【Research Analysis】Can Fidelity Act as an Anchor for the Crypto Marketplace in the Sea of Uncertainty?

23 Oct, 2018 03:40
source: 香港奇点财经 Wesley Yung

Author’s View: Despite the decline in the price of cryptocurrencies, the increased regulatory scrutiny, hacks of cryptocurrency exchanges, people not only want to invest in cryptocurrencies but would allocate some of the money from traditional investments. Brown said “People wanted to get in on the wave and this is residual from that. It was all over the news. People were seeing every day a person getting rich from investing in Bitcoin.” There is still a very strong demand as a lot of investors, for the time being, are just waiting to see when the market will start picking up and then make their next moves. It is predicted when Bitcoin starts trading between $8,000 and $8,500 again, people will be back in action and get a scoop of the ice cream.

The market may be fairly static at a low price level now but recent activities will only help lift the market sooner or later. Yale’s well-known chief investment officer, David Swensen, who manages the school’s $29.4 billion endowment, has invested in two funds dedicated to cryptocurrencies. Other endowments — for Harvard University, Stanford University, Dartmouth College, Massachusetts Institute of Technology and the University of North Carolina — have also reportedly made allocations in at least one cryptocurrency fund. With big name Fidelity now joining to provide cryptocurrency trading and custody services, acceptance and confidence among institutional and retail investors for cryptocurrencies will without a doubt move up.  Tom Jessop, head of Fidelity Digital Assets Services, said neither Fidelity nor institutions it services are distracted by price. He compared the technology’s long-term potential with moving financial services to the internet.  “We don’t focus too much on the price. It’s a foundational technology — people are trying to get exposure to the trend and expect volatility in the assets themselves.” The move by Fidelity may encourage more big name financial institutions to follow suit and get a share of the market once Fidelity can prove its capability.

Regulators, specifically the U.S. Securities and Exchange Commission (SEC), have already been preparing for actions. For instance, it is launching a portal called Fintech Hub to engage with companies using blockchain, artificial intelligence and more. While Asia is the most vulnerable area with the highest number of cryptocurrency cyberattacks, it is just a matter of time before cyberthieves target more popular trading platforms in the U.S. A potentially more secured trading and custody platform provided by Fidelity comes at the right time. However, It is interesting to see how regulators will react to the recent activities in the cryptocurrency space and how they will work with financial institutions and cryptocurrency exchanges to prevent frauds and hacks while also allowing the space to grow at its own pace.

 

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While cryptocurrencies such as Bitcoin and Ethereum are still struggling to recover, the cryptocurrency space is having likely one of the most impactful news of its time. The future of cryptocurrencies is being filled with fog as it has failed to continue with the bullish trend, regulators have increased scrutiny and the general retailers haven’t accepted it as a trustworthy payment method. However, a recent move by Fidelity Investments might be changing the status quo and future of the virtual currency market.

Fidelity Investments is forming a new and separate company called Fidelity Digital Asset Services, which will handle custody, safely store digital assets and execute trades on multiple exchanges for investors. Their goal is to make digital native assets such as Bitcoin more accessible to investors. Fidelity can be called a pioneer as it is the first Wall Street incumbent to officially provide cryptocurrency solutions to the public.

Restoring faith in Cryptocurrency Exchange Platforms 

Although cryptocurrency companies like Coinbase, Gemini, BitGo, and banks like Goldman Sachs and Northern Trust are having or working on similar solutions, Fidelity is the first big U.S.-based financial services company to officially provide cryptocurrency services. Its big size ($7.2 trillion in customer assets, 27 million customers, 13,000 institutional clients) and past efforts to develop technology through incubators that house artificial intelligence and blockchain projects will very likely help push forward the growth of the crytocurrency market. The fact that the cryptocurrency investment is now adopted by a recognised financial services provider will also change the general public’s perception of cryptocurrencies and drive greater confidence for investors.

