Hi everyone!
More changes: from now on, this newsletter will come out on Sunday evening, at around 5pm ET. We hope this is more convenient – I don’t know about you, but I rarely get enough time to stop and read newsletters, even those as compelling as this one (right?), in the middle of a weekday. I’m not suggesting you should interrupt your Sunday for this, but even if you don’t, at least it will be in your inbox waiting for you when the week kicks off on Monday.
(Those of you paying attention might have noticed that I’ve also changed the format of the sublines – spot that song?)
This week I look at what we think institutional investors want vs. what they say they want, and at the next evolution of the vocabulary mind games that this sector so likes to trigger. There are also some deeper thinks about the past week’s more intriguing developments, from new products that hint at liquidity shifts, to technology advances that should impact adoption, and more.
And we have a new report out, our first CoinDesk Monthly Review, which presents a selection of charts that look at some of the threads we've been working on. You can download the report for free here.
With that, read on…
- Noelle
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The next conversation
Before I came across bitcoin, I thought I understood money. I worked in finance, moved lots of it about, and felt I had a reasonable grip on things. Then, in early 2014, I watched a “What is Bitcoin?” video on Khan Academy and realized I didn’t understand money at all. I understood numbers, and conflated them with “money,” as most people who work in finance today still do.
Anyone who starts pulling on the thread “what is money?” invariably ends up drawn to bitcoin, whether they believe in its potential or not. It’s a fascinating tool with which to ask deeper questions, and through those, to understand the role money has played in the evolution of our civilization. It is also a fascinating base from which to start to imagine what the money of tomorrow could look like. Read some books on the history of money (I especially recommend David Graeber’s “Debt” and Felix Martin’s “ Money: The Unauthorized Biography") along with some bitcoin thought pieces and you’ll find that it’s hard to stop thinking about it.
Now that crypto assets are well on the way to altering our collective understanding of the term “money,” it’s only logical that the next concept to be questioned is the meaning of word “payments.”
Coinbase founder Brian Armstrong’s riff on what “payments” could come to mean makes compelling reading – and sheds some light on recent acquisition announcements coming from ICE, owner of the New York Stock Exchange and of New York-based crypto exchange Bakkt.
Last week, the Wall Street Journal reported (paywall) that ICE had made an offer for online marketplace eBay, which had many of us perplexed. Why would the owner of the New York Stock Exchange want to buy a sprawling virtual store?
We weren’t the only ones wondering: shareholders weren’t convinced, either. The offer, which was made without engaging in formal negotiations, was withdrawn two days later.
In an almost simultaneous, plot-thickening twist, crypto subsidiary Bakkt last week revealed the purchase of loyalty rewards company Bridge2 Solutions, to support the development of a consumer-focused digital payments app. Now, why would an institutional-grade crypto exchange want a consumer payments app? Adding new derivatives makes sense. Expanding the range of assets makes sense. But consumer payments, how does that fit in with institutional investment? (And what is Starbucks doing lurking in Bakkt's list of shareholders?)
However, look at these moves through the lens of Armstrong’s thread, and the purchase of Bridge2 and the aborted acquisition attempt of eBay start to make sense. It’s about payments. Correction, it’s not just about payments – it’s about how crypto assets can redefine payments.
We’re not just talking about new P2P payment protocols such as bitcoin. We’re talking about what “payment” even means. If I read an online article in exchange for looking at an ad, is that a payment? What if a token was involved? If I’m using up some of my pre-paid phone minutes chatting to my sister, am I making a payment? What if a smart contract held the pre-paid amount in escrow and dripped the actual consumption cost to the network provider?
Once the pipes are in place, this could have a broader impact on securities as well. Imagine paying for your music listening with fractions of your Spotify shares. Is that a payment?
