Institutional entry unstoppable, cryptocurrency infrastructure compliance accelerating

In 2019, the fastest developing areas of compliance in the U.S. cryptocurrency industry were derivatives and custody, which are two crucial infrastructures. These compliant institutions are expected to provide a channel for traditional "old money" such as university endowment funds and retirement funds to invest in cryptocurrencies.

Written by: Pan Zhixiong, Director of ChainNews Research

Let's boldly predict: the continuous entry of institutional investors into the cryptocurrency market, or the institutionalization of the cryptocurrency market, will be an unstoppable trend.

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Signs have already emerged. The 2019 annual investment report released by the U.S. cryptocurrency investment firm Grayscale showed that institutional investors accounted for 71% of the total investment, with hedge funds leading the way. In addition, Grayscale's fundraising in 2019 reached a record high of $600 million, surpassing the total amount raised by Grayscale products from 2013 to 2018. Grayscale's data has long been considered an important indicator of institutional investment entry.

Grayscale's annual fundraising amount since its establishment in 2013

In the United States, the compliance of the cryptocurrency trading system is accelerating, becoming the foundation for institutional investor entry.

After all, the U.S. remains the most important cryptocurrency market globally. By taking the U.S. as a reference, it is evident that in 2019, the compliance progress of cryptocurrency infrastructure has accelerated significantly, surpassing any previous year. A landmark event was the launch of the cryptocurrency derivatives exchange Bakkt led by the Intercontinental Exchange Group, the parent company of the New York Stock Exchange, which finally went live, offering physically-settled Bitcoin futures contracts.

Compared to the quiet year of 2018, many derivative platforms and custody platforms obtained corresponding operational licenses in 2019, capable of providing foundational and compliant financial infrastructure for the entire market. Only when fully compliant with regulatory requirements can traditional financial markets consider investing in cryptocurrencies, especially pension funds, university endowment funds, and high-net-worth individuals looking to invest in Bitcoin as an alternative asset.

Kelly Loeffler, former CEO of Bakkt who was appointed as a U.S. Senator, stated that the buyers most likely to participate in trading on the Bakkt platform are university endowment funds and retirement funds because "they are usually at the forefront of the latest investment concepts." In addition, Loeffler hopes that more brokers serving retail investors can join because the millennial generation (born in the 80s and 90s) and Generation X (born in the late 60s to 70s) in the U.S. are eager to trade Bitcoin, and brokers are always looking for new products to attract more customers.

Morgan Creek, a traditional asset management company, is now focusing on cryptocurrency assets

In early 2019, the U.S. asset management company Morgan Creek did just that. They established a $40 million blockchain venture capital fund, in which besides two retirement funds in Fairfax County, Virginia participating in the investment, Morgan Creek stated that the fund's investors also include a university foundation, a hospital investment institution, an insurance company, and a private foundation, among other traditional institutional investors.

Although Morgan Creek's new venture capital fund currently focuses mainly on equity projects and some cash-flow token projects, as more compliant infrastructures are established, these asset management companies and licensed institutions will have the ability to provide investment channels for these traditional "old money."

The compliance of U.S. cryptocurrency will be reflected in many dimensions, but derivatives and custody are two very important infrastructures, and were the fastest developing areas in 2019.

Interestingly, all of the trading and clearing organization licenses issued by the U.S. Commodity Futures Trading Commission (CFTC) last year were for cryptocurrency derivatives exchanges. In addition to Bakkt, which uses Intercontinental Exchange licenses, and Tassat, which acquired its license through the purchase of trueEX, there were a total of 4 CFTC-approved exchanges that could offer Bitcoin derivatives trading last year: Bakkt, LedgerX, Tassat, ErisX.

SeedCX was also a popular compliant exchange last year, having obtained SEF licenses to conduct swap contract trading. However, in September last year, the status of this license was changed to "Dormant," indicating that the exchange had not conducted any trades for 12 consecutive months and would need to submit application materials to resume operations. Additionally, the Chicago Board Options Exchange (CBOE) announced its exit from the Bitcoin futures contract market last year.