The reason is that it helps alleviate the core risk of investing in cryptocurrencies – cyberattacks. Cryptocurrencies are partly famed for its decentralized and unregulated natures, which can expose them to cyberattacks. If the cryptocurrency market were to reach a wider investor crowd, it would have to remove certain vulnerabilities of cryptocurrencies and build more secured trading and custody platforms. According to CoinDesk’s 2018 State of Blockchain Report, $1.6 billion in cryptocurrencies had been stolen from clients as of the end of June. Just like the stock market, investors’ confidence in crytocurrency exchanges directly impacts market sentiment and hence the market performance. Bitcoin dropped further after the Bithumb incident in June following a serious decline so far this year. Bitcoin is down more than 50 percent from its record high near $20,000 in December.

Compared to a rigid foundation and development of the stock exchange system, the cyptocurrency exchanges have been developing rapidly in a short period of time without much long-established structure. Many cryptocurrency exchanges charge fees for trading and storing currencies for customers at the same time. This is in contrary to how stock exchanges work, where they facilitate trading but do not hold securities for investors. On a platform where both the trading and storage of assets take place, cyberthieves that manage to break in can conveniently rob a crytocurrency exchange just like robbing a bank – get hold and cash out the cryptocurrencies. Cryptocurrency exchanges are “easy to breach, with minimum effort and expense from attackers and with maximum return on investment,” said Robert Statica, president of BLAKFX, a cybersecurity firm in New York. The services provided by Fidelity, where it will source the assets from large over-the-counter crypto trading firms and hold them in custody in “cold storage”, a way to store cryptocurrencies “offline”, are similar to storing securities in bank accounts separated from the stock exchanges. This innovative service will certainly make the life of cyberthieves harder.

However, from a regulatory perspective, it is likely that the adoption by Fidelity to provide cryptocurrency services would attract more scrutiny and ultimately more regulation. It is worth being more patient to see how government regulation and the cryptocurrency space can be integrated while not limiting the development of cryptocurrencies. Tighter regulation to a certain degree will be beneficial in closing the regulatory gaps. For instance, in the case of South Korea, one of the biggest markets for trading cryptocurrencies, regulatory gaps have made it less compelling for exchanges to step up security effort, said Stacy Scott, managing director at cybersecurity and investigations frim Kroll. According to Wall Street Journal, a government inspection of 21 cryptocurrency exchanges in South Korea earlier this year found that no firm met all 85 inspection standards established by authorities, but there is no law to enforce and penalize exchanges. Any regulations will need very careful execution in order not to limit the growth and development of the cryptocurrency space, after all, the space is built upon a free and independent ecosystem. It will be more reasonable to limit the regulation to the security layer, specifically cybersecurity and fraud, without interfering the functionality and free flow of the cryptocurrency ecosystem.

Potential Effects on Institutional Investors 

The impact by Fidelity will be most prominent in institutional clients as for now, its services are available to institutions such as hedge funds, endowments and family offices but not to retail investors yet. It is argued that the lack of custody and other back office services by brand name financial companies has kept the institutional investors from embracing the cryptocurrency market. Fidelity Digital Asset Services can act as an anchor for the marketplace that currently drifts in the sea of uncertainty, helping the marketplace to mature and become more stable once more institutional investors enter the market. “Our goal is to make digitally-native assets, such as Bitcoin, more accessible to investors,” Abigail Johnson, chairman and chief executive of Fidelity Investments, said in a statement. However, it is not without concern that as more traditional financial institutions enter, the market will be dominated and controlled by them, influencing the price level of cryptocurrencies. Therefore It is also important to provide the service to retail investors anytime soon and it is just a matter of time before it trickles down to them.

Potential Effects on Retail Investors 

Although the Fidelity’s services are not available to retail investors, it could help boost the validity of cryptocurrencies, eventually expanding downstream to the retail crowd.  When the CME Group and CBOE World Markets launched their Bitcoin futures in the early 2018, most of the online brokerages were reluctant to offer it to their retail clients due to the worry that the price fluctuation and lack of regulatory oversight could get their customers in trouble. The launch of Fidelity Digital Asset Services acts as a approval of the cryptocurrency space first time by a large institution. Having said that, their services still need to be proven and mature while it is in the process of onboarding its first clients now and become generally available sometime in early 2019. Time will tell if Fidelity is smart enough to capture the first mover advantage in this space or it has risked its life in the hope of becoming a pioneer. After all, there needs to be careful planning and execution and any failure will cause Fidelity serious harm.

