Delta-one securities for cryptocurrency

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By:
Peter Lee
Published on:

As more retail and high-net-worth investors embrace cryptocurrency, lightly structured delta-one synthetics now allow institutional investors to allocate to a new asset class.

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Jamie Dimon, CEO of JPMorgan

You’ve just launched a company that makes it easy for people to invest in cryptocurrency, letting them buy, sell, store and exchange blockchain-based digital assets with a single app that combines a multi-currency wallet, hybrid exchange and initial coin offering (ICO) engine. What’s the first thing you spend your start-up funding on?

Swiss-based Eidoo knew exactly where to blow a chunk of its change: a full-page in the Wall Street Journal deriding Jamie Dimon’s contention that bitcoin “is not a real thing” and his threat to sack anyone trading it at JPMorgan.

“Maybe Jamie will fire you,” ran the banner ad for Eidoo, next to a simple picture of its app running on a smartphone. “But you’ll be free to trade in the crypto world.”

The good news for Eidoo is that the first-day marketing hasn’t blown all the money it should be spending on coders that it raised through its own token offering. 

Dinosaurