Cryptos may be in a bear market, but blockchain investment keeps ramping up.
Blockchain refers to all the various forms of “distributed ledgers,” and are one of the key technological innovations underlying cryptocurrencies. Distributed ledgers allow data to be securely exchanged directly between peers without the need for intermediaries or privileged record-keepers — potentially making many business and administrative processes more rapid, more efficient, and more resistant to tampering and falsification. Distributed ledgers came to prominence with bitcoin, but businesses and governments are investigating them for hundreds of potential uses.
According to KPMG, U.S. blockchain investment in the first half of 2018 topped that in all of 2017. The professional services firm writes:
“Based on our experience, the rapid growth in blockchain investment overall can likely be attributed to a number of factors — including the widespread applicability of blockchain to help harness efficiencies within financial institutions. Blockchain’s capabilities extend from recordkeeping and the registration of transactions to documentation management and supply chain management. While it has primarily been looked at from a banking and insurance point of view to date, the reality is blockchain opportunities abound and could enhance processes for any number of U.S. and global businesses.”
It’s not just in private business that blockchain research and adoption is accelerating. One recent example is in the Indian state of Telangana, which has a population of more than 35 million people and a land area equal to that of Denmark. The state government was preparing a study to evaluate the effectiveness of input subsidies for village farmers and discovered that the state’s land records were riddled with errors. This is true of a large part of India’s property records — a fact which can produce interminable court cases and can make it very difficult for businesses to acquire property with which to expand.
Mumbai-based blockchain firm Regko provides blockchain-based digital asset registry and is implementing a blockchain solution to create a tamper-proof and reliable land registry for Telangana. Several other Indian states are following suit, including Rajasthan and Andhra Pradesh. The use of blockchain is especially attractive in a country like India that is struggling to overcome a long tradition of corruption in local government. This may be one reason why blockchain innovation will appear first in developing countries — a phenomenon similar to “leapfrogging,” when developing countries skipped the construction of landlines and went straight to wireless communication technology.
Financial System Integration
When will cryptos come back to life again? When visible progress on critical problems and issues is made. In our view, these include:
- The SEC approval of exchange-traded funds to track cryptos;
- Viable, widely adopted solutions to chronic crypto network problems of high latency and slow transaction speed;
- The arrival of a “killer app” for cryptos, analogous to email or web browsers for the internet — an app that no one can do without;
- A shakeout of the hundreds of coins and tokens with no real use case;
- Greater integration into the regulatory framework, giving institutional and retail investors confidence that markets are not being manipulated;
- Institutional solutions for the custody and trading of cryptos; and
- Greater integration into the financial mainstream.
These are some of the aspects of the digital asset landscape that we monitor and where we are looking for significant developments — both to tell us about the overall state of the crypto markets and to alert us to new platforms and projects that could take off because they offer a solution to some critical problem.
Note that many of them are of particular interest to institutional investors. It is when institutional investors feel that mechanisms for trading and holding cryptos are safe, and protected from fraud, market manipulation, and security risks, that cryptocurrencies as a whole will begin to realize their promise as a new asset class.
There have been a few recent developments that alert institutional investors — professional money managers, pension funds, hedge funds, and so on — will be noticing.
The first, which we mentioned recently, was the announcement by Intercontinental Exchange [NYSE: ICE] of the launch of a cryptocurrency trading and custody solution, a subsidiary company called Bakkt. ICE owns the New York Stock Exchange, as well as many other global bourses, and has deep, specialized experience in commodity trading. By holding digital assets in a vault and matching buy and sell orders between customers on their platform, they could bring institutional-grade order fulfillment to crypto trading. Crypto purists — who are increasingly irrelevant as drivers of crypto sentiment — would object that the centralized nature of this platform is contrary to cryptos’ fundamental character as purely decentralized assets. If you read news or criticism of this kind, don’t pay attention. Bakkt will be a game-changing development for digital assets. Other platforms will follow suit, but the expertise that ICE brings to digital assets, and the significance of their entrance into the crypto arena, are an early sign that cryptos are maturing.
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This development could be a new lease on life for bitcoin itself, challenged over the past two years by numerous competitors. The bitcoin network is painfully slow, orders of magnitude slower than established payment networks, and orders of magnitude more expensive, so the prospect of bitcoin use for everyday commercial transactions has long been forgotten. However, the godfather of cryptos can still function as a store of value — its nature as “digital gold,” especially in countries experiencing unstable currencies and political turmoil. Bakkt will highlight that function by making bitcoin easier to trade off-network.
The second recent development in this area is that Germany’s second-largest stock exchange, in Stuttgart, is launching a crypto trading venue, an app (“Bison”) for crypto trading, and a platform for initial coin offerings (ICOs). (You can check out the app offering here.) This will be the first time that a crypto trading app will be integrated with an established global stock exchange — also a potentially game-changing development in terms of giving institutional investors confidence in the integrity of markets.
It’s important to note that these developments signal that cryptos are moving beyond the hot-house of speculative trading among a relatively small number of holders, mostly retail speculators, and beginning to enter an arena where economically significant demand will be expressed by institutions. As the world’s “big players” — pension funds, sovereign wealth funds, and the like — are able to express their demand for digital asset exposure, that will likely signal the arrival of the next crypto bull market.
Investment implications: Monitor the factors that we mentioned above to gauge the overall direction of sentiment in crypto and digital asset markets. For speculation, direct your attention to companies and platforms that are providing real solutions to some of the digital asset problems and bottlenecks that we have identified.
For more commentary or information on Guild Investment Management, please go to guildinvestment.com.