The crypto age is upon us, and everyone is doing his or her best to jump in. Bankers, hedge funds, mutual funds, and pension funds have shown interest in the new wave. The entrance of mainstream institutions into this space indicates the beginning of a new turn of events. Financial institutions began by scoffing at the concept of crypto, but today they are gradually investing in a technology that many are anticipating will disrupt the financial sector.
Utility and security tokens
With ICOs raising over $6 billion in the first quarter of 2018, the crypto market has grown at a faster rate than anyone would have expected. Regulatory authorities have been left in the dark unsure of how to approach this thriving industry. Admittedly, it can be challenging to distinguish a token worth regulating and one that isn’t. The decision to regulate will boil down to the enforcers being able to differentiate between a utility and a security token.
A utility token, often referred to as an “app token”, is not designed as an investment vehicle. A utility token is merely a digital coupon for future use of a company’s services. They are not in themselves forms of investment as they do not have the potential to earn their owners any profits.
On the other hand, security tokens come in different forms. For example, security tokens can be backed by real estate or can be redeemed for precious metals. Security tokens are the equivalent of stocks in the traditional sense with the investor expecting to profit from the investment. This financial element puts security tokens in the same regulatory basket as any other security. The government’s position is that since one is getting a revenue stream from the token, then it is not any different from traditional stocks.
Security tokens for the institutional investor
The uncertainty surrounding the regulation of ICOs, and in general the crypto market, has been at the center stage of discussion with many players looking forward to a more regulated industry. Utility tokens have dominated this space for a while now; however, the many shortcomings, including the fact that utility tokens are illiquid, have made the market undesirable.
For the cryptocurrencies and companies launching an ICO to attract institutional investors, they must set policies for self-regulation. The ICO market seems to be drawing a number of players, with the majority of the players and token selling companies unable to understand basic token economics. Some of the tokens listed as utility tokens by these companies are not actually a utility—they are security tokens. These downfalls have scared some institutional investors away.
With security tokens in place, most problems faced by token investors will be put to rest. Token securities are bridging the gap between the traditional market and the crypto market. On the same note, these securities are more aligned to everyone’s interests. The investor will be protected; their assets will be tradable and easily transferable while individuals around the globe who want to invest in promising ICOs will be able to do so almost effortlessly.
The rise of regulated crypto exchanges
CoinMarketCap, a platform that tracks capitalization of various cryptocurrencies, estimates that more than 1600 cryptocurrencies are circulating in the market today with a combined value of approximately $290 billion. Investors around the world, including institutional investors, are keen to trade in this space. A slew of platforms have come forth to fill the infrastructural gap and enhance the seamless exchange of digital assets. Though many view them as exchanges, their operations are similar to those of e-brokerages. The rapid growth of these exchanges is reminiscent of the electronic brokerage firms of the dotcom bubble a few decades ago. Most of these exchanges are unregulated and unreliable further diminishing the possibility of institutional investors investing through such exchanges.
Lately, the number of fully compliant cryptocurrency exchanges has been rising. The Intercontinental Exchange (ICE) has plans in place to leverage the Microsoft cloud in creating an open, transparent, and regulated exchange for digital assets. Working together with The Marquee Group, BCG, Microsoft, and Starbucks, the organization will create a platform that will enable institutions to spend, store, or even trade cryptocurrencies on a global network. This move will impact this unregulated industry positively by bringing in a level of trust.
Presence of stable cryptocurrencies
It is evident that there is a great potential for cryptocurrencies to excel. However, the volatile nature, as well as the constant fluctuations in prices of these coins, has dealt a major blow to the industry’s growth. Remember, any good currency should be in a position to store value and act as a unit of account. To achieve this, players in the market are bringing in “stable coins.”
Stable coins, commonly referred to as the “Holy Grail” coins are stable versions of cryptocurrencies whose market value is pegged to stable currencies or assets such as the Euro. Stable coins are not any different from the popular bitcoin. What puts them above the typical cryptocurrencies is their level of stability. This aspect of cryptocurrencies has improved this coin’s position as a medium of exchange and a store of value.
