and Pakistan to launched a blockchain-based remittance service to improve remittance efficiency between the two countries.
In terms of launched products, emergent crypto payment company lead the space. A few leaders in the space include BitPay, TenX, BitPesa, Coinbase, CoinGate and Bitwala. These companies have built the technologies that currently allow merchants to accept crypto payments, which inherently means that they are also making it easier for consumers to spend crypto.
There is now a new wave of companies, like Graft Network and Pundi X, which have the mission of making crypto POS-friendly. Graft, for instance, has built a blockchain payment processor, which have participants including miners to facilitate real-time payment authorization and payout brokers to allow merchants accept any crypto while still being able to cash out in their desired currency.
Pundi X, which is currently focused on Indonesia, on the other hand, is developing technologies that it incorporates into devices so they are “blockchain-ready.” It is already deploying its POS in Indonesia.
Institutionalization In Services
The service space of the cryptoassets industry is developing rapidly, with incumbent services companies such as the Big Four audit firms, Accenture, McKinsey and Boston Consulting Group all investing heavily and providing advisory and consulting support required to grow the industry. Accenture leads the park with a reported 37 blockchain-related patent filing. The consulting company also works with enterprise blockchain leader IBM and Microsoft on several blockchain technology developments. Ernst & Young made two major moves last year. First, it acquired a patented technology that is able to connect to multiple exchanges and wallets to offer better visibility of transactions and inventories. Second, it unveiled a prototype of its product that will allow enterprise users to transact securely on a public blockchain, Ethereum in this case.
One key takeaway here is that large institutions are interested in venturing into the crypto space. However, as the KPMG report states, regulation is about the biggest hurdle that the crypto industry has to overcome see more institutionalization. Therefore, it is plausible to expect increased institutional participation as the regulatory landscape around cryptoassets smooth’s out.