When it comes to digital assets, 2019 has been a rocky year as cryptocurrencies such as Bitcoin took a major hit while trading volumes shrunk. Phil Mochan, co-founder and head of strategy & corporate development at Koine, reflects on the past year and predicts likely trends for 2020.
Over the past year we have seen continuing market development progress, negative regulatory sentiment, and price volatility of the principal digital asset (Bitcoin or BTC), which started 2019 at USD 104bn market cap and soared to USD 377bn, before declining to around USD 130bn, with further declines predicted.
Additionally, trading volumes and order book depth of exchanges have diminished in favour of OTC trading, though overall volumes appear to have risen slightly.
Retail participation would seem to have reached a plateau; though, from the growth of digital asset conferences (in Asia and US notably), growth of settlement coin volumes, and switch to OTC based trading, it would appear that family offices are increasingly deploying capital into the digital asset space. This may be because either they are seeking a hedge against a general market collapse, or looking to improve overall portfolio returns through limited diversification.
As well as this, several new OTC desks, operated by hedge funds, opened for business taking significant market share. Hedge funds began trading operations or liquidity provisioning using their principal capital to explore the market characteristics and develop effective trading strategies, but the expected wave of allocation to these funds by institutional asset managers has not yet been observed.
It is safe to say crypto has had a difficult year. As a result, a number of organisations have emerged in an attempt to help move crypto along and brighten its future.
In October, BAKKT opened for business in the USA, with a business model designed to create a regulated equivalent of BTC spot price. Its modest reception, cold store security model, and distribution tie-up with Starbucks indicate that retail markets are its focus, despite its “institutional” positioning.
In addition, Europe had its first Exchange-Traded Fund (ETF) issued in September of this year, whilst in the US, domestic ETF’s have made very limited progress. However, a legal ruling in Canada has paved the way for the first issuance, scheduled for 15 December in Toronto, which, through bi-lateral treaty arrangements, will be eligible for US listing in 2020.
The Securities and Exchange Commission (SEC) continues to have issues in approving ETF products due to what appears to be the inadequate security models of existing US custodians. The Chicago-based hedge funds also confirm that this is their view, and this inadequacy is, consequently, both a limiting factor in their being able to draw down funds from institutional asset allocators, and in developing trading strategies.
Focus on security
A new security model is emerging to replace the highly manual and insecure hot wallet/cold store methodology (which suffered from over $7m of losses in 2019 on exchanges alone).
This fully automated model now offered by IBM, Anchorage and Koine, both upgrades the security and improves operational flow, though to date, only Koine has fully resolved the issue of counter-party risk. The evaluation and subsequent take-up of this new model should facilitate further capital formation in 2020.
In the US, the first broker dealers have obtained licences to offer crypto trading to the retail market, and there is now a substantial back-log of applications working their way through the regulatory apparatus.
In the industry, there is a sense of a split forming between the blockchain crypto-asset innovators (evangelists, some might say) and the traditional capital markets industry who, on the whole, would prefer to retain existing market structures and processes.
This can be seen from the pivot to retail of many existing digital asset infrastructure providers including Fidelity (who launched their licensed custody and trading platform in 2019), Kingdom Trust and indeed Anchorage (who VISA helped finance in July this year). It seems that many of these innovators are disbelieving of institutional capital ever entering the market.
Meanwhile, asset servicing, particularly lending, continues to grow and over 70% of major exchanges now offer margin trading. On the other hand, only one of the top 10 exchanges currently provides a Binary FIX API which is the standard expected for traditional capital markets.
Throughout the year there has been a steady growth in stablecoins, primarily in USD, with Tether’s issuance more than doubling to $4.1bn and other coins growing to over $2bn and daily trading volume exceeds $25bn.
Other digital assets
The growth of other digital assets has been subdued. Whilst there has been continuing growth of tokenised property, meeting the needs of Asian retail investors, this has not yet created notable pools of liquidity. Several major token issuance platforms have pivoted from microcap equity towards corporate bonds and other credit instruments where the benefits of digitalisation are evident and demand is exigent.