With these factors in mind, the legitimacy of the stable coins has sparked controversy for a number of reasons. Tether, one of the most popular USD-backed cryptocurrencies has forced many potential investors to think again. The owners of the Tether (USDT) claim that its value is pegged on USD and that 1 USDT is worth a dollar. However, the crypto exchange Bitfinex has been issuing more USDT than available USD.
Another point of concern regarding this currency is that Bitfinex and Tether share the same leadership, putting the legitimacy of the coin into question. So far, no external audit on the company’s cash reserves has occurred, further worsening the coin’s position as a stable currency.
Tether’s lessons have been learned by other companies seeking to join the market. TrueUSD is one example of a stable coin that is working hard to avoid Tether’s trajectory. Unlike Tether, every holder of TrueUSD security is a beneficiary of the funds in the escrow account holding the funds. To improve safety and to comply with the anti-money laundering provision, TrueUSD has ensured that all users go through an anti-money laundering process. To further solidify its position as a real Holy Grail coin, TrueUSD will publish attestation reports on a regular basis in order to show that all TrueUSDs in circulation are secured by USD.
Financial institutions joining the space
Besides banking, the internet has disrupted many other industries. The emergence of cryptocurrencies brought about independent currencies that store and transmit value faster than any bank. Banks can no longer ignore this blockchain-enabled financial system. Otherwise, they risk falling by the wayside.
Goldman Sachs’ involvement in a token launch was a major boost to the sector. Although, the investment bank’s CEO Lloyd Blankfein had earlier dismissed the craze that came with bitcoin, recently, Goldman Sachs backed Circle which is a blockchain network enabling peer-to-peer trading. This move raised the eyebrows of major players in the industry indicating possible widespread adoption of the technology and cryptocurrencies. Circle offers a security token whose value is pegged to the dollar making it a stable token which is appealing to institutional investors.
The recent move by billionaire Steven Cohen to back Autonomous Partners, a blockchain hedge fund project goes a step further to show how institutions are ready to venture into the industry. Autonomous Ventures was launched in 2017 and aimed at providing institutional investors with a blockchain-supported investment platform.
Scams in the industry slowing the adoption of ICOs by institutional investors
The ICO market is expected to hit $20 billion in 2018. Investors are steadily flowing in hoping to get in early enough for the next big token. With so much money floating around an industry such as this one, fraudsters and scammers are all over preying on unsuspecting investors. Fraudsters come in all levels, from low tech deceptions such as the sharing of fake ICO wallet addresses on social media to more sophisticated scams.
In the past year, the likes of plexcoin, which was set up by Dominic Lacroix, raised $15 million before the Securities and Exchange Commission declared it a cyber scam. The owners of Benebit a startup that raised $2.7 million vanished mysteriously. Unlike in an initial public offering where the exchange commission dictates the disclosure and audits of true financial statements, scams are rampant in ICOs as regulations are just starting to be enforced. However, with a little due diligence, investors can detect and avoid scams.
Investors can do a few things to overcome scams, first one needs to carry out due diligence to see if whatever is being offered can truly be achieved. Secondly, a detailed review of the startup’s white paper will go a long way in helping one understand the whole company. Review the feasibility of the project including how the company plans to achieve its objective. Try analyzing the amount expected to be raised and if they really need such an amount to undertake the venture.
The year 2018 and beyond
Going forward, we expect more small players in the space with disruptive innovations. Just like IBM didn’t create Apple, Walmart did not create Amazon, and Goldman Sachs did not build the bitcoin, it is the small players and startups which will shape the future of blockchain.
The year 2017 was the year of utility ICOs and 2018 investors have learned from the mistakes of the past year. 2019 will be the year of security tokens. The adoption of the stable coins and the rise of regulated exchanges is attracting institutional investors. Whatever we have in 2018 in terms of institutions joining the space is just but a tip of the iceberg. We expect to see more flow in.
In the next few years, the crypto space will be a gold mine, and we are likely to see value for these assets. The year 2018 moving forward is an adoption phase. The adoption of the blockchain technology and security tokens as investment vehicles will continue to take shape. This technology adoption trend and subsequent regulation of the space will inspire more institutional investment further widening the gold mine.