Early Investing

Crypto Has Two Markets, and You Need to Pay Attention to Both

Crypto Has Two Markets, and You Need to Pay Attention to Both
By Andy Gordon
Date October 10, 2018

When I’m checking out crypto current events, I look at three things. I check crypto prices several times a day. It’s the least important of the three. But I feel compelled to do it.

Technology developments are next on my list. At the end of the day, it’s all about blockchain technology – whether it works… whether it can scale… and whether it can offer true privacy and security. Every day brings me fresh clues for these fundamental questions.

For those of you who follow my posts, you know that I like what I’m seeing these days on that front.

But it’s the third thing – who’s investing and why – that’s becoming really interesting. I believe we’re at a critical turning point. Consider this quote from Bill Barhydt, the CEO of cryptocurrency investment app Abra…

There really is zero large-scale institutional money from the West in crypto right now.

Barhydt made this statement this spring. And his observation was on the money.

But a mere half-year later, that’s no longer the case.

All Hail Yale?

The big news last week was that Yale had invested in two (two!) crypto hedge funds.

Like all endowment funds, Yale can’t take big risks with the billions of alumni dollars it manages. But it’s also expected to generate alpha gains… not an easy tightrope to walk. Yale has done it as well as any endowment, averaging returns of around 12.6% since the mid-1980s (the fund is currently valued at $29.4 billion). A big part of its bag of tricks is identifying up-and-coming alternative asset classes before almost everybody else.

Yale just put a chunk of money into Paradigm, a crypto fund that will be investing in early-stage cryptocurrency, blockchains and exchange projects. The $400 million fund was set up by Fred Ehrsam, Coinbase co-founder; Matt Huang, a former partner at Sequoia Capital; and Charles Noyes, who previously worked at Pantera Capital.

It also put money into Andreessen Horowitz’s new $300 million crypto fund.

With these investments in crypto, it looks like Yale is leading the pack again.

But that’s not exactly true. Yale is “merely” part of a bigger trend that began about four to six months ago.

That’s when large institutional buyers, including hedge funds and big miners, began replacing high net worth individuals as the dominant participants in crypto transactions of $100,000 or more. Using private trading desks, the over-the-counter (OTC) market did anywhere from $250 million to $30 billion of daily trades in April, say researchers that include Digital Asset Research and TABB Group.

As for the public exchanges? They handle about $15 billion in daily trades, according to data from CoinMarketCap.com.

Insiders knew about this trend long before Yale grabbed the attention of the ever “diligent” mainstream press. “We’ve seen triple-digit growth enrolling in our OTC business,” says Jeremy Allaire, CEO of Circle Internet Financial. Bobby Cho, global head of trading at Cumberland (DRW Holdings’ cryptocurrency OTC trading unit), says that “hedge funds have replaced high net worth individuals as our biggest buyers.”

A Tale of Two Markets

Because this is happening away from the public exchanges, it’s getting little public notice. But here’s the thing…

It’s really a tale of two markets right now. In the public exchanges, supply is running ahead of demand. Many of the companies that raised hundreds of millions of dollars through their successful ICOs last year are now selling their coins to fund operations.

In the OTC market, the imbalance goes the other way. Many coins are in short supply. Brokerage firms have sprung up to help institutional buyers find inventory so they can make their big orders.

So what happens next? Institutional money will begin migrating to the exchanges. And it’s only a matter of time.

A few things need to happen first. Exchanges need to offer custodial solutions to the institutional players. Coinbase is leading the charge with its Coinbase Custody service. Gemini is the latest exchange to offer custodial insurance to its buyers.

Volume needs to pick up so these large institutional purchases don’t move prices on the public exchanges. This has become a chicken and egg dynamic.

Regulators would like to see volume increase on the exchanges before opening up the gates to more crypto-targeted investment products. Institutional players would like to see the Securities and Exchange Commission approve (and regulate with a “light touch”) more cryptocoin activities such as ICOs and ETFs. They’re rightly convinced that increased volume would follow.

Fortunately, private-sector initiatives like Bakkt are picking up the pace on this front. Bakkt – the brainchild of the owners of the New York Stock Exchange – will allow investors to buy, trade and store bitcoin and (eventually) other cryptocurrencies on a federally regulated market. It expects to get a green light from the Commodity Futures Trading Commission in November to begin operations.

Better, more secure infrastructure from third parties is needed. There are lots of initiatives on this front. Banks like Northern Trust, Goldman Sachs and Citigroup are forging ahead with the development of custodial solutions. Startups BitGo and itBit recently came out with custodial services/products as well.

This is exactly how I expected it to happen.

Institutional investors dip their collective big toe in the crypto waters via private trading desks. Then institutional money begins leaking into the public exchange market. Liquidity goes up as volatility (which is low right now) goes down. Custodial risk is removed. And then regulators finally begin regulating…

All of which powers the public crypto bull market. This is followed by Yale’s move being hailed as prescient.

But you know the truth… that the pieces were in place and began gaining traction way before Yale made its move.

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