To find out what it will take for retail investors to embrace cryptocurrency investing, LendEDU, the online student loan lender teamed with The Daily Hodl, the cryptocurrency news website, to survey 1,000 U.S. adults that invest via a brokerage account that doesn’t offer cryptocurrency trading. None of the investors surveyed own digital tokens. The results are: 52% of respondents said they are likely to use their brokerage accounts to invest in cryptocurrencies if they had the option; 59% of those investors said they would scale back investments in stocks, bonds, and other traditional products to invest more in cryptocurrencies; 41% of those polled said they would trust a traditional brokerage over the likes of Coinbase, the leading operator of a cryptocurrency exchange; 39% would even trust Amazon.com over Coinbase when it comes to handling cryptocurrency investments.

“It ties into the overall perception of virtual currency,” said Michael Brown, research analyst at LendEDU. “There’s still a dark cloud over virtual currency and even the name cryptocurrency sounds a little bit sketchy to be people. They think its used in the dark web and not for the best reasons. They don’t fully understand.” LendEDU found that only 44% of the survey respondents who had interest in cryptocurrency investing would do it outside their traditional brokerage. As for trading in digital tokens via Amazon, that too could be because of its reputation, said Brown. Amazon and traditional brokerage firms have established its brand name for years, with a certain level of reputation and trust in its security and convenience. Cryptocurrency exchanges like Coinbase have yet to established a trustworthy brand name.

What this means is that it is reputation and trust that matter when it comes to choosing cryptocurrency exchange even one has proved a certain degree of expertise. Fidelity has been in operations for 72 years and has established a strong presence in financial services that can leverage resources from itself. For this reason, it is not too difficult for them to also attract retail investors to use their services, expanding the overall market and footprint of the cryptocurreny market. The other takeaway from the survey is that retail investors are still interested in investing in cryptocurencies, they just don’t have confidence in non-traditional exchange platforms in general. In other words, they still trust the coins but not the exchanges. Fidelity could well be their first brand name trading platform to restore their confidence.

Summary

Despite the decline in the price of cryptocurrencies, the increased regulatory scrutiny, hacks of cryptocurrency exchanges, people not only want to invest in cryptocurrencies but would allocate some of the money from traditional investments. Brown said “People wanted to get in on the wave and this is residual from that. It was all over the news. People were seeing every day a person getting rich from investing in Bitcoin.” There is still a very strong demand as a lot of investors, for the time being, are just waiting to see when the market will start picking up and then make their next moves. It is predicted when Bitcoin starts trading between $8,000 and $8,500 again, people will be back in action and get a scoop of the ice cream.

The market may be fairly static at a low price level now but recent activities will only help lift the market sooner or later. Yale’s well-known chief investment officer, David Swensen, who manages the school’s $29.4 billion endowment, has invested in two funds dedicated to cryptocurrencies. Other endowments — for Harvard University, Stanford University, Dartmouth College, Massachusetts Institute of Technology and the University of North Carolina — have also reportedly made allocations in at least one cryptocurrency fund. With big name Fidelity now joining to provide cryptocurrency trading and custody services, acceptance and confidence among institutional and retail investors for cryptocurrencies will without a doubt move up.  Tom Jessop, head of Fidelity Digital Assets Services, said neither Fidelity nor institutions it services are distracted by price. He compared the technology’s long-term potential with moving financial services to the internet.  “We don’t focus too much on the price. It’s a foundational technology — people are trying to get exposure to the trend and expect volatility in the assets themselves.” The move by Fidelity may encourage more big name financial institutions to follow suit and get a share of the market once Fidelity can prove its capability.

Regulators, specifically the U.S. Securities and Exchange Commission (SEC), have already been preparing for actions. For instance, it is launching a portal called Fintech Hub to engage with companies using blockchain, artificial intelligence and more. While Asia is the most vulnerable area with the highest number of cryptocurrency cyberattacks, it is just a matter of time before cyberthieves target more popular trading platforms in the U.S. A potentially more secured trading and custody platform provided by Fidelity comes at the right time. However, It is interesting to see how regulators will react to the recent activities in the cryptocurrency space and how they will work with financial institutions and cryptocurrency exchanges to prevent frauds and hacks while also allowing the space to grow at its own pace.

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