By Salil Deshpande
September 12, 2018

There have been rumblings about financial institutions adding crypto services to their offerings, raising new funds for digital currencies, and even launching dedicated trading desks.

But until institutional investors have a regulated, full featured trading exchange with diverse sets of spot and derivatives products, their adoption will crawl at a snail’s pace, and crypto will continue to fall short of being the robust, legitimate asset class that it can be.

Institutional exchanges for cryptocurrency represent a multi-billion-dollar whitespace market. Various parties—including Intercontinental Exchange, parent company of the NYSE—are vying to get such venues up and running. But some of the exchanges in development today face significant regulatory hurdles, and may be held back from launch until they wrestle with complex issues like securities custody and settlement.

So, what are institutional investors to do since many want to make meaningful moves in the crypto markets now, not years from now?

Why Crypto’s Retail Infrastructure Won’t Work for Institutions

Crypto was born “retail first.” In many ways, crypto wouldn’t exist without the early adoption of retail speculators and entrepreneurs. But this came at a cost, because building an asset class “retail first” ignored the largest consumers of mature asset classes: traditional institutional capital. These investors and speculators provide liquidity for consumers, stabilize prices and drive innovation around valuation.

But large institutional players demand levered products (derivatives), highly reliable infrastructure hosted in Wall Street data centers, and compliance features that fit in with their existing trading desks.

This is why institutional investors will be challenged to adopt existing retail focused crypto exchanges. Not necessarily because all are untrustworthy, but because they were built retail-first. That said, trust is indeed an issue for institutional players, as many retail exchanges are unregulated and based offshore.

Crypto needs better “rails” in place to turn it from an asset class into a capital class. But it is “here to stay.”

Making Crypto a Capital Class

What’s needed to make crypto a capital class is to allow physically delivered forwards, or the delivery of the actual asset after the expiration of a trading contract. This will be instrumental for getting institutional investors into crypto—but the existing infrastructure has problems delivering this.

The Chicago Mercantile Exchange and the Chicago Board Options Exchange have started down this path by offering financially settled forwards for Bitcoin (cash settled in lieu of physical Bitcoin). However, because of the thin liquidity in the underlying spot markets, these contracts are subject to manipulation at settlement and distrusted by institutional venues. Daily volumes in August averaged just over 30,000 Bitcoin equivalent on CME and 5,000 on CBOE .

This is why Bain Capital Ventures joined OKCoin USA to lead a $15 million Series B in Seed CX, a licensed cryptocurrency exchange to offer institutional trading and settlement for both spot and CFTC-regulated derivatives. This company will give institutions access to the levered products they want, with settlement functionality—including physically delivered forwards—on its platform.

Centralized or Decentralized?

Ultimately, two parallel worlds will form to support the crypto asset class:

  1. a centralized system that mirrors the traditional financial system, but with many friction points removed, creating an on-ramp of fiat into the crypto world.
  2. a decentralized, trust-less replica of the centralized system with protocols built to support each independent function.

One cannot exist without the other and both can flourish together.

There’s benefit in crypto assets and services that fall into the second, i.e., the decentralized, category, because they offer an alternative, non-fiat way to store value and conduct business without reliance on the competence and ethics of sovereigns and central banks, a notion that will gain more appreciation.

Central banks—especially in the developing world—can harm national economies if they can’t overcome systemic shortcomings and stem inflation or devaluation. This is why some companies are developing “stablecoins” whose value is less prone to fluctuation, in one case pegging the value of a digital coin to the U.S. dollar. A decentralized digital currency like this can protect a society from the fallibilities of its own central bank.

Decentralized money markets built with blockchain will also be of great benefit to the developing world, as they will enable people to lend, borrow and earn interest on their crypto assets without the burden of counter-party risk.

There is plenty of opportunity to create new ways for the hundreds of millions of unbanked and under-banked people to join the global economy. Decentralized crypto assets can help people worldwide.

But cryptocurrency as an asset class will not fully develop until institutional investors get off the sidelines and into the game. And what these investors want is a centralized, trusted venue for trading these new currencies.

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