ICE Creating New Cryptocurrency Market: A Double-Edged Sword
Intercontinental Commerce (NYSE: ICE), mom or father of the New York Stock Commerce, presently launched it is establishing Bakkt, a model new ecosystem for cryptocurrencies, along with various companions. This generally is a fundamental step inside the mainstreaming of bitcoin and cryptocurrencies. Nevertheless it certainly’s moreover a double-edged sword, on account of it’s most likely the beginning of Wall Avenue creating financial claims to bitcoin out of thin air (and by no means backed by exact bitcoins), which could offset just a few of Bitcoin’s algorithmically-enforced scarcity. Perhaps that’s why bitcoin’s price declined barely after presently’s announcement by ICE.
Bakkt is however further proof that incumbent institutions are increasingly more taking the “be part of ‘em” technique to cryptocurrencies, as explored in Half 1 of my 3-part assortment regarding the establishing rivalry between cryptocurrencies and Wall Avenue. Bakkt would possibly convey many positives to cryptocurrencies:
- it ought to most likely entice further institutional consumers to cryptocurrencies,
- it may resolve the custody draw back that has so far saved huge institutions from investing inside the cryptocurrency asset class due to the absence of knowledgeable custodian, which the SEC requires for funding advisors that deal with $150 million or further,
- it may help regulators turn into further cosy with the sector to see ICE involved, and
- most importantly—it ought to perhaps entice firm issuers to spice up capital using the Bakkt ecosystem. Cryptocurrencies provide issuers the prospect of covenant-free and preference-free capital at low value. Merchants have confirmed their willingness—rational, individually—to commerce customary investor protections in return for the low friction costs involved with cryptocurrencies—there are not any underwriters, trustees, swap brokers, exchanges, custodians, clearinghouses or central securities depositories involved in cryptocurrency issuance, and—very importantly—cryptocurrency trades settle instantly and with no counterparty hazard. Moreover, issuers incur solely a small proportion of the costs of being a public agency, equal to investor relations costs, proxy solicitation costs and the quite a few compliance costs related to public-company financial reporting and auditing. Furthermore, cryptocurrency issuers can repurchase money or execute a younger/change provide far more successfully than for standard securities.
I doubt it’ll probably be very prolonged sooner than fundamental firm issuers be part of Telegram and Eastman Kodak in elevating capital by the use of these markets. That’s the nice form of financialization—attracting new consumers to the networks, each of whom (in proof-of-work blockchains) makes the networks safer by bringing new laptop computer sources to the networks, immediately or circuitously on their behalf—and that, in flip, makes the networks further decentralized, resilient and proof towards assault.
Kudos to ICE for being first!
Nevertheless ICE’s data moreover has downsides. As explored in Half 2 of the 3-part assortment merely two days prior to now, Wall Avenue’s solely shot at controlling cryptocurrencies is to financialize them by the use of leverage—by creating further financial claims to the money than there are underlying money and thereby influencing the underlying coin prices by the use of derivatives markets. It’s nearly inconceivable at this stage for anyone to understand administration of the Bitcoin group (and sure the alternative big cryptocurrency networks too), so Wall Avenue’s solely fundamental avenue for controlling them is to financialize them by the use of leverage.
The financial system has perfected the art work of leverage-based financialization, sadly, and ICE’s announcement about plans to launch a regulated, bodily bitcoin futures contract and warehouse (matter to CFTC approval) in November means leverage-based financialization might be going coming to bitcoin in an infinite method.
That’s exactly what I’d warned of in Half 2:
“As cryptocurrency markets develop extra, proper right here’s what I’ll be searching for: financial institutions beginning to create claims in the direction of cryptocurrencies that are not completely backed by the underlying money (which could take the kind of margin loans, coin lending / rehypothecation, coin-settled futures contracts, or ETFs that don’t 100% observe the underlying money at any given second). None of these are going down on the market however, though.
“To this point, regulators have solely allowed bitcoin derivatives in cash-settled sort amongst fundamental derivatives counterparties. Whereas cash-settled derivatives can affect the value of the underlying asset, the magnitude of the impression is lower than the impression if derivatives had been settled in an underlying that is “exhausting to borrow” or “specific” (using securities lending parlance). Bitcoin may be very “exhausting to borrow” so a requirement to ship the underlying bitcoins into derivatives contracts would amplify bitcoin’s price fluctuations.