Many of the dozens of other issuance platforms are likely to evaporate in 2020 unless they find niche market opportunities.
Incumbent financial market institutions have also become actively involved in exploring the opportunity for digital assets, though the vast majority of their activities are exploratory as they seek to both understand the technologies and the business model impact of transformation.
Their market communications will strongly indicate that they are attentive to the transformational opportunity, though, in practice, few have made progress that is likely to have long term impact.
Fnality (UBS) and JPMorgan have both formed industry groupings around settlement coins, and over 100 banks participate in the R3 consortium which operates an enterprise based blockchain called Corda. And Nomura has, after much delay, come to market with a digital custody solution based around the ledger technology and a licence out of Jersey.
SIX notably made announcements of its intent to launch a digital exchange in 2020 based on Nasdaq and Corda platforms. Other incumbent exchanges are exploring similar initiatives, notably in Asia and Middle East.
Lastly, we heard from Facebook about their Libra project, which had garnered a consortium to build a new retail payments infrastructure. The impact is likely to be greater in the reaction from regulators and central banks than in the success of the project itself, which is tied up in seeking regulatory approvals and has lost several key members of its consortium after political intervention, most notably Mastercard.
Predictions for 2020
2020 is likely to be a year of two halves. The first half is likely to see subdued retail trading in digital assets as BTC, in particular, finds a new price level. However, turmoil remains a factor in the principal equity or bond markets, which could feed through to volatility in digital asset prices.
In the second half of the year, we are likely to see the first ETF’s listed in the USA, possibly even with SEC approvals. Large scale broker dealers, now licensed for crypto-assets trading, will launch retail BTC trading (such as TD Ameritrade to their 11million+ retail clients, soon to be merged with Charles Schwab). They will do so off the back off new professional exchanges, such as LGO and Eris-X (licenced for crypto-spot and derivatives) and professional market infrastructure (independent post-trade solutions, such as Koine, covering custody and settlement).
Furthermore, similar market structures will emerge in Europe though with different licensing frameworks. Asset allocators will also finally start to put money into the hedge funds and we could foresee perhaps $10bn of new capital allocated in late 2020. These changes will lead to significant volume growth in second half of year, and price rises in the principal crypto-assets.
It is likely to be a year of bifurcation of the market venues, with perhaps somewhere between 20% and 30% choosing to pivot to the emerging institutional demand. This will lead to: business model transformation, significant technology upgrades and a significant growth in market volumes, of somewhere between 50% and 150%, in both spot and derivatives markets. Exchanges will start to set out voluntary standards of operation and codes of conduct.
The post-trade infrastructure will begin maturing and, for the first-time, asset-allocators will receive real time reporting from funds administrators.
The first large cap corporate bonds will be issued in 2020, probably in Europe first, and potentially the first digitalised credit instruments. Property tokenisation will see early signs of take-off in Europe with US lagging behind.
Incumbent exchanges such as Nasdaq, LSE, SIX and Euronext will make notable announcements on the execution of their plans to shift over the next decade to digital securities.
Crypto expected to grow
In Europe 5MLD regulations will upgrade the perceived quality of local crypto-exchanges, which is likely to positively impact market share. Licences for the first Digital CSD’s will be issued in Europe and possibly the Middle East.
Stablecoin announcements will probably grow faster than volumes, but it’s entirely possible to envisage total issuance > $10billion by year end, with daily trading volumes > $40billion/day by the year end. We will look to see a new stable coin emerging in Asia around Q4 2020, designed for institutional capital markets. Settlement coins, backed by the largest banks, will fight for market share amidst limited volumes.
In contrast, we expect the Libra project to make limited headway in 2020, but we might see central banks increasingly signposting the way forward towards their own issuance of digital money. However, no central bank issuances of any significance to retail market will take place in 2020.