ICE seems to be betting that the way to get mainstream adoption of crypto assets is to incorporate them into apps that funnel vast volumes of payments. And Bakkt, with the backing (or bakking?) of the owner of the world’s largest stock exchange, seems well positioned to trigger an entirely new conversation around something we have long taken for granted. And, in the process, start to bring traditional capital markets and crypto markets even closer together.
It’s not about crypto markets and traditional capital markets meeting in the middle – it’s more about both of them converging on an entirely new horizon.
Why are we here?
Binance published the results of its second survey of institutional clients, which compiled the preferences and concerns of 76 investors that manage funds ranging from $100,000 to more than $25 million.
The report revealed a surprising split: very few respondents (7 out of 76) have invested in crypto for macro or fundamental reasons. The vast majority are involved for technical analysis and high-frequency trades.
This highlights the eternal debate around “who are the crypto investors of tomorrow?”. Many of us have been operating on the premise that, if we convince investors of the macro value proposition, they will enter the sector in droves. But this survey suggests that focusing on technical traders is likely to be a more profitable strategy.
Yet, given the strength of the story, the macro strategy is still likely to be the main driver for mainstream institutional involvement, which is not yet a feature of crypto markets. And surveys are always selective: this one focuses on investors from relatively small institutions that come from traditional finance and have been involved in the crypto sector for one to three years – the investors of today, rather than of tomorrow.
In the end, the main question is not which type of investor to talk to. It’s what is our goal – short-term profit, or long-term impact?
The survey threw out some other intriguing observations: - It turns out that regulation is the strongest potential growth driver for participants, as well as one of the most significant risks.
- The second- and third-highest growth drivers are the involvement of traditional exchanges, and the development of options contracts and other derivatives, respectively.
- Most respondents prefer exchange-based custody, and very few use third party services.
- More institutional investors are interested in staking than in lending returns.
These results are from a limited sample of 76 institutions – but that’s a reasonable number when it comes to institutional surveys. We also need to bear in mind that Binance – an exchange with a material interest in the survey outcome – is the one asking the questions, and its product positioning could have an influence on the questions asked. The survey also excludes U.S.-based institutions, with a few exceptions, and the U.S. institutional market is arguably the largest in the world.
Nevertheless, the survey makes for compelling reading given the surprising conclusions, and could validate or help shift the strategies of businesses targeting the institutional market – for the time being, at least. Things change fast in crypto land.
– Noelle Acheson
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BIG IDEAS
A post from crypto exchange Coinbase digs into the differences between bitcoin and gold, and highlights bitcoin’s superior auditability, portability, scarcity and divisibility, as well as more overlooked advantages such as low fees and privacy. TAKEAWAY: I’ve never understood why most people take at face value that gold’s supply is scarce. Apart from the fact that the total gold supply is based on estimates, there’s the question of price: the higher the price of gold, the more profitable it becomes to extract from previously unreachable sources (sea beds, asteroids…). Bitcoin is the only commodity whose supply is not based on an estimate and is totally insensitive to price.
SEC Commissioner Hester Peirce has proposed a “safe harbor” for token projects, which would give them three years of relatively light oversight to enable them to reach sufficient decentralization to avoid having to register as a security. TAKEAWAY: While the crypto sector jumped up and down with glee at this announcement, it’s not really news. It’s an appealing idea, but unlikely to change anything in a material way. Hester has often been the voice of dissent on the Commission; her term ends in June; and she includes the requirement to disclose information (this could end up being as onerous or more so than publicly listed shares).
Imposed quarantines and logistics delays in response to the spread of the coronavirus are affecting the operation of mining farms and the delivery of new machines. TAKEAWAY: While statistics are scant, the disruption to supply chains and employee movement could soon start to impact bitcoin security by reducing the number of mining machines actively working to maintain the network. For now, the bitcoin hash rate (representative of the power invested) does not seem to have taken a noticeable hit – but it’s important to remember that the hash rate is an estimate , not a direct measurement, and is something we should keep an eye on, especially in the run-up to the halving just a few months away.
