The lack of trusted custody solutions is one of the main hurdles holding back institutional trading of cryptocurrencies according to consultancy GreySpark Partners.
Greyspark said in a report, Charting the growth of cryptocurrencies, that the number of crypto-hedge funds has increased significantly over the past two years but the creation of funds is slowing down, mainly due to the lack of trusted custody solutions. The consultancy expects the number of funds to reach between 160 and 180 by the end of this year, which is only 2% of the 5,500 hedge funds trading other asset classes globally.
“The market is waiting for big houses such as State Street and Northern Trust to take on this role,” added the report . “Difficulties in accessing liquidity or finding capital-efficient instruments for short or hedge positions is also an issue.”
Business Insider reported yesterday that Goldman Sachs is postponing plans to open a cryptocurrency trading desk, due to regulatory uncertainty, and the investment bank is looking to launch a custody product for the new assets instead.
William Benattar, head of fintech at GreySpark Partners, said in an email to Markets Media regarding the custody issue: “All institutions, not matter the type have one thing in common: no one is ready, no one is even near to be ready but yet, in an attempt to get the first mover advantage a few institutions are going public claiming that they are operational.”
Benattar added that traditional custodians need to follow customers and adding digital assets will become necessary to prevent clients moving to a different service provider. For exchanges, the combination of a digital assets platform and custody services makes sense as it provides customers with end-to-end services. “The trade life-cycle is fully covered (clearing, settlement and custody, in some instances fiat to crypto conversion is also supported),” he added.
For example, Deutsche Börse has formed a distributed ledger technology, crypto assets and new market structures unit as it expects the digital economy to be more decentralised. Jens Hachmeister, head of the new Deutsche Börse team, said in an interview on the German exchange’s website that new technologies could potentially cut across the entire value chain from initial pubic offerings to settlement and custody.
Another German exchange operator, Boerse Stuttgart Group, is aiming to create an end-to-end infrastructure for digital assets. Switzerland’s stock exchange – owned and managed by SIX – is also building a fully integrated trading, settlement and custody infrastructure for digital assets.
In the US, Intercontinental Exchange has launched Bakkt, a new company which will use Microsoft cloud solutions to create an open and regulated global ecosystem for digital assets. The Bakkt ecosystem is slated to include federally regulated markets and warehousing along with merchant and consumer applications in the digital asset marketplace, which it estimates at $270bn (€232bn).
Benattar said: “Bakkt is a game-changer. It shows how investment in digital assets can be institutionalised and paves the way for large financial institutions to join in. The message is that bitcoin (and cryptocurrencies) credit cards and bitcoin to your pension fund is not so far off.”
In the context of custody and private keys management, he added that Ledger is the most advanced solution. “Ledger supports multiple digital asset and currency types and they have set up multi-signature approvals, enabling compliance oversight of individual transactions with controls and approval options,” said Benattar.
In addition to custody, another hurdle for institutions is that cryptocurrency liquidity is highly fragmented across multiple pools so it is difficult for institutional investors to assess prices and trade in a consolidated fashion.
Market participants are beginning to provide more cryptocurrency data to institutional investors. In July Thomson Reuters teamed up with CryptoCompare to integrate data for 50 coins into its financial desktop.
Sam Chadwick, director of strategy in innovation and blockchain at Thomson Reuters, told Markets Media at the time: “Having data on Eikon will help institutionalise the market by providing validation on cryptocurrencies that exist and by building the ecosystem.”
Chadwick expects that Thomson Reuters will eventually provide the same level of data as in traditional markets and new types of data such as blockchain analytics.
Another hurdle for institutions is that inadequate liquidity also exposes crypto-assets to high volatility.
“Compared to other large pools of capital within financial services, cryptocurrencies are still small – but catching up at a compound annual growth rate of more than 550%,” said the report.
Greyspark analysed the growth rate of cryptocurrencies between May 2016 and May 2018. The consultancy predicted: “At the growth rates listed, cryptocurrencies would overtake the entire US stock market by November 2020.”
As these hurdles are overcome, GreySpark expects more institutional traders to enter the cryptocurrency market, which is also reflected in the launches of ‘institutional-grade’ exchanges such as Archax and BeQuant.
Archax said today it has chosen Aquis Technologies, the financial and regulatory technologies services arm of Aquis Exchange, to supply trading technology for the new venue when it launches in the first half of next year.
Graham Rodford, chief executive of Archax, said in a statement that using a regulated multilateral trading facility operator to run its core matching engine, and using Aquis’ market surveillance team, will fast track the venue’s time to market.
David Lester, advisor and non-executive director at Archax, said in a statement: “For an institutional exchange to be successful, the choice of technology is key. I am delighted that Archax is choosing to partner with Aquis, a proven operator of technology for existing regulated, high-performance markets.”
Lester is the former chief strategy officer of the London Stock Exchange Group.
Benattar concluded: “The global cryptocurrencies trading landscape is maturing to a level at which real-money institutional investors are becoming incentivised to actively place end-investor capital into the marketplace.”