Crypto specialist Copper on why institutions haven’t bought into crypto
There are a lo...
Dmitry Tokarev, the CEO of Copper, discusses the state of cryptocurrency in relation to institutions, and why they have yet to adopt it.
There are a lot of reasons to feel full of confidence for the burgeoning cryptocurrency market midway through 2019. Prices have rebounded and there is a fresh surge of interest from new crypto hedge funds. Yet, there is a gap in the market which remains undeveloped and immature: the currently minimal institutional participation.
There are several reasons why this is so. First of all, there is considerable legal and regulatory uncertainty surrounding the status and correct treatment of cryptocurrencies. It is not yet clear if crypto will be treated as a security, currency, commodity or even a utility.
Many grey areas remain. And these ambiguities make it very difficult for institutional buyers to manage their investments and be certain they are compliant with what regulators expect.
Some national regulators have said more than others about crypto, and some appear highly dubious about the new asset class. The UK’s Financial Conduct Authority, for example, has proposed a ban on the sale of derivatives and exchange traded notes (ETNs) linked to crypto to retail buyers – saying it’s "impossible to reliably value the derivatives contracts or ETNs linked to them".
In the US, Facebook’s proposed new digital asset, Libra, has run into opposition from the US legislature. While In June 2019, the Securities and Exchange Commission (SEC) announced a $100m lawsuit against messaging app, Kik Interactive, for an allegedly illegal initial coin offering (ICO) in 2017. None of this is likely to encourage institutional buyers to get involved.
The disparate nature and practices of the now more than 500 cryptocurrency exchanges doesn’t help adoption by institutions either. On-boarding procedures are far from uniform and can often take weeks or months.
This means, for example, that the Know Your Customer (KYC) process, which institutional buyers must complete, takes far too long. Each exchange has a different way of doing it so it is not as if once completed the buyside firm can use the same documentation for a different exchange. Regulators are increasingly assertive about KYC protocols, so it’s not something that can be side-stepped, and rightfully so.
The cryptocurrency market at the moment also lacks the liquidity to tempt the largest buyers. Institutional players need to be able to enter and exit a market with ease and to trade in large volumes. Even the largest exchanges aren’t set up for this kind of demand; they were designed with retail buyers in mind.
Reportedly, the largest ever crypto margin call was $460m on OKEx Bitcoin Futures in July 2018, but $416m was left unfilled. The margin call couldn’t be filled, eradicating the entire orderbook. This sort of thing doesn’t give the big players much confidence.
A well-known and well-documented impediment to greater institutional participation is the lack of a reputable and comprehensive custodial solutions. US institutional buyers are compelled by the terms of the 1940 Investment Advisors Act and also the 2010 Dodd-Frank Act to use the services of a so-called ‘qualifed custodian’.
Institutional investors are not only obliged by law to use a custodian, but the distressingly common theft of crypt assets makes a quality custody solution a necessity. According to a report from crypto security firm CipherTrace, $356m was stolen from accounts in the first quarter of 2019, and in total $1.2bn was lost through a combination of theft and fraud.
As self-custody is not an option for institutional accounts, there are two options: rely on the exchanges to provide custody or look for a third-party provider. Exchanges don’t fit the bill as they don’t provide the separation of roles and controls to make the institutional client feel comfortable, and as noted above, they are idiosyncratic and difficult to deal with.
This leaves the third-party custody providers – whose solutions have been rapidly evolving recently. There is a great deal of work and investment devoted to developing a solution that is both secure and accessible. Custody providers are also providing an increasing number of additional services – such as prime brokerage and settlement solutions, differentiating themselves from standard secure wallet solutions.
With institutionally-focused solutions coming to market, we are starting to see a turn-around (albeit a slow one) towards providing an infrastructure that suits institutions’ needs.
For example, launched in August 2018, Copper has what it says is the industry’s first server-less (offline) co-sign custody solution, using a ‘walled garden’ approach – incorporating the investment manager, exchange accounts and the custodian.
Multiple signatures are required to withdraw funds within the walled garden, protecting a fund from bad actors.
There are a number of other notable solutions in the space. For example, in the first quarter of 2019, Fidelity unveiled a crypto custody solution, thus becoming the first undisputed heavyweight to enter the space. State Street is also said to be looking at the market, as are JP Morgan. And Goldman Sachs have already invested in a crypto custody offering.
Coinbase launched its institutional service a year ago and, according to an interview with chief executive officer Brian Armstrong in May 2019, it now has $1bn assets under management from around 70 institutions.
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Crypto funds constituted some 20% of all hedge funds launched in 2018, while the number of identity-verified crypto users doubled in 2018. In April 2019, Reuters reported that venture capital investment in crypto had totaled $850m in the first three months of the year, already on course to better the $2.4bn seen in 2018. Moreover, individual investments are getting bigger: 2018’s total came from 117 investments, whereas this year’s tally stems from just 13, Reuters reported.
