Simon Taylor

TL;DR 2017 was the year that Bitcoin entered mainstream consciousness, from prime time news slots to wall to wall coverage on business networks.  Bitcoin was the story in financial services and fintech this year.  2018 will be the year crypto has to grow up; it’s make-or-break time.  Are you positioned to take advantage if it continues to grow?

Over the last few months I’ve heard one thing from conversations across the industry: forget about DLT, it’s all about crypto now.

Why was 2017 the year of the crypto asset?

Simply put, the never-ending price rises from nearly $1,000 in January to over $19,000 at its peak in early December.  At the consumer level, services like coinbase.com were opening as many as 500,000 “wallets” per day and struggling to cope with demand.  This gold rush-like clamour for access to Bitcoin, driven by speculation, forced people to engage with the topic.

Away from consumers, institutions such as hedge funds, wealth funds and pension funds followed the family offices in looking for large scale access to the cryptoasset markets.  In 2017 we saw much more than exchanges that allow consumers to buy Bitcoin; we now have grown up financial market stuff like:

  • OTC desks, where market makers such as Gemini, DRW and Circle allow you to buy significant quantities of Bitcoin across multiple exchanges
  • Futures contracts (from both CBOE and CME) as a regulated financial product
  • Custodians such as Xapo, Vo1t and Coinbase allowing large funds to “store and protect” their Bitcoin at scale and in a way complaint with their regulations

Why was 2017 the year of Bitcoin? Because the institutions moved in, and they’re just getting started.

Why are institutions interested?

This point has been made by many others before but it bears repeating: it has become harder to make money from financial markets. A decade of growth against low interest rates has created low volatility. In English: if the market is moving (i.e. volatile) there is money to be made.

Asset managers and institutions find themselves in a market where there is margin compression.  They’re simply not as profitable as they used to be, having come away from 2008 much stronger than the banks that supply them.  They’re looking for growth, yield and a return that isn’t coming from traditional markets.

Crypto markets returns

By contrast, the crypto markets are the Wild West.  They’re subject to rampant market manipulation (e.g. pump-and-dump and front-running) as well as suffering from immature infrastructure, but crucially they offer the possibility of massive returns.  Let’s just compare January 1st to December 31st 2017 (source: coinmarketcap.com):

Jan 1st 2017

December 31st 2017


The market overall has been the bigger story than Bitcoin alone.

Where there is reward there is risk

At the end of 2017 it looks like either the party is over or just getting started.  With Bitcoin having pulled back below $13,000, the wider crypto asset markets are seeing similar pull backs.

1) Regulatory Risk

It’s entirely possible moves like those by the South Korean regulator limit the amount of investment coming into the markets.  In the East, regulators have either taken the Japanese approach with steps to legitimise but regulate the market, or the Chinese approach to regulate but potentially suggest the activities are not legitimate.

With the rise of the “pump-and-dump” (discussed later), as well as a general fear for great losses to consumers, regulators may be forced to act more if the market is unable to clean itself up.

2) Panic sell off

The problem with a market based on speculation is that it doesn’t take much for the sentiment to turn.  As late December has shown, crypto markets can go down as well as up.  Although it’s known that Bitcoin has a history of 30% corrections after a rally, this is a little more sustained.  If Bitcoin continued to slide, what would that mean?  It certainly hasn’t fallen off a cliff, but could it?

With the possible exception of Ripple’s XRP, very little looks positive in crypto lately.

3) Run on the exchanges

If we did see a panic sell-off, do the exchanges have enough real currency on their books to pay investors?  We’ve already seen the likes of Kraken and GDAX struggle to cope with volume when the price rises, so what happens when it falls and everyone wants their money back? If investors bought Bitcoin at $1,000 but now want $13,000 for their Bitcoin, is there enough cash to pay for all of that?  It’s impossible to say but it’s something to factor in.

4) Real value or revenue

Vitalik Buterin recently nailed it with this tweet:

The dirty little secret of crypto is that for all its wild price increases, there isn’t any underlying economic value being derived…yet.

The key word in that sentence is “yet”; it has the potential to, but we have to get from where we are now to somewhere better in 2018 otherwise we could see the thing unravel in a proper crash.

The bull case for crypto

This blog post is not offering financial advice, but as a general principle you should never invest an amount you’re not willing to lose.  This is especially true in crypto.  Yet as “sophisticated” institutional investors move in, they may have the shoulders to absorb losses.