“Lastly it’s most likely regulators will approve bitcoin-settled derivatives amongst fundamental derivatives counterparties. At the moment, banks may be making an attempt to borrow the underlying bitcoin—and that’s when the custodial preparations made by institutional consumers will start to matter. Will custodians make their custodied money on the market for borrowing in “coin lending markets” as they do with securities lending presently? Or will they deem the cybersecurity risks of lending money (which entails revealing personal keys) too extreme relative to the extra return on the market for coin lending? And might institutional consumers even allow coin lending by their custodians? Regardless, when bitcoin-settled derivatives appear on the scene, it’s very most likely that cryptocurrencies may be “exhausting to borrow” for pretty some time on account of HODLers (long-term holders) private most money and barely use custodians.” (emphasis added)
Why does this matter? Bitcoin has algorithmically-enforced scarcity, and that’s an infinite part of what provides it price. If Wall Avenue begins to create claims to bitcoin out of thin air, unbacked by exact bitcoin, then Wall Avenue will attain offsetting that scarcity to some extent.
The similar pattern occurred in commodities markets, equal to gold and silver. It moreover occurred in credit score rating derivatives, which, sooner than the 2008 financial catastrophe, had grown to 10x the size of the underlying firm bond market and had turn into the proverbial “tail that wagged the canine” by driving the value of the underlying firm bonds.
If a giant diploma of leverage-based financialization ever happens to bitcoin, the group that secures the Bitcoin group with its processing power would possibly switch on to a singular foreign exchange. Sadly, the data on this entrance is already not good, as retailers confirmed that day-after-day liquidity for synthetic variations of bitcoin is already roughly $15 billion, which is 3x bitcoin’s day-after-day spot liquidity of roughly $5 billion. Leverage-based financialization of bitcoin thus far has occurred principally exterior of the US—a wonderful occasion of that’s Hong Kong-based change OKEx’s affirmation presently that thought-about one among its shoppers had fundamental losses on a leveraged $400 million futures place, inflicting it to claw once more $9 million from its shoppers to cowl the change’s loss.
Nevertheless there’s trigger to be optimistic, due to HODLers, on account of bitcoin is an equity-based asset that will solely be financialized if holders convey their money into the financial system.
To sum, liquidity arising from the good form of financialization is a gigantic optimistic for cryptocurrencies, nevertheless, to quote from Half 2:
“…liquidity arising from leverage-based financialization—which creates claims to cryptocurrencies out of thin air—is the opposite side of the double-edged sword. Cryptocurrency speculators will encourage this on account of it’ll most likely drive short-term options, nevertheless long-term HODLers will resist it simply by holding their money away from the financial system. Accordingly, further of the good form of financialization is extra prone to occur in cryptocurrency markets than the unhealthy kind. This suggests alpha (further return) options is also on the market to institutional consumers. It moreover means Wall Avenue is unlikely to succeed at “capturing”cryptocurrencies.”
Lastly, cryptocurrency market contributors presently seen the irony of this quotation from ICE’s CEO, Jeffrey Sprecher, in its press launch:
“In bringing regulated, associated infrastructure together with institutional and shopper capabilities for digital property, we intention to assemble confidence inside the asset class on a worldwide scale, consistent with our observe report of bringing transparency and perception to beforehand unregulated markets.” (emphasis added)
Bitcoin already has perception and transparency precisely on account of no centralized institution controls it. Nevertheless a centralized institution that is allowed to create financial claims to bitcoin out of thin air has the potential to erode just a few of that perception and transparency.
Luckily, for present bitcoin consumers, HODLers usually tend to make that troublesome by storing most bitcoins exterior of the financial system and making it the epitome of “exhausting to borrow.”
Disclosure: I private cryptocurrencies and investments in blockchain companies, along with Kraken, Overstock.com and Symbiont, and I labored on Wall Avenue from 1994-2016, most currently working Morgan Stanley’s pension choices enterprise.