Is the Institutionalization of the Crypto Market Already Happening?

The crypto market is no longer relegated to enthusiasts alone, and with the massive profit potential on display, institutional investors have been open to entering crypto markets - let’s take a look at how this institutionalization has progressed.

Wall Street’s enthusiasm for the crypto market is bubbling up while its institutions eagerly await guidance from regulators. In the past few months, major Wall Street players have been getting in on the crypto action. Having started a trading desk for Bitcoin futures in May 2018, Goldman Sachs is now gearing for the launch of a Bitcoin trading operation. On Wednesday (June 6), reports emerged that Fidelity is looking to step up hiring for crypto projects and possibly build its own digital assets exchange.  These moves will likely lend further credibility to the crypto realm.

It seems that institutions are already building crypto operations and simply waiting for the regulatory green light to go on so they can flip the switch.  But when is that going to happen? What is the regulators’ stand on the crypto market?

In an exclusive interview for CNBC on Wednesday, SEC chairman Jay Clayton made it clear he supports the development of blockchain technology. He went on to add it could be especially beneficial to the securities industry.

“I think that blockchain technology has tremendous promise for the securities industry, eliminating costs. The cost of verification in the security industry is incredibly high. If we can make that more efficient – terrific,” Clayton told CNBC on the sidelines of the Sandler O’Neal Global Exchange and Brokerage Conference in New York City.

The crypto community, however, is eagerly waiting for clarification on three important issues. First, it wants to know whether initial coin offerings (ICOs) are securities and therefore falling under the purview of the SEC. Second, it needs clarity on whether altcoins like Ether and Ripple are securities. Finally, the crypto market awaits the criteria the SEC wants met to approve Bitcoin exchange-traded funds (ETFs) as a couple of years have gone by with no decision made yet.

Clayton declined to comment on how the SEC would rule on these issues. However, he made it clear the crypto industry would have to conform to existing rules and regulations regarding the sales of securities.

 “I understand that there is a great deal of discussion about these crypto assets, but again, we are not going to relax on rules based on the level of discussion. We need to know that the pricing is certain, we need to know that the assets are there and we need to know that it is going to function as our retail investors would expect these products to function,” he stated.

On the same day and during the same event, CNBC also sat down with Brett Redfearn, the SEC’s new trading and markets director. Asked about whether ICOs or altcoins are securities, Redfearn said:

“When looking at these issues it is not as obvious as one would think. So we had a number of different products that we looked at and we created this test, when people look at different characteristics and have to determine if it is a security. And quite frankly, not all of them are obvious on its face exactly what it is. So we will continue to clarify when it is possible.  I think there will be more statements coming forth from the commission on that, but in the meantime we are highly encouraging any market participant who is involved in this space to really look at these products and run that test and decide whether they meet the [criteria] of being defined as a security.”

Redfearn also declined to comment on whether altcoins are defined as securities. Although he refrained from speaking about specific products and whether their future will be determined via litigations, he said:

“I do believe that there would be statements on one of these products forthcoming in the future, providing some more guidance on that. So I don’t know what is the likelihood of litigation on these specific products.”

We can only speculate as to which product he was referring to and when these statements would be released.

The director also mentioned the SEC was looking at these questions on different levels – security, broker-dealer registration, and exchange registration. According to their examinations, “there are numbers of so-called exchanges that are trading ICOs that I would think we would see more registrations as ATS (Alternative Trading System) or as an exchange,” Redfearn said.

There are already registration rules in place for broker-dealers and exchanges (or ATS), and they could be applied to the crypto market. However, the infrastructure for fair market pricing and best execution is a bit more complicated and needs to be developed. Most likely, the SEC would have to devise a set of rules similar to Regulations NMS, which are applied in the equity market.

It seems that the SEC, like everyone else, is struggling with the definition of altcoin and any token or crypto coin. Although embraced by the SEC chairman, blockchain technology has created a product lacking any characteristics of the products we know today, be it a security, commodity, asset, or any other. Otherwise, we would already have a clear set of rules in place.

The reality is that a cryptocurrency is indeed a new type of product, neither an asset nor a security or a commodity. It has a hybrid nature and is therefore quite likely to end up defined in such a manner. More specifically, it might be defined as a security at the ICO stage when the company receives money from investors to build the software. However, once its network is live and its coin in use (as the oil driving the network engine, so to speak), it might become classed as a commodity. Ethereum is an example of a company/token facing this dilemma. Ethereum initially had the coin, but now it has its own functioning network, and the token could be perceived as a commodity. In fact, they call it “gas” when you spend ETH to run the network.

It could be that the SEC defines Ethereum as such a hybrid product – a security at its early ICO stages but a commodity once it has a functioning network. This may be the product and related statement Redfearn was alluding to.