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Everyone involved in the busy, volatile space of blockchain and crypto can remember where they were when JP Morgan Chase boss Jamie Dimon derided cryptocurrencies as a “fraud” in 2017. And they tend to have the same granular memory of the day JP Morgan Chase became the first global bank to announce its own crypto offering, JPM Coin, to help institutional customers transfer large sums of money instantaneously.
Nikhil Kalghatgi is a partner at CoVenture Crypto, which employs crypto strategies around electronic quantitative trading and smart indices. CoVenture also has an advisory arm to help other financial institutions get their mind around the crypto ecosystem.
For entrepreneurs like Kalghatgi, JP Morgan’s reversal was sweet justice. “We kind of knew they couldn’t stick with that position forever,” Kalghatgi said. “But for them to be the first big bank to embrace crypto, that was an added bonus.”
In this interview with Karma Contributing Editor Michael Moran, Kalghatgi discusses what he sees as the start of a trend that will sweep through the financial services sector.
Michael Moran: Why are some financial institutions flocking into crypto while others remain skeptical?
Nikhil Kalghatgi: The three primary reasons are custody, regulation and liquidity.
On the custody side, you've got trillions and trillions of dollars in assets. And interestingly the vast majority of those are controlled by the top five providers. So about 60% (of crypto assets?) are custodied by Bank of America, State Street, JP Morgan, Fidelity and a handful of others. You've had an emergence of crypto native custodial providers, and that's great and if necessary.
However, it doesn't really matter when it comes to real investors, large corporations and financial institutions. They want to be (with) one of those Tier 1 players. What we've seen is Fidelity, State Street and a handful of major players are coming in, most recently announcing custodial services as of March 2019, so we're starting to begin to see these mainstream Tier 1 custodial services.
The second issue is the regulation. Cryptocurrencies are very clearly regulated in the United States. Either they’re securities or seen as potential securities. Things like Bitcoin and Ethereum are very clearly not securities as determined by the SEC. They’re taxed very clearly. The problem is that there are a lot of grey areas emerging on the fringes and that's really what's scares a lot of the financial institutions.
What we're seeing right now are proposals aimed at clarifying a lot of these grey areas, but I think that this will also take a year or two years before we have clarity. Nonetheless, you're starting to see the big financial institutions and companies come in. A number of companies that provide political and regulatory services to large Fortune 500 companies are now involved. The No. 1 request from their customers these days involves crypto. These Fortune 500 CFOs and treasurers are asking: “Should we be including Bitcoin and Ethereum into our treasury management?” This is pretty mind-blowing, generally you see large Fortune 500 companies as the laggards in thinking about how to manage their treasuries. That usually makes them very conservative.
However, they are starting to think of crypto as a potential solution for a problem they’re familiar with. For example, what if their question is : “Do you believe that there will be a potential global contraction in the future?” And if you do, this is a solution that you might want to think about. There is a very clear alternative in cryptocurrencies which have no correlation to the NASDAQ and S&P 500 or other major indices. All of a sudden you start to see these large corporates leapfrog into the cryptocurrency ownership.
Liquidity questions are slowing uptake because people want to make sure that they can get out of their positions. Liquidity is the hardest nut to crack in crypto, and I say that because there's a big difference between what we hear in the headlines versus the reality.
For example, if I wanted to buy half a million dollars of Bitcoin during the peak amount of liquidity where the aggregate cryptocurrency market is in the high hundreds of billions of dollars and there is a market cap of deploying $400 billion to $500 billion, the spreads were quite large. Fast forward six months to the summer of 2018, crypto is 60 percent smaller, liquidity has dried up, and if I wanted to buy half a million bucks on Coinbase, I can do it easily, at about half the spread.
How is that possible? Liquidity has improved, but it's consolidated onto a handful of players.
Michael Moran: So what does this say about the larger crypto/financial services ecosystem? The highs of the Bitcoin Bubble are behind us. So why are financial institutions flocking to crypto today?
Kalghatgi: In fact, it's not just financial institutions; it's larger corporates. And what we're seeing is a flock to high-quality liquidity.
Michael Moran: What are the applications and cryptocurrency solutions you’re seeing today?
Kalghatgi: The primary applications of cryptocurrencies today are around capital infrastructure services and settlement. There's a lot of talk around how cryptocurrencies are difficult to value; what are the real applications; and are they replacing sound money.
So the applications today for a lot of these businesses I believe are going to be first in these services around money before it gets to this idea of entirely replacing dollars and cents and payment systems. And I'll explain why.
What are capital infrastructure services and settlement? They are primarily all the services that you can imagine around custodial banks, around trading, around the data around them and the technology infrastructure.
An example of these types of things would be trade facilitation. You've got custody and settlement clearing and security services in the example of data and information. You've got data aggregators. Things like E*Trade, where people are learning about them and not just doing the trading itself, and then you've got services that provide technology infrastructure.
You can imagine this includes cloud services and messaging things like Bloomberg or compliance and regulatory reporting regimes -- even credit services and things like prime brokers. So these are kind of like all the services we associate with capital infrastructure. And I find that cryptocurrencies and applications today are likely to be seen first in settlement, which is probably the biggest and most ripe opportunity for wealth creation today. Today if (you) want to buy a home, even if you already (have) the money and it is all cash, it's going to take 72 hours to move your title. That's crazy. That is worth a lot of money.