The Institutionalisation Of Cryptocurrency
Diversification across asset classes is the foundation of any long-term investment strategy. Diversification, investors know, offers not just protection from overall portfolio volatility, but also holds out the prospect of higher returns over time.
So the appeal of cryptocurrencies to investors—especially institutional investors—is obvious. Here is not only a new asset class, but one that is also highly liquid, giving it an advantage over ‘stickier’ assets such as commercial property, land, and physical infrastructure.
Some may say that cryptocurrencies are too volatile for a place in an institutional investor’s portfolio. And certainly, the gyrations in the value of bitcoins over the past few months have been extreme; we saw it reach a few dollars short of $20,000 just before Christmas, and then fell to $6600 by early April. But for such investors, fluctuations are part of the landscape, and no different from the fluctuations and volatility experienced in many stock and shares investments.
In fact, it can be argued that this volatility is to be welcomed, because in it lies opportunity. With an asset displaying volatility and price fluctuations, skilled institutional investors can add value for their clients by executing trading strategies designed to capitalise on that volatility. In a perfectly flat price range, there is far less opportunity to add such value.
We believe institutional cryptocurrency investing is inevitable. Going forward, cryptocurrencies will form part of a growing number of multi-asset investment portfolios. But that inevitability doesn’t mean that cryptocurrency investing is necessarily easy, or straightforward—not yet anyway. In particular, for cryptocurrencies to be freely tradable, and to be accessed by those other than crypto enthusiasts, there will need to be the kinds of mechanisms and infrastructure in place that are taken for granted in more traditional asset classes.
If we take a look at those traditional asset classes, it’s not difficult to see a series of services underpinning the buying and selling of financial instruments—services that are often provided to market participants by intermediaries. Reliable exchanges, for instance. Payment system mechanisms. Hedging and trading mechanisms. The ability to borrow or lend financial instruments within an asset class. Futures trading. And for all these capabilities to be provided in exchange for fees that are both reasonable and transparent. These capabilities underpin and lubricate the financial markets of the world—and cryptocurrencies are no different.
What prevents intermediaries from offering these services and mechanisms? It’s certainly possible, at first sight, to point to regulatory interventions. Authorities in China, for instance, have banned cryptocurrency trading exchanges, and prohibited initial coin offerings. In the United States, the Securities Exchange Commission is considering its position. So too is South Korea. On the other hand, European regulators appear more optimistic, a stance true of London too.
But such regulatory intervention is unlikely to prove a long-term barrier. In taking their positions, regulators are trying to protect ordinary consumers and retail investors, not institutions. And as institutions are already regulated, of course, it is reasonable to take the view that further intervention is unnecessary. Certainly, our view here at Lendingblock is that we welcome working with regulators, and have so far worked very proactively with them.
The simple fact is that the services and mechanisms that are needed in order to underpin an effective market in cryptocurrency investment are simply too new to have yet been delivered. The need has been recognised and potential providers—providers such as ourselves, here at Lendingblock—are positioning themselves to come to market with a service offering.
In our own case, the role we intend to play is that of an intermediary acting between borrowers and lenders of cryptocurrencies, just as in the world of equity investing, where shares are borrowed and lent in order to support trading strategies. The lender earns an income; the borrower gains the required liquidity to execute their strategy. As the intermediary between the borrower and the lender, we play a vital role: bringing the two parties together, acting as a trusted conduit, and providing the means through which the lender is paid their income, and the means through which the borrower secures the cryptocurrency that they need.
More than that, we meet institutional borrowers’ and lenders’ requirements in terms of security, privacy, and verification—enabling trustless verification of identity, providing total privacy for the duration of a transaction, and high levels of security through two-factor verification. A transaction with Lendingblock is carried out through cryptocurrency asset-agnostic and consensus-agnostic ‘smart contracts’, pulling together different blockchains to provide the required liquidity in a single, smart bundle.
And we’re not alone, of course. Right across the sector, other intermediaries are emerging, each offering a different piece of the puzzle. The required capabilities, mechanisms and services will continue to emerge, and will be in place to serve the institutional marketplace as cryptocurrency trading and investment gathers pace.
The numbers are impressive. Taking figures from the International Securities Lending Association as a basis, cryptocurrency assets in circulation could reach $600 billion by 2020. Assets used as collateral could climb from zero today to $20 billion. And the revenue earned from that lending, assuming a 1.5% fee, could reach $300 million. As the drive to develop the required mechanisms and services picks up momentum, it is figures like these that are propelling the effort.
And at Lendingblock, rest assured that we’re playing our part, giving investors the infrastructure needed to thrive in the crypto market.