Hash rate (TH/s) over past 60 days, 7-day average
MARKETS
The U.S. Marshals Service will auction approximately 4,040 bitcoin (worth almost $40 million as I type) on February 18, the first such auction since the end of 2018. TAKEAWAY: This is interesting not only for the level of the winning bid – that’s a lot of bitcoin on the block (cough, sorry) – but also for whether or not a “premium” is implied for provenance. These are “clean” bitcoin – no matter what their history, these bitcoin have been “washed” through the US Marshall’s office, and therefore there is no risk of retroactive splashback from illegal previous use. This is not generally a risk that worries investors anyway, but you never know.
The latest report from Security Token Group lists operating security token exchanges and tokenized securities, along with trading figures. TAKEAWAY: The figures show low volumes and few listed tokens, which highlights how young and untested the security token market is. So far, there seems to be much more interest from issuers and infrastructure than from actual investors. Still early days, though.
NEW PRODUCTS
Last week crypto exchange FTX has launched a token (TRUMP) whose value is based on a Trump victory in 2020, closely followed by similar products for other presidential candidates such as Biden, Warren and Buttigieg. TAKEAWAY: Apart from the fun portfolio combinations you could play around with, this is yet another sign that the center of crypto derivatives activity is not in the U.S. The creativity and speed with which they were spun up underlines the relative flexibility of “offshore” exchanges (FTX is domiciled in Antigua and Barbuda).
Digital asset trading infrastructure provider SettleBit successfully tested a service that allows the transfer of bitcoin without removing it from cold storage. TAKEAWAY: The removal of tokens from cold storage for trading is not just a point of vulnerability, it also usually takes a while (as it should). Removing that step should increase security, remove settlement risk and add flexibility. Although, as with most “excited” press releases, there are more questions than answers: what is the latency? How is this different from what Coinbase and Gemini already do? Who is responsible for the KYC and how does this impact privacy?
Malta-based Binance, one of the world's top cryptocurrency exchanges by trading volume, now allows users to borrow tether (USDT) at zero percent interest to fund futures trading using Binance USD (BUSD), held in their Binance wallet, as collateral. TAKEAWAY: I may be missing something, but I don’t see the advantage here. Isn’t one of the advantages of holding BUSD in your Binance wallet that you could move it around instantly without cost? And why would you want to exchange BUSD, supposedly 100% backed by U.S. dollars held in FDIC-insured banks, for USDT, which is not?
Binance also announced the launch of a Futures Market Maker Program to incentivize liquidity on its futures platform by offering a “negative fee” for selected trading pairs. TAKEAWAY: This highlights the intensifying competition in crypto derivatives, and should further push liquidity offshore. Binance futures went live in September 2019 and already dwarf the CME’s bitcoin futures in volumes, although they launched almost two years earlier. This is not going to do much to assuage the concerns of U.S.-based institutional traders and the SEC that price discovery is increasingly coming from “lightly regulated” venues.
BitGo is expanding its institutional cryptocurrency storage service to Europe with the launch of two entities in Switzerland and Germany. TAKEAWAY: BitGo will find itself competing in Germany and Switzerland with commercial banks, who have been given the green light by regulators to custody crypto assets for their clients. Will institutional investors choose a startup, however well-funded, over a regulated and insured financial institution? Will the banks outsource their custody offerings to experienced firms such as BitGo?
European expansion has also been on the mind of Chicago-based crypto exchange Seed CX – it has added euro trading pairs for the major cryptocurrencies, stablecoins and even the U.S. dollar. TAKEAWAY: Yes, you read right – straight-up FX pairs. This could mean that the exchange is shifting its focus from crypto assets to trading technology – it has recently spent considerable effort developing settlement service Zero Hash. Yet that was built with derivatives in mind, and the current expansion seems to be focused on spot markets. Is there a bigger change afoot? If so, does this indicate growing recognition that demand for regulated crypto derivatives is not materializing as expected?
