And why it might happen sooner than you think !

Last November, I was discussing the crypto bubble pop scenario with my brother and as we were going through all the different possibilities (a big exchange hack, a series of government bans, etc …), we concluded that if institutional investors (insurers, top tier funds, big companies, family offices, etc …) get in the game, we might go to a total market cap of over 10 000 Billion USD. If they don’t then … the dance might stop at any moment.

After calling out TenX’s PAY overvaluation during the last summer, I spent a great deal of time studying the different approaches to value a token and one thing kept bugging me: there are many theoretical applications for the blockchain technology, and many projects, yet there are no practical, real life applications. Running ICOs and raising funds put aside.

This led me to reflect on what is lacking right now in the crypto market to get the money of Institutional Investors flowing. And here is my top 3 :

Security and Physical Infrastructure

This is obvious for many of us, you just need a hardware wallet to store your coins, however B2B storage solutions are just starting to develop and IT managers are not used to storing “Digital Gold” on their local hard drives or USB keys. Last December, Ledger closed a 75M USD series B round to, amongst others, bring crypto to the corporate world. Other companies are working on this as well, Xapo for example offers a different type of “over protection” inside a bunker in Switzerland. While insurance companies are also working on solutions to protect both users and exchanges and cover the risks of hacks or theft.

All these pieces are coming together and will constitute the foundations allowing crypto currencies to be a “safely stored” financial product.

Regulation

What is a Bitcoin ? A commodity, an asset ? How should it be taxed ? Where to put it on a balance sheet ? These questions need concrete answers and regulators all over the world are trying to figure it out. While it has been accepted that there is a new class of assets (crypto assets) — cf G20 conference of march 2018- some tokens still fall under the securities law and thus need to follow different sets of rules. Others are utility tokens and it looks like they are going to keep this status. This uncertainty is unbearable for a fund as both the financial and reputation risks aren’t worth it. Polymath is doing a great job tackling this problem. The company introduced Securities Tokens (STs) that will allow having a safe environment to issue and invest in this type of tokens. The work they are doing is a mix of tech and law where the POLY token will be used to pay for the different fees when registering on the network, issuing or trading a securities token. The positive involvement of the Canadian and US regulators is encouraging and we can expect to see the first issuances by the end of the year. TZERO by Overstock is also working on an exchange for these STs. Another older project is tackling a slightly different issue : Melon, this one will allow the creation and management of portfolios and funds on the blockchain. The three projects deal with regulatory and legal matters that are important when it comes to having Institutional Investors joining the party.

Basic Investment and Risk management tools

And these ones are the least obvious; hedge funds, regular funds, investment banks and others rely heavily on an ecosystem that allows them to manage their risk, hedge certain bets and structure complex financial products. Sometimes they just buy and hodl but most of the time their investment strategies require the use of different products allowing them to build a portfolio with a certain risk profile. Some of the basic tools they need are :

Derivatives, Margin Trading and Shortselling, Lending markets, OTC markets.

These needs are either non-fulfilled or partially fulfilled at the moment. I will take the time to detail what is being built right now and why it will help shape the future of finance on the blockchain :

- Derivatives: these are contracts (not smart contracts but rather financial contracts) that behave in a certain way depending on the price of their underlying asset (it can be a security, interest rate, commodity, etc …). They are used in order to hedge certain risks or have more leverage. Their main advantage is that they require less capital investments. Let’s say a hedge fund manager took a long position on NEO when it was 50 USD in November 2017, by January 2018 NEO is worth 190USD, he is worried it will plummet overnight. What a derivative allows him to do is to buy an option to sell his NEOs at 190 USD in a year from now for example. This option is a derivative product and is priced on the market. This is a classic example of a common tool in financial markets, would it be with securities, bonds …

There are currently 2 projects working on derivatives, the first is @dydxderivatives and the second is @dharma. While their teams are rather small, the two are founded by former Google Developers who happen to have also worked at Coinbase. The VC funds backing the two projects are also impressive (Y Combinator, Polychain to name a few). Dharma announced recently that they are not going to ICO and they took an interesting stand on the use of ICOs in general while dydx founder is still exploring the best way to offer derivatives on the blockchain. The two projects are not direct competitors as Dharma is taking on Credit Derivatives while dydx is more of a generalist. The Credits Derivatives market is HUUUUGE to quote an infamous President, the derivates market needs no introduction.

- Margin Trading and Shortselling : Simply put this is the ability to leverage positions either long or short. Shortselling is the ability to sell an asset that is not owned or that is borrowed, it is motivated by the belief that the asset price will decline allowing it to be bought back at a lower price later while making a profit. Margin trading is about borrowing funds in order to trade a financial asset, the assets value serves as a collateral for the loan and a certain amount of cash is also needed to pay the interest rate, the fees and to cover a potential decline in the price of the traded asset. So both activities need a Lending Market.

