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.
Stripe backs Step - the digital bank for teens
The Series C round raised US$100m in capital from a number of backers, including Coatue, TikTok star Charli D’Amelio, actor Jared Leto, and Will Smith’s Dreamers VC, for the enterprise.
Step provides a free FDIC-insured bank account and Visa card to teenagers. The accounts are backed by Evolve Bank and there is no subscription charge for its usage. Users don’t pay for their accounts and there are also no overdraft fees.
The mobile banking app enables parents to set controls and limits on spending and encourage responsible finances. According to data released by the company, 88% of the platform’s users say this is their first bank account.
To date, Step has seen great success in the marketplace. The company has raised more than $175m from investors and now has 1.5m users.
Stripe, which was founded by Irish brothers Patrick and John Collison, previously led Step’s $22.5m Series A round in 2019.
Step's Series B funding round also brought in $50m, and has a distinctly celeb-tinged reputation with investors including Justin Timberlake and the pop duo The Chainsmokers.
Users get access to a free, FDIC-backed bank account, a spending card and P2P payments platform to send and receive money instantly.
CJ MacDonald, chief executive of Step, said the company is aiming to improve the financial futures of the next generation. “Step is the only banking platform that enables teens to start building a positive credit history before they turn 18 and does not charge fees of any kind.
He has previously spoken about the importance of financial literacy for young people. “Money is just one of those things where I think the more educated and equipped you are early, the better decisions you can make down the road,” he told . “And you can also prevent yourself from making costly mistakes. I mean, the average American doesn't have $400 in emergency savings and pays $350 a year in banking fees. If we can help this next generation just ultimately be smarter and more educated as it pertains to money, I think we'll all be better off.”
Kyle Doherty, managing director at General Catalyst and Step board member, explained, “Gen Z is flocking to modern financial solutions that can be easily embedded within their digital lives and Step has a unique model for how to do this right.”
The news follows on from Stripe’s recent announcement that it plans to acquire TaxJar. The fintech, which builds software for online businesses that automates the reporting and filing of sales taxes, will most likely be integrated with Stripe’s billing services.
Currently, No terms have been disclosed but the Boston start-up had raised more than $60m from investors including Insight Partners.
Stripe chief financial officer Dhivya Suryadevara said of the move, “With TaxJar, we will help millions of internet businesses running on Stripe with their sales tax and make it easier for them to sell internationally.”