With that said, the late 2017 sell-off may have more to do with end of year profit-taking than any real weakness in demand.  The lack of volatility and return remains true.  Crypto assets, especially Bitcoin, fill a financial product void if nothing else.  This alone makes the potential for their ongoing focus in 2018 likely.  All the new eyeballs in the institutional world, plus a set of “whale” investors (those with a large Bitcoin or other crypto asset holding) are likely to get back to work and continue to drive the price.

As @colingplatt once said, Bitcoin is a liquidity-gobbling monster. Why would you ever sell (unless for short-term profit taking)? It’s a religion that depends on people believing the price will go up over time.  2017 may have made believers of some folks with deep pockets.

So what will happen in 2018?

The big question raised by Vitalik is a key one; all of this speculation is on the back of projects that are yet to prove their value.  As such:

Prediction 1: “Web 3.0” projects will gain traction

Arguably the key benefit of blockchain technologies is their ability to be decentralised and increasingly, decentralisation is seen as a benefit for cybersecurity of data or for industry solutions where centralisation had not worked historically.  It’s in these areas we start to see the permissionless blockchains (e.g. Filecoin) gain (possibly limited) traction in 2018.  As a result, investing institutions will look past Bitcoin and the top 10 crypto assets to alt-coin markets, bringing depth to those markets.

Prediction 2: Institutions will need the knowledge and infrastructure to safely invest in and manage crypto assets

Institutions and banks have a knowledge gap and an urgency to act in this space. Many will fail to act and will miss the opportunity, meaning newer funds and fund managers may rise to prominence. However, there are a myriad of “just arrived, here’s my fund” types out there to be avoided!

The market is missing much of the infrastructure these institutions would expect, especially in the token sale arena, but this also presents a major opportunity to entrepreneurs.  This impact on the ICO markets + increased regulatory pressure + an increase of technical and best practice across the industry =

Prediction 3: ICOs will get smaller and more legitimate

More than $3bn has been raised across 2017 in token sales, with the ability to capitalise on massive “investments” drawing the sublime and the ridiculous to launch their own token sales.  Early projects such as Filecoin ($250m), EOS ($200m) and Tezos ($230m) created a gold rush that has been further catalysed by the rise in crypto prices.  If you raised $100m in Bitcoin in January you’d have $1.3Bn in Bitcoin today.

These “uncapped” raises are already running into trouble, however, with the SEC and many global regulators releasing investor warnings. Rumours of VCs pushing companies unlikely to deliver to do a token sale to create a liquidity event and general bad practice and poor governance spell trouble for this nascent market.

In 2018 I think we’ll see many of the best practice initiatives mature and take a sensible approach to involving regulators and protecting investors whilst maintaining the innovation that makes the ICO compelling.  Crowdfunding a new generation of internet infrastructure in an age where the internet of the 1990s is subject to increasing cybersecurity risk.  Continuing this theme:

Prediction 4: The first “pump-and-dump” ring will be arrested as organised crime

Mainstream coverage of “pump-and-dump” is limited, but as the name suggests, an individual or group with a large crypto holding engage in price manipulation., often through closed internet chat forums such as IRC channels or telegram groups.  These darker corners of the internet are harder for law enforcement to penetrate and largely ignored by regulators, yet they resemble the boiler rooms of the 1990s.

The individual or group begins to gradually increase the price of a small cap crypto asset to show the price is on the up.  As this happens they begin to win support for the “pump” phase with a wider group.  This wider group “pumps the price” in the hope that the market will notice.  The organiser then picks a spot at which to “dump” when investors outside their group have begun to rush in.

Regulators and law enforcement have yet to really attempt to address this issue, but with crypto assets now so valuable it is a geopolitical risk to ignore this organised crime.  Which leads to my final prediction:

Prediction 5: 2018 is the year crypto has to grow up

Summary

Crypto assets are in their difficult teenage phase.  Challenging, inventive and chaotic.  If, as I suspect, investor interest can be maintained throughout H1 2018, institutions need to consider the following:

  • Where can they get the skills to understand this market?
  • What infrastructure do they need to manage the risks?
  • How can they explain these to investors and capitalise on the benefits?
  • Who are the reliable counterparties in these markets?
  • What fiduciary responsibilities can be managed with new vs. old tools?

Answering these questions and many more like them will be the key to winning for institutions in 2018.

Are you ready?

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