There are currently 2 projects that are focusing on bringing this into life. The first is @Lendroid and the second is b0x Team. The two projects are taking different approaches when it comes to solving the technical and logistical issues linked to the management of the collateral and the margin calls. Lendroid is 0xProtocol inspired and it’s aim is to build an ecosystem around the protocol. They have partnerships with most of the Decentralized EXchanges and Relayers using 0x and they are expanding their partnerships to other projects such as MelonPort and Makerdao. The project started early 2017 and did an ICO a few months ago, the founder is a serial cryptocurrency entrepreneur and Y Combinator alumni.

b0x is the contender. While there is a certain level of transparency and the team already put a first version of the protocol on the main net, I noticed that the fierce competition in this field makes it difficult to have enough data to compare the two protocols.

To put it more clearly : in 2017 the margin trading market represented more than 80% of the total trading volume for BTC in Japan which has a 60% market share worldwide. The total volume for lending and margin trading was 550Bn USD while regular trading was a bit less a 100Bn USD. Meaning that if the total market cap for a protocol like 0x is at 250m USD right now, Lendroid and b0x have the potential to be roughly 5 to 10 times bigger. Of course this needs a more in depth study but the basic comparison is simple. The technical solution and implementation is not as simple and elegant as the 0x one thus the teams tend to be secretive about their case studies, solutions and research results. b0x is in its ICO pre-sale phase and planning its ICO for Q2 2018 at a 34M USD hardcap, Lendroid is currently at a 54M USD mcap. The two projects are also in an indirect competition with dydx and Dharma. In order to be able to build derivatives there needs to be margin trading, shortselling and lending ! Which leads us to …

- The Lending Market : At first sight, this one is simple. But this is the cornerstone of the whole system. Without Lending, there is no short selling, without lending there is no margin trading, no derivatives and no risk management. And I was surprised to see how non-developed this market is for traditional crypto-assets. If US securities were to be on the blockchain, tokenized securities lending would be a 2trillion USD market. Meaning the first activity is Trading and right after there is Lending.

If we put aside Lendroid, dydx, b0x and dharma, I only found one project that is focusing on this market. And they are doing it on purpose. LendingBlock is often compared to ETHLend or SALT when in reality they are taking on a totally different market. They are working on offering a cross-chain lending platform and starting with BTC, ETH and the likes while planning on tackling the securities lending market. Talking about the necessary infrastructure that can allow institutional investors to get into crypto, LendingBlock is the kind of infrastructure that is needed. As a matter of fact, the team is composed of former Investment Bankers along with tech experts. The project is B2B focusing mainly on hedge funds and they just finished raising 10mUSD (ICO hardcap and total mcap) recently.

- The OTC markets : OTC stands for Over The Counter and this basically means transactions that happen directly between two parties and without others being aware of it. Meaning not in a centralized exchange nor in an open market. Why is this important ? When talking about institutional investors, we are talking about large amounts of money that could move the markets in a direction or the other. When the data about offer and demand for large transactions is transparent, this also leads to some market manipulation. Imagine someone willing to sell 50 000 BTC when the daily volume is around a 100m USD. The same happens in the securities market, there are large players that deal with each others by email or over the phone. Sometimes it even looks like this :

There is also one project who is tackling this issue : Republic Protocol, if you are already familiar with 0x (and I hope you are by the time you are reading these lines) then REN is doing the same with Dark Pools. A dark pool is an alternative exchange that allows traders to put in trades without having their intentions disclosed until the trade is complete. This answers another one of the many needs institutional investors have. The project has an incredible team and has received funds from Polychain and Accel Partners.

Conclusion :

As you can see there are many different pieces in this puzzle and what is actually both funny and sad is that a rather small fraction of the projects are working on it. My deep believe is that the blockchain scaling issues will be solved more sooner than later as the awareness of the world changing potential of the technology grows and matures. The institutional investors should follow pretty quickly as blockchain is already on their radars. This will reshape an old industry that was one of the least disrupted by the age of information technology and later put the foundations for new forms of governance.

This was my second article, it was a bit technical so I hope it was clear enough and helpful. If you have any remarks or questions please put them in the comments section.



Also if you would like me to go more in depth with any of the mentioned projects, I would gladly do (I have already spent enough time researching them). Please list them in the comments and I will try to pick the ones that are the most asked for / interesting for you guys to do a quick market / valuation analysis.

Your comments are my oxygen.

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