With the addition of the Chicago Mercantile Exchange (CME), which launched Bitcoin futures in 2017, the current legal venues for trading Bitcoin derivatives in the United States can be seen in the chart below:

CFTC License Overview

As Bitcoin is classified as a commodity rather than a security, Bitcoin derivatives exchanges do not require approval from the U.S. Securities and Exchange Commission (SEC). Another significant development last year came from the CFTC chairman, who defined Ethereum as a commodity rather than a security. This suggests that in the future, these exchanges that have obtained CFTC licenses are likely to introduce Ethereum futures contracts when the time is right, without being restricted by the SEC.

Of course, a compliant futures market does not necessarily guarantee a bull market. The first compliant Bitcoin futures were launched by CBOE on December 10, 2017, followed by CME a week later. Almost on the same day, Bitcoin hit a near $20,000 all-time high but then began a months-long decline. Many still believe there is a connection between the introduction of Bitcoin futures and the subsequent crash in 2017, not only because of the severe price bubble at the time but also possibly due to market players profiting from short positions through the futures market.

In addition to trading, asset management institutions also rely on compliant custody institutions to safeguard assets. Custody institutions holding trust licenses can not only handle the custody of cryptocurrency assets but also tokenize physical assets, such as gold circulating on Ethereum. A significant event was when the cryptocurrency financial institution Paxos' trust company obtained a license from the New York State Department of Financial Services to issue PAX Gold, a cryptographic asset exchangeable for physical gold on Ethereum. Paxos claims this is the first regulated digital gold product, where 1 PAX Gold represents 1 troy ounce of gold stored in London professional vault facilities, with its value directly linked to real-time gold market value, providing the speed and liquidity of digital assets.

Most digital asset custody institutions made substantial progress last year, such as acquiring trust licenses or launching new products, including:

• Coinbase acquiring custody provider Xapo's institutional business
• Bakkt launching its custody business independently of the derivatives exchange
• Gemini relaunching its custody business
• Paxos introducing the encrypted gold coin PAX Gold
• Fidelity Digital Asset Services (FDAS) launching custody services
• Anchorage going live with custody services

In the United States, trust licenses are issued by state regulatory bodies, with the most popular being New York State, where the global financial center, New York City, is located, and South Dakota, known for its well-developed trust industry. Along with several established custody institutions, the institutions currently holding trust licenses for digital assets custody can be seen in the chart below:

U.S. Licensed Digital Asset Custodian Institutions

These companies provide legally protected asset custody services for institutional investors, exchanges, pension funds, and asset management institutions. It is foreseeable that more large institutions will venture into alternative asset investments next year.

Even the earliest cryptocurrency license, "BitLicense," announced at the end of 2019 that it would adjust its framework, optimize some processes, and possibly ease the burden on some institutions. Since 2014, the New York State Department of Financial Services has required virtual currency service providers to obtain an operating license in the state, known as "BitLicense." Many institutions had previously complained about the cumbersome process of this license, leading some exchanges to decide to stop serving users in New York.

Outside the U.S., the Financial Action Task Force (FATF), an international anti-money laundering organization, introduced guidelines mid-last year for virtual currencies and service providers, requiring providers to share user data.

Many countries may consider using these guidelines as a crucial foundation for regulating cryptocurrencies. The current rotating chair of FATF is Liu Xiangmin, Director-General of the Legal Department of the People's Bank of China, who stated in a thematic report during a plenary session that virtual assets like stablecoins could pose money laundering risks. Generally, such service providers should adhere to FATF standards, and national regulatory authorities are responsible for implementing anti-money laundering and counter-terrorism financing rules through national laws.

In 2020, other countries are likely to emulate the U.S. structure for cryptocurrency market regulation, covering existing cryptocurrency-related products comprehensively from trading, custody, anti-money laundering, securities laws, and more, including wallets, exchanges, custody, investments, lending, and even staking. Whether these regulatory measures will stifle innovation remains uncertain, and any companies exploring this field in the U.S. will have to face these regulatory bodies or choose to exit, as seen with exchanges like Poloniex.

This article is authorized for reposting by ChainNews. Source: ChainNews (ID: chainnewscom)

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