CRUNCHING NUMBERS
The seven-day average of the number of bitcoin transfers to exchange addresses has dropped sharply over the last six months, indicating a lower intent to sell. TAKEAWAY: Looking at blockchain data to discern investor behaviour is likely to play an increasingly prominent role in asset analysis, yet the discipline is still in its infancy. It’s not just that wallet labelling is still an inexact science (explained well here ); it’s also that the scope of the selected metrics is debatable (for instance, should we look at transfers to exchanges, or at overall balances?)
Larry Cermak of The Block shared a series of charts to highlight the recent shift in market sentiment. TAKEAWAY: I’m generally wary of statistics that demonstrate sentiment reversals, as it is too easy to fall into the confirmation bias trap (seeking out data to support a pre-conceived thesis). And, a month does not a trend make. But, seeing the charts in sequence does hint that this price rally may indeed be supported by increased market interest.
Crypto exchange Bitstamp’s first sector overview takes a look at some metrics behind bitcoin, ethereum and litecoin adoption. TAKEAWAY: One interesting observation is that SegWit – a new type of data structure that frees up block capacity – has had an impact in reducing transaction fees despite the price going up – and this is with just over 50% industry adoption. Growth in the use of SegWit-style blocks is likely to push fees down further, which could have a material impact on miner profitability post-halving. Yet it could also boost bitcoin use by broadening the range of possible use cases, which could end up increasing fee income overall.
ADOPTION
Lightning Labs, developers of bitcoin’s lightning network which aims to power a fast payments system on top of bitcoin, has raised $10 million in Series A financing as it gears up to launch its first paid service for merchants looking to accept bitcoin payments. TAKEAWAY: That a protocol second layer gets this level of funding shows that the business model of bitcoin payments has support. Whether the apps currently being built on the protocol get traction is actually not the point – what’s interesting is the buy-in that second-layer scaling is attracting.
Smart contract platform RSK (based on bitcoin) has launched an interoperability bridge joining it to ethereum, effectively allowing users to move RSK- and ethereum-based digital assets between the two protocols. TAKEAWAY: Anything that facilitates cross-protocol pollination broadens the range of applications by an order of magnitude. While it is not yet clear what those applications will be, this is a functionality worth keeping an eye on.
Eth 2.0 – the next iteration of ethereum, which involves a security model switch from Proof of Work to Proof of Stake, and which promises higher transaction throughput as well as lower costs – is due to launch in 2020 “with 95% confidence,” according to researcher Justin Drake. TAKEAWAY: The upgrade is a big deal. On the one hand, solving the transaction bottlenecks and latency would give a huge boost to potential use cases. On the other hand, ethereum will run on a new technology, which is risky. The steady string of delays highlights the complexity of the task, and doesn’t do much to assuage investor concerns.
At the end of January, Citigroup and Goldman Sachs executed an equity swap transaction on a blockchain platform, with a fraction of the usual paperwork, middlemen and potential for error of the traditional process. TAKEAWAY: The potential impact of blockchain technology will not just be felt in new types of assets; it can also transform how traditional assets are traded. Equity swaps are just a fairly obvious tip of the iceberg, and what we learn from experiments like this will shed a light on the plumbing of capital markets more broadly. This won’t have a direct impact on portfolios today, but it will affect access to capital and returns for almost all fund managers within a few years.
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| Hot on the heels of our first Quarterly Review, we have just published our first Monthly Review. We want this series to be a short and sweet selection of charts to do with some of the themes we’re looking at. Our aim is to trigger conversations and push forward further enquiry – suggestions welcome! You can download the report for free here.
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Previous newsletters: 58, 59, 60, 61, 62, 63, 64, 65, 66, 67, 68, 69
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CoinDesk is not an investment advisor. This newsletter is for informational purposes only, and any comments here do not constitute investment advice. |
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Institutional Crypto - You Can't Always Get What You Want