Last week’s news that BlackRock is confident of securing regulatory approval to launch a spot bitcoin exchange-traded fund in early 2024 only added to a renewed sense of confidence in a digital asset market still recovering from the high-profile collapse of FTX one year ago.
Reports that US equities watchdog the Securities and Exchange Commission is preparing a ruling on as many as a dozen spot crypto ETFs including BlackRock’s have driven bitcoin in recent weeks to $36,800 (£30,000) from $26,800 just four weeks ago.
These are levels not seen since the second quarter of last year as bitcoin plummeted off its late 2021 high of $48,000, subjecting crypto markets to additional scrutiny which led to the collapse of FTX late last year.
Speaking in early November as news circulated of an imminent SEC decision on the proposed US spot crypto ETFs, Robert Gaskell, a partner at London-based blockchain advisory firm Appold, said the approval of a US spot crypto ETF could kick-start the long-awaited institutional adoption of digital assets.
“If you are a corporation or an individual with a pension fund, and you want to hedge or balance your portfolio, there are no easy ways to increase your exposure to digital assets. You could buy a bitcoin mining stock or buy the digital assets themselves but then you’ve got custody issues and increased overhead and operational issues, whereas a spot ETF opens up the market for exchange-traded funds that track the price of bitcoin cost-effectively.”
Gaskell continued: “This could be as early as Q1 2024 with many products, including big names such as BlackRock, queued up and ready to launch once the green light is given. This will allow large corporations to have digital asset exposure and hold these easily tradeable exchange-traded products on their balance sheet without having to hold Bitcoin itself.”
The SEC, the UK’s Treasury and the European Securities and Markets Authority, which plans to introduce the first part of its Markets in Crypto-Assets (MiCA) regulation in June next year, are all working on their own regimes, trying to strike the right balance between competitive advantage and investor protection.
Gaskell said: “The UK has studied MiCA to understand what lessons can be learned to make it better for the UK. The Treasury is keen to make the UK a friendly jurisdiction for investment into technology which will ultimately cross into digital assets and the tokenisation of real-world assets.
“The UK Treasury’s objective is for financial services firms to start using this technology on scale whereas, until now, we have only seen tests. The feeling is that banks investing in tokenisation are being held back by regulatory uncertainty.”
Pete Osborne, a partner at Appold and former director at Singapore Exchange, said: “Once those clear guidelines come into play, the fear of a regulatory fine and reputational damage diminishes. We know of projects in stealth mode while waiting for these rules to be made clear.”
Appold partners Pete Osborne (left) and Robert Gaskell
The competition between authorities when working to regulate this potentially lucrative industry is already being played out around the likely US approval of the spot crypto ETF, said Gaskell.
“While the US asset managers are lobbying the SEC for the crypto ETFs, there are projects with European asset managers trying to unlock the UK. The UK does not want to be left behind and the European asset managers understand this, so there is pressure to address that.”
Gaskell believes this regulation will act to align more closely the new digital asset firms and “traditional finance” banks and brokers.
“Regulation of digital assets should ultimately converge the two communities because you have the traditional firms looking to scale while the technology firms will be saying use our technology to achieve that scale. However, the traditional community needs to ensure the corporate and operational governance of the technology providers they use is fit for purpose,” he said.
For Appold, this convergence between digital assets and traditional finance will be realised in the banks’ use of new technologies to tokenise some of their core assets.
Osborne said: “If you look at blockchain as a whole regarding capital markets, you can tokenise these assets at very low cost and with almost instantaneous settlement speeds. Financial institutions may not be able to charge their clients as much in fees as they do now, but they can reduce their cost base significantly by adopting and scaling this technology, which can ultimately heighten profitability. That is very appealing.”
And Osborne also sees the potential for convergence in prime brokerage, a term that is already being applied in the digital asset space though he questions if what is being offered there really is prime brokerage in the conventional sense.
“The problem with the prime brokerage business model is that it tends to rely on a sizeable balance sheet. With the prospect of regulation giving more clarity into this sector, there could be an appetite for banks to roll digital prime brokerage into their current traditional prime brokerage divisions. They have the balance sheet and they have the whole book of institutional clients that will seek to trade and hold these assets.”
He continued: “That will put pressure on the current digital-only “prime brokers” and raise the question of whether banks would look to acquire these firms or do it themselves. That will be interesting to observe as the digital “prime brokers” may be valuing themselves at premiums that aren’t too favourable for the banks.”
Osborne said the market-making sector is similarly divided between traditional finance firms that have set up digital assets divisions and a newer generation of digital asset liquidity providers.
He said market-makers in digital assets had good years amid heightened volatility but “conditions changed post the FTX bankruptcy”.
The Appold partner continued: “From our engagements, we understand that the more successful strategic approach for market-makers during this year has been to offer other services on top of pure market-making and liquidity provision.
“The two areas that have boosted revenues from those companies are over-the-counter (OTC) broking in mainstream digital assets and liquidity provision in non-core digital assets.” For Osborne, non-core assets are the smaller, alternative digital assets where liquidity providers can negotiate more generous commercial terms based on the higher risk profiles.
The Appold partner added: “The larger and better-regulated market-making/liquidity provision firms have also been exploring the use of derivatives and options in creating structured products along with financial service providers who have institutional and wealth management distribution channels.”
Osborne concluded that, while 2023 has appeared quiet, Appold has seen more development around improving service offerings and heightened dialogue in potential strategic ventures. Another key area has been generating alpha by earning yield on digital assets instead of taking a position and just relying on beta.
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