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Crypto and Institutional Adoption - Part 2: Infrastructure


After writing about institutional grade crypto asset based financial products in the first article, in this edition I will shed some light on the business initiatives you need to keep an eye on. In a sea of noise and rumours, it's hard to find out what's really happening and what is fake news. I hope this piece will bring you some clarity with respect to the relevant developments. Some high profile companies are currently building the infrastructure for what I like to call the era of decentralised digital investments. Let this piece guide you through what's currently being developed and who are leading out.

The developments are categorised over three different areas; custody, exchanges, and asset management services. There are many little initiatives in the space, and writing about all of them is impossible, so the focus will be on the initiatives that come from the better known names in the industry..


Asset Management Services


Let's start with a giant from the conventional asset management industry. Fidelity (worlds 4th largest asset manager) launched Fidelity Digital Assets late 2018 after reviewing crypto for 4 to 5 years. They aim to bring asset custody, trading execution, and “dedicated client service" to institutional clients. Coindesk offered a great write up about Fidelity's new business initiative which is scheduled to start somewhere this quarter.


Galaxy Digital, the "merchant bank of crypto", founded at the end of 2017 by Michael Novogratz (,who has a interesting bio,) recently announced they are raising 250m USD to fund new crypto businesses, aside from their own balance sheet based funded initiatives. Initially the idea was to set up a hedge fund, but when prices reached ridiculous levels in dec17/jan18, Michael chose to change plans and opted for building the "Goldman Sachs of Crypto".


Exchanges


A popular more recent initiative in the crypto community is BAKKT, which is building an open, seamless global network to enable you to buy, sell, store and spend digital assets. BAKKT is backed by Intercontinental Exchange and they are launching a physically settled bitcoin future which is expected to start trading this quarter. The physical settlement in this case is what makes it special, as opposed to the cash settled alternatives. BAKKT will be taking care of storage and ICE will take care of clearing.


Circle was found in 2013 and offers four products. Circle Invest offers investment services. With Circle Pay you can send money like a text. Circle Trade offers OTC trading (monthly volume currently over 2 billion USD). Circle also acquired Poloniex as one of the larger retail focussed crypto exchanges. Together with BitGo (who offers institutional grade wallets and custody solutions), these are the two most interesting crypto businesses backed by Goldman Sachs.


SeedCX is working hard on an institutional grade exchange platform with segregated onchain wallets for their clients. Seed CX and its subsidiaries already hold the following licenses: Swap Execution Facility (CFTC), Introducing Broker (NFA), Money Services Business (FinCEN), and Money Transmitter (over 24 states, including Delaware, Illinois and Connecticut), and it has a pending BitLicense with NYDFS. They are aggressive in their fee structure as taker fees are just 8 bips which is on the low side compared to their competition.


ErisX is considered to be a competitor to BAKKT and will be launching in Q2 2019. TD Ameritrade, Virtu, DRW, SIG, Cboe, Digital Currency Group and Pantera Capital are behind this new initiative that will offer spot and physically settled future markets on Bitcoin, Bitcoin Cash, Ether and Litecoin to both institutional and retail clients.


LedgerX is the first federally regulated exchange and clearing house to list and clear fully-collateralized, physically-settled bitcoin swaps and options for the institutional market. The U.S. Commodity Futures Trading Commission (CFTC), which regulates virtual currency derivatives, oversees LedgerX's registration as a swap execution facility (SEF) and derivatives clearing organization (DCO). While LedgerX focus is on institutional investors, retail investors are well served by Deribit.


Coinbase is already a very well respected player in the industry and used to serve retail only. With prime, Coinbase is also entering the arena to fight for a share of institutional capital and they just set foot in Asia and Europe to serve institutional clients.


Custody


In one of my earlier pieces I already wrote about the different custody solutions, so I will reduce the content here towards some of the latest developments. Custody is believed to be one of the most critical hurdles for institutional adoption. The most promising custody provider at the moment is Fidelity as it will leverage on the name it has built over the years. Fidelity is expected to go live in March. Next to Fidelity, BAKKT will also offer custody services. BAKKT by itself might not be a name that rings a bell, but ICE (Intercontinental Exchange), who is behind the initiative, certainly is.

A remarkable fact on our own Dutch soil is that ABN AMRO (one of the larger Dutch banks) is currently testing bitcoin wallet "Wallie" as part of their retail offering. Not an institutional grade service, but interesting enough to mention here. Their competitor ING is mainly focussing on custody solutions and STO's (Security Token Offerings) as major directions to explore further in terms of business potential.



Liquidity Providers


DRW is a Chicago based high frequency trading firm focussed on offering liquidity and has been around since the 1980s. It's one of the larger well known parties involved in market making for a large range of financial instruments. In 2014 they founded Cumberland Mining as a specialised crypto asset trading company within DRW. Aside from running their own trading strategies, they offer liquidity through their OTC desk on a range of crypto assets for 100k+ tickets.


After DRW other liquidity providers like Susquehanna, Jump, Hudson River and FlowTraders jumped into the space as well and lots of ex-traders from the better known high frequency trading firms and larger banks are setting up shops everywhere. With liquidity being scattered over an enormous amount of exchanges, there are plenty of opportunities out there for the smaller shops, while some of the larger houses consider the current volumes not big enough to compete with their current business in terms of generation of revenue per head.


Final Remark


I expect to see a better institutional crypto landscape by the end of 2019 as different initiatives will go live throughout the year. The interest was there and currently still is as we can induce from the Greyscale Bitcoin Trust premium. Even though the premium has come down significantly, it's still there indicating that people are willing to pay a premium over the net asset value to get easy access to digital assets.


With all these new initiatives in an industry that's intellectually challenging, it isn't hard to imagine that human capital at conventional companies takes a hit. A good write up by Coindesk was discussing the hunt for blockchain talent. Not only from the tech side, but also from the investments side. Especially Goldman Sachs faced an outflow of high profile people into this brand new industry. So, we see talent on the move and new institutional grade infrastructure arise. All great, but without actual entrance of institutions it's worth nothing. In that context it's good to see that a couple of institutions in the US are leading out. Swensen with the Yale Endowment was one of the first to jump and endowment funds of Harvard, Stanford and MIT followed suit. Last week we also saw two US pension funds making their entry, which to me is a very big milestone on the road to institutional adoption.


How far is your organisation with their preparations for the rise of this new asset class and the infrastructure that comes with it? Are you ready for the opportunities that are around the corner, or do you need a helping hand?