At the beginning of July, Prime Factor Capital, a London-based hedge fund manager set up by former employees of BlackRock and RWE AG, became the first cryptocurrency investment firm to win the stamp of approval from UK regulators and will be regulated as a full scope alternative investment manager under EU rules.
Slowly but surely, the world of cryptocurrencies is changing.
FIVE things fintechs must do to keep investors onboard
New investors flocked to the stock market during the COVID-19 pandemic. Thirty-eight percent of investors said they had never had a brokerage or similar account before opening one in 2020.
Low or no-fee trading options have helped accelerate the trend – nearly half of new investors said they accessed their account primarily through a mobile app. As FinTechs, how do we create the trust needed to keep new investors in the market and create a fruitful customer experience for them?
The financial industry does a disservice to individual investors if we merely offer tools that focus on making money quickly, an approach that usually backfires. Instead, the surge of interest presents an enormous opportunity for those who want to help more consumers use financial technology to educate them on responsible spending, saving, and investing in order to achieve financial wellness current fintech tools have welcomed individual investors in the door.
Now, it’s time to focus on education and improving their experience going forward. There are several ways those of us in fintech can step up to shape the future of retail investing so that it works better for everyone, starting with the following areas.
Equal access to financial wellness education
Financial health should be available to everyone — but today, not everyone has the educational resources to achieve it. One study shows that only 3.9% of students from low-income schools were required to take a personal finance class. What they aren’t learning in school or from family members, fintech companies can provide on their platforms.
The companies should move from solely offering financial services to a more responsible model of education, advice, and prescriptive choices to help consumers develop better habits and make wiser financial decisions. Not only can they empower consumers and bridge historical wealth divides, but they can also stimulate growth by opening up new consumer segments.
Just as we’ve come to expect that our fitness routines are tailored to our individual bodies, we’re also ready for finance tools that go beyond one-size-fits-all solutions. But only six percent of financial institutions say they’re using the kind of technology that allows them to deliver a deeply personalized experience. Fintech tools need to reflect that financial success looks different for each of us.
For one consumer, it may mean providing guidance on how to pay off student loans early; for another, it may mean prescriptive actions that enable them to stick to a budget for the first time; for a third, it could look like prioritizing environmental, social and governance (ESG) investments, so that her portfolio aligns with her political beliefs.
Now, we are seeing financial technology beginning to meet the demands of personalized finance in a substantial and meaningful way.
The rise of AI-Powered Advice
Big-picture advice and predictive guidance used to be a feature of high-end financial advisory firms — a perk only available to those who could afford it. But thanks to rapid advancements in data analytics and artificial intelligence (AI), that kind of holistic advice is now more accessible than ever. AI-driven robo-advisors can parse many different streams of financial information, delivering customized answers to key questions: Is it time to buy a home, or is it smarter to keep renting? Can I afford to take out another student loan?
Intelligent connectivity powered by AI can anticipate consumers’ needs and next steps, making proactive suggestions that guide them along the path to financial wellbeing. Fintech companies can also help consumers identify when their financial picture becomes too complex for a robo-advisor, and help them find a human financial advisor to meet their needs.
Focus on financial mental health
New investors are quickly finding that the market can be overwhelming. That’s not surprising, financial anxiety is common and studies show that financial stress can have an impact on mental health for some.
It’s not enough for fintech companies to give retail investors access; they also must provide the guidance and support that help consumers manage their financial well-being. Educational tools can ensure that consumers are well informed about their options.
Predictive analytics can anticipate consumers’ questions, serving them key information and insights before they ask. Features that emphasize a comprehensive notion of financial well-being, rather than short-term wins and losses, can also help ensure that consumers are keeping their eyes on the bigger picture.
Gamification for good
The surge of gamification apps has done an impressive job making investing as engaging as playing a video game or joining a social media platform.
Much of the current use of gamification emphasizes short-term thinking, but there’s also an opportunity to help consumers think more broadly about their overall financial picture. One example is peer benchmarking, a feature that enables help consumers to see how their financial habits compare to those of friends and fellow consumers.
Gamification can also be used to incentivize making smaller, smarter choices — for example, rewarding saving over making an impulse buy.
The future of fintech is about more than just broadening access to the markets. It’s about making sure more individuals have access to the tools that can help improve their financial well-being—in the ways that suit their own circumstances and needs. The potential to act within their own set of individual priorities, with their long-term financial wellness in mind is much more empowering to a consumer than simply relying on short-term, high-risk investments.
About the author: Brandon Rembe is CPO at Envestnet Yodlee. He has over 18 years of experience building high-growth technology, software, and information service companies, Brandon has worked across a broad spectrum of enterprises from early-stage ventures to global businesses.