News that Wall Street investment bank Morgan Stanley was planning to offer Bitcoin swap trading for its clients helped resuscitate the market last week. Crypto’s total value rallied back above the $200bn boundary by early on Thursday afternoon; it had sunk to below $190bn the day before.
Despite derivatives sometimes being disparagingly referred to as ‘synthetic bitcoin’, crypto has become obsessed by the financial products. Starting in December, an already bullish market flew up to over $800bn when CBOE began offering bitcoin futures. This intensified in the summer as the community awaited the SEC’s ruling on Bitcoin ETFs. When regulators pushed back their decision until the end of September, the market cap fell by a third in less than a week.
That Morgan Stanley are reportedly already in a position to offer crypto derivatives to their customers was a big morale boost for the community. Despite this summer’s setbacks and an extended bear market, synthetic bitcoin should just be around the corner.
Or maybe not.
ETFs aren’t up to scratch
Fran Strajnar is in almost all parts of crypto. From his base in Northern New Zealand, the CEO of Techemy oversees a complex operation that includes data analytics, a media source, as well as a blockchain identity tool that enables quick identification for AML and KYC purposes.
In a conversation with Crypto Briefing in the reception of his hotel in the City of London, Strajnar explains that crypto derivatives are unlikely to be approved by the end of the year. “We’re still at least a year away from the institutions having the infrastructure and financial products ready”, he said.
Having spent a good portion of the summer reading through ETF applications (“My god they’re a boring read”, he summarised), Strajnar argues most are in breach of financial regulation. “Basically they have to prove that their crypto derivatives don’t represent a qualitative risk to retail investors”, he said. “The biggest problem at the moment is most are qualitative risks”.
Financial authorities, including the SEC, take decisions partly based on whether something represents a real risk to investors using their personal money. Regulators will only approve new financial products, like crypto derivatives, once they’re satisfied that the applicant has sufficient liquidity and safeguards in place that protect retail investors. Assets with high volatility, like cryptocurrency, are heavily scrutinized to ensure extended market fluctuations don’t lead to a complete washout.
The SEC suspended trading in Bitcoin and Ether Exchange Traded Notes (ETNS), last week. Created by XBT Provider, the regulator said the decision was taken because of confusion in the US market regarding these securities.
Unfortunately, many of the current applications still don’t have the correct safeguards, says Strajnar. The ETF proposed by the Winklevoss brothers – which the SEC denied at the end of July – was based on prices taken from their own exchange, Gemini. As well as concerns about Gemini not having sufficient liquidity, Strajnar argues there’s “a massive conflict of interest” in using the exchange’s data, as it could expose the market to manipulation.
“The VanEck-SolidX Bitcoin ETF is better [than the Winklevoss ETF], but it’s still not there”, says Strajnar; applicants need to improve their regulatory compliance angle if they want to succeed in getting their ETFs approved. “The SEC isn’t stupid: they’ll keep denying until applications meet their criteria”, he adds.
Are crypto derivatives good?
Sources over the past few months have expressed doubt in ‘synthetic bitcoin’. One London-based investor told Crypto Briefing he felt derivatives ‘stole the show’ over the summer and deflected attention away from areas of crucial technological development. He was worried that financial instruments opened the door for the large centralized institutions to dominate the space. If cryptocurrency is about decentralization, it certainly shouldn’t make money for an elite cadre of investment bankers.
Despite this, most observers are in favor of crypto derivatives; approval would enable an influx of new capital from the institutional investors. A significant surge in demand for cryptocurrency would cause the underlying asset to rise in value, an ideal outcome for existing holders.
Perhaps more importantly, crypto derivatives are fully-regulated products. Approval by the financial authority creates regulatory certainty, enough for the big institutions to start heavily participating in the space. Similar to when CBOE began trading bitcoin futures at the end of last year, synthetic bitcoin enables traders who cannot currently participate to engage with cryptocurrency.
“Synthetic products open up pathways for capital that is otherwise restricted from exposure due to an inability to trade and settle with the underlying asset,” said CoinShares‘ head of research, Chris Bendiksen in an email. “Furthermore, synthetic crypto-products already come with built-in custodial solutions, relieving the end consumer from the technological hurdles of self-custody.”
Did Synthetic bitcoin cause a u-turn by the banks?
When it comes to crypto converts, Morgan Stanley isn’t alone. Smelling the potential, Goldman Sachs is exploring a new derivative called a non-deliverable forwards, as well as developing its custody solution.
Citigroup is looking at offering Digital Asset Receipts, which they say is the closest way to participate in the space without owning the actual asset; the owner of the New York Stock Exchange, Intercontinental Exchange, is building its own bitcoin exchange which will be used to trade futures.
This is truly a watershed moment. Less than a year ago, the big banks denounced crypto as little more than a fraud and means of exchange for drug dealers. They’re now falling over one another to get the first crypto derivative to market.
Strajnar sees this as the natural maturation of the sector: from small beginnings, as crypto grew it initially faced rejection; as its true potential is realized, it is now moving towards acceptance. “We’re going through the epochs”, he says. “Right at the beginning crypto was for cyberpunks, then it attracted the anarcho-capitalists and libertarians…we’re now at the beginning of mainstream acceptance”.
Rather than reject input from institutions, Strajnar sees the long-term benefits. As the interview drew to a close, Stajnar said that the one key benefit with the big banks entering the space was rapid increase in available capital.
Not only will the market grow, it’ll mean that more investment can go into infrastructure and project development that will increase the chances of crypto doing what it is supposed to do: become a free, global currency.
The author is invested in BTC and ETH, which are mentioned in this article.