Institutional investors to awaken ‘Cryptostein’
The next big bubble is only moments away…
In 2008/9 Bitcoin came thundering into our lives, promising game-changing technology while threatening to disrupt the social structure of modern civilisation, in the form of blockchain. In its simplest sense, a blockchain is an immutable, public and decentralized set of records, linked using cryptography. These qualities offered an alternative to the current fee-based transaction validation system and threatened the viability of third party intermediaries. Banks, mortgage brokers, real-estate agents, infrastructure services and more were seen to be vulnerable. Ten years later, Bitcoin has settled at around US$6500 (a modest 812,499% gain) and the market has expanded to include over 1600 cryptocurrencies. However, is the world any different? Not really. In an ironic twist, it seems the qualities that drove blockchain’s initial publicity are preventing its mass adoption. Simply, a lack of regulation and financial controls are fuelling volatility and preventing institutional investors from entering the market. Nonetheless, when the lightening rods of systematic regulation and investment protection are connected we can expect to see institutional capital flood the market, creating a financial monster and the next great bubble.
It is common to hear cryptocurrency is the new ‘technology bubble’ of our time, evoking fear into the wallets of most investors as the 2000 crash haunts clear in their minds. However, this common misconception fails to consider the fundamental drivers and relative sizes of the two markets. First, at its peak the .com bubble had a market capitalisation of between US$3–5 trillion. The cryptocurrency market, with a market capitalisation of US$425bn as of the 24/04/2018, only makes up 10% of this.
Second, the sources of capital fuelling the two markets are completely different. During the .com bubble institutions are reported to have made up 63.6% of active technology purchases. Another 19.4% was created by mutual funds and only 17% was a product of direct investment. Currently, more than 90% of investment in the cryptocurrency market is created by retail investors. Therefore, by extrapolation, if the floodgates preventing institutional investment are lifted, the ‘cryptocurrency bubble’ could inflate more than 9x its current state.
The reason institutions have refused to enter the market is not based on a lack of interest or profit potential. Reports show that opportunities for exceptional revenue and alpha have created significant institutional interest, with large players like Goldman Sachs, Bank of America and JP. Morgan’s investing millions in the blockchain and cryptocurrency market. What’s more, the effect institutions have, even today, on the pricing of the market is significant. In fact, when Goldman Sachs announced it had terminated its plans to establish a crypo-trading desk, the crypto markets valuation fell dramatically (see table). This is compounded by the fact that every time an exchange traded fund is rejected by the SEC, prices fall in a similar fashion.
So, what is preventing institutional adoption? Simply, a high degree of volatility and no systematic regulation creates significant risk that large institutions are unable to absorb. Many developing countries, like South Africa, offer zero protection to investors in ICO’s, while the UK and US have adopted a ‘wait and see’ approach. The legal definition of cryptocurrency is highly contentious and current legislation is not tailored for this rapidly evolving technology. Taxonomy is uncertain and cross boarder confusion creates opportunities for money laundering.
“Cryptocurrency is a real challenge for us because, on the one hand, there is the innovative side of it and wanting to stay in the forefront of technology’s improvement of finance. On the other side of it, there is the possibility of cryptocurrencies being used for activities that the bank wants to have no part of.” (CEO of Barclays, Jess Staley)
So, is a collapse imminent? In my opinion, no. The .com crash was caused by institutional investors pulling capital out of the market in mid-March 2000 (which occurred despite an acceleration in retail investment). The cryptocurrency environment, as described above, is significantly smaller and void of institutional capital. This means, systematic withdrawal is less likely and harder to coordinate. As better regulation and legislative control is implemented institutional capital will begin to flow into the market, causing rapid appreciation. Using the jay-curve as a guide I believe we are in a period of temporary decline. At some point, cryptocurrencies will boom — and I’ll be there for the ride. The next big issue, is determining which cryptocurrencies will be onboard the next spaceship to the moon.
Disclaimer: This is not intended investment advice. Please do your own research before investing. The nature of cryptocurrency is inherently speculative so only invest what you are prepared to lose.
