Revenue generated from crypto exchanges could more than double to as much as $4 billion (about 442 billion yen) this year amid the collapse in the prices of digital assets, according to Sanford C. Bernstein & Co. analysts, Bloomberg, a major media company reported.
The buying and selling of digital currencies including Bitcoin generated $1.8 billion in fees at the largest crypto exchanges last year, or about 8 percent of the revenue seen on traditional exchanges（about 550 trillion yen).
（Source: CoinPost）
Many people may have been surprised to hear that total revenue generated from crypto exchanges could increase by twice as much as last year in spite of the falling prices of digital assets.
We will explore what is happening behind this predicted revenue increase at crypto exchanges, and look at reactions from the financial industry and institutional investors who have announced their intentions to enter the cryptocurrency market.
Coinbase launches custody service amid the collapse in prices of digital assets
One of the reasons why the revenue of cryptocurrency exchanges is increasing despite the decline in prices is the existence of a custody service for digital assets provided by Coinbase Inc., a major U.S. exchange.
Coinbase’s custody service has been provided to hedge funds and institutional investors, attracting more institutional investors to the cryptocurrency market.
As an agent of investors, a custodian provides a wide range of services such as storage and management of securities, receipt of principal and interest by a proxy and dividends delivery and settlement of deposited assets, management of investment performance, and exercise of voting rights.
Coinbase aims to have 100 large institutional customers by the end of the year with as much as $5 billion in assets under management, said Sam McIngvale, who is leading Coinbase ‘s custody service, in a phone interview in July 2018.
Services offered by custodians like Coinbase are expected to assist hedge funds and institutional investors to invest in digital coins as they are required to use so-called regulated custody, which meets the fiduciary requirements of U.S. officials. Availability of such services could lead to an influx of new capital into crypto markets.
Coinbase has been talking with the SEC (Securities and Exchange Commission) and FINRA (Financial Industry Regulatory Organization) to ensure compliance. “We sort of have an understanding with the SEC and FINRA, and it allows us to execute contracts with clients and take the first deposits”, McIngvale said.
While the service is available now only for Bitcoin, Ether, Litecoin and Bitcoin Cash, the company plans to add 40 kinds of digital assets including XRP (ripple), ADA (cardano), EOS by the end of the year.
Coinbase charges 10 basis points (0.1%) in monthly fees. As of August 2018, it added customers including Polychain Capital, which reported that it had more than $1 billion dollars in assets.
With this addition , Coinbase would bring in ￥2 billion yen or more monthly fees from custody service alone.
The stance of Institutional investors
The custody service Coinbase started has contributed to the increase in revenue of the crypto exchanges in spite of the declining market trend. However, it isn’t clear if the service has gained trust from investors due to limited materials for making judgements as the service has just begun.
This uncertainty is attributable to a legal and systematic issue inherent to custody service and cryptocurrency as explained below:
Transactions for digital currency are carried out on blockchain, a distributed type of technology in which we assume that the owner of a traded cryptocurrency and the person who conducts a transaction are one and the same person.
On the other hand, a custodian manages assets trusted by institutional investors as an agent. The custodian manages and keeps investors’ assets like “safe keepers”. In trading cryptocurrency through the custodian service, the currency is sent to the custodian’s address, and as a result, the ownership of the traded currency is transferred to the custodian, not the investor.
This causes a problem for institutional asset managers who use custody service. They manage and operate assets entrusted by their investors and in doing so, they must follow a compliance principle that operation and asset ownership must be clearly separated. This principle makes it difficult for institutional investors to use a custody service for digital currency as the ownership of the currency becomes ambiguous as mentioned above.
The institutional asset managers don’t want to run the risk of losing trust from their customers, so they are hesitant to execute contracts with custody services.
Institutional managers such as Goldman Sachs and JP Morgan have shown interest in entering the digital currency market and blockchain business, but they have not made specific moves to do so for the aforementioned reasons as well as the fluctuation of market prices.
Is ETF approval the Key?
What is drawing the most attention from the industry is whether the SEC will approve to list and trade various Bitcoin (BTC) exchange-traded funds (ETFs).
If the SEC approves BTC ETF, BTC can be securitized and setting up and changing portfolios can be done more flexibly and quickly.
However, the Securities and Exchange Commission has so far rejected Bitcoin ETF applications altogether.
As a background to this, there are two factors:
- External environmental problems such as regulatory trends in each country
- BTC ETF is not ripe for the current market
The regulations on cryptocurrencies are not keeping up with the current situation, and they vary widely from country to country. Moreover, as the external environment issues, counter-measures against cracking at exchanges are insufficient as seen in the Coincheck incident.
Also, as stated in the discussion on custody service earlier, there is a compliance issue that ‘operation and ownership must be clearly distinguished’.
The cryptocurrency market is very sensitive to small changes in the above conditions and can be dramatically affected by them.
Although high expectations for the ETF approval in the market are understandable, in the current situation where prices are not stable, the SEC (the US Securities and Exchange Commission)’s concern that Bitcoin is not ripe for ETF is valid.
Which market should we pay attention to going forward?
It is essential to resolve the SEC’s concerns steadily in order to get ETF approval for cryptocurrencies. In doing so, we have to clear various issues. We believe that advancement of blockchain technology is indispensable, rather than changing superficial conditions. Approval of small transactions and swift efforts using LN (lightning network) have the potential to solve various problems. Although just started, many engineers are implementing a variety of efforts to realize their ideas.
As for CTIA, we will pay close attention to not only the cryptocurrency market but also the blockchain industry, and we will continue to inform you of latest developments.
