BUILDING TRUST IN THE CRYPTO MARKET
The cryptocurrency (‘crypto’) market is on the rise. Bitcoin, the main altcoin with a market share of over 60%, has seen its price increase from around $4,000 in April 2019 to over $10,000 in July 2019, despite the recent Congressional hearings on Facebook’s Libra.
In tandem with increasing prices, institutional investors are getting more involved in the market. Last year, we saw institutional investors surpass high-net-worth individuals (HNWIs) for the first time in terms of purchasing cryptocurrencies. It’s fast becoming part of a diversified investment strategy. Whilst there is still a strong UK/US footprint, we’re seeing deals in Switzerland, Hong Kong and Canada.
The speed of professionalization in the cryptocurrency market has ramped up, with much of the recent growth driven by more efficient financial infrastructure. This is helping financial institutions to take a more considered look at crypto, and use it to revamp their portfolios. As of July 2019, the total market capitalization for these digital assets in circulation is just under $300bn. It’s likely that this will rise above $300bn in the near future, though longer-term prospects depend on how the industry adapts to upcoming regulatory framework, with the likes of the Financial Industry Regulatory Authority (FINRA) looking to apply rules that will provide a stable platform to trade digital assets while reducing risk.
Trading volumes have been boosted by a sharp rise in over-the-counter (OTC) trading as crypto projects look for liquidity. In the so-called ‘Crypto Winter’ of 2018, crypto-centric OTC desks, including Genesis Trading and Circle (backed by Goldman Sachs) started reporting tremendous growth and this trend is continuing. According to research by Diar, over 25% of Bitcoin in circulation now sits in addresses that have a balance of between 1,000 and 10,000 BTC – volumes that point to financial institutions.
These institutional investors opt for OTC trading as opposed to spot exchanges for a number of reasons. Exchanges often have low liquidity in their order books which rules out large orders, OTC allows large orders without an unfavorable impact on the price, and exchanges limit the total number of Bitcoins that can be traded in one go – Coinbase, for example, has a daily trading limit of $25,000.
That said, there are a few complications that both buyer and seller could run into when they want to set up an OTC trade. There is often no guarantee that the asset (altcoin) will be delivered or cash paid. Most OTC brokers don’t provide an appropriate custody solution, which increases this settlement risk. It’s also worth noting that current OTC trading doesn’t include suitable Know Your Customer (KYC) procedures as it lacks the monitoring and surveillance tools of traditional trading systems.
A Safer Trade
However, there is a different avenue that institutional investors can explore. OTC trading via escrow can effectively tackle these risks and issues. This more robust approach benefits both sides of the trade as the escrow agent will follow everything to the letter. The seller benefits from dealing with a party that has funds to make the purchase, whilst the buyer can be confident a trusted independent party won’t release funds until the altcoins have been received. Crucially, by trading via escrow there is no need for participants to seek out an additional custody solution – it’s already in hand – and the escrow agent will perform KYC as part of the service provided.
If you go down this route, it’s important to select a global partner to avoid any multi-jurisdictional issues cropping up. The right partner will always start with a rigorous KYC process. Once both parties have been positively identified and no red flags are raised, they will move to exchange the cryptocurrency and the cash. In most cases, it is best to first run a simulated deal with a small exchange of cryptocurrency, backed by cash in escrow, between the address of the seller and that of the buyer to establish a working link to build on.
Crypto represents a good opportunity for investors and it has a big future. There will undoubtedly be market consolidation, with a small number of the 1,500+ altcoins in circulation emerging as a favored core. As institutional investor appetite increases, bigger names will enter the arena. You can stay ahead of the game by using an escrow agent to implement custodial arrangements and manage the risks associated with this emerging asset class.