Innovation | 04.18.18
Fast-Evolving Cryptocurrency Space Draws Greater Attention
With so much hype surrounding Bitcoin, the rise of virtual money — better known as cryptocurrency — is impossible to ignore. Even amidst plummeting valuations and signs that the fever has broken, the promise of transformative financial technology remains a compelling long-term proposition.
For financial advisors, the rapidly expanding crypto category warrants caution, of course, but also a degree of open-mindedness if only to be able to relate to a younger demographic. Advisors also need be prepared for warp-speed-evolving trends that could very well re-wire the financial system and inevitably encroach upon their long-unchallenged domain.
"There’s been so much rapid development in this space,” says Ben Marzouk, an attorney with Eversheds Sutherland, a Washington, D.C.-based securities regulatory law firm. “We’re now seeing federal and state securities regulators attempt to apply the traditional rules and regulations of the securities industry to this rapidly evolving industry of digital currencies.&rdquo
A recently published McKinsey & Company study estimates that there's now roughly $350 billion in cryptocurrency capital, much of it tied to Bitcoin, the largest cryptocurrency. Bitcoin flirted with $20,000 per token late last year, but it has since dropped more than 50 percent, shedding $175 billion in market cap. The dizzying swing underscores the manic speculation associated with cryptocurrencies and blockchain, the underlying distributed-ledger technology that supports the issuance of digital coins.
Online counterparties now, in theory, can transact directly with one another while circumventing traditional financial institutions though it's not yet clear to what extent digital coins are being used to pay for things. Such ambiguity almost appears beside the point amidst a stampede of interest reaching all the way to the highest levels of the financial industry:
- Chicago derivatives exchanges have deemed Bitcoin a commodity, creating futures and options products tied to it. Commodity Futures Trading Commission Chairman J. Christopher Giancarlo said at a congressional hearing that virtual currencies should be met with "a thoughtful and balanced response" and that distributed-ledger technology has "enormous potential.”
- The Securities and Exchange Commission is currently reviewing whether to allow NYSE Arca to list a pair of Bitcoin-futures-tracking Exchange Traded Funds.
- Charles Schwab has indicated that it might offer Bitcoin futures trading at some point.
- Western Union revealed it was experimenting with Ripple, the third largest cryptocurrency after Bitcoin and Ethereum. After suffering steep declines, Ripple's market-cap stood at about $25 billion as of late March 2018.
One question advisors might be asking: How much longer before what seems like a flash-fad gains greater staying power and goes mainstream? The answer could rest in part with regulators who are moving aggressively to understand the space and keep pace with the proliferation of digital coins, including initial coin offerings (ICOs) and their related sales activities.
A Warm Regulatory Embrace
One of the reasons for the recent plunge in cryptocurrency valuations is rising regulatory scrutiny. But just as the SEC's clampdown on ICO-related enforcement actions confirms what many suspected — a sort of “wild-west” environment rife for fraud — the agency's watchful eye is also a form of early-days validation. Start-up brokerage platforms such as Coinbase attracted millions of users in 2017 on the back of phone-based Bitcoin trading applications, drawing the attention of traditional institutions and, not surprisingly, the SEC. The SEC wants these digital coin platforms — another example being the popular trading app Robinhood, which recently allowed cryptocurrency trading — to register as exchanges to the extent that they’re offering a platform to buy and sell ICOs or digital coins that qualify as securities under the federal securities laws. Circle, a crypto-centric financial services firm, just announced a deal to buy crypto exchange Poloniex. But before Poloniex, Circle reportedly approached the SEC about registering the exchange, which would make it the first to do so. Was the SEC receptive? Circle seemed to think so, according to some media reports. Still, for the moment, uncertainty continues to cloud how cryptocurrencies are regulated.
A U.S. District Court judge recently sided with the CFTC’s authority to regulate cryptocurrencies as commodities. SEC Chairman Jay Clayton has issued a statement suggesting that the Commission expects to have regulatory jurisdiction over ICOs as securities. With each passing day, regulators are more visible in exerting their reach, signaling a recognition of the staying power of financial technology, and why traditional financial industry members are behooved to pay more attention to the space.
Rapid Growth of Crypto Funds
The SEC recently started reaching out to more than 100 hedge funds that invest in cryptocurrencies that are, at present, unregulated. You might be asking: There are more than 100 crypto funds? Yes, and most of them were launched last year. One industry estimate put crypto fund assets north of $2 billion.
One of the largest such funds is BlockTower Capital, which quickly raised $100 million for its discretionary trading strategy; it is now closed to new investors.
The Stamford, Connecticut-based fund, backed by two Silicon Valley venture capitalists, was co-founded by Ari Paul, a former investment officer with the University of Chicago endowment. Paul tweeted earlier this year his expectation that the industry will soon be driven by crypto index funds. "We're in the third inning of the birth of a new industry," he recently said in an interview with a website called CryptoMeNow.
It would not be a surprise if some type of fraud gets rooted out in the coming months as the SEC gathers info on crypto funds. However, there's a flipside to this exercise: the SEC will glean a pile of information that it can use to develop policies.
According to Ben Marzouk, the SEC’s ongoing investigation of ICOs “means that the industry is waiting to see how and if the SEC attempts to shoehorn ICOs into the existing securities laws, or if an entirely new regulatory framework will emerge for these ICOs.”
One thing is certain, cryptocurrency is still quite volatile. When considering clients’ wealth-management needs, this is a sector to watch closely and see how — and if — it develops.
Rich Blake A veteran journalist based in New York City, Blake has covered the financial world for numerous publications, including Institutional Investor, ABCNews.com and Reuters. Blake was a co-founder and executive editor of Trader Monthly magazine. The Buffalo native is the author of three nonfiction books, including “The Day Donny Herbert Woke Up,” which is currently being adapted into a motion picture. In 2004, Blake was nominated for a National Magazine Award in the Reporting category for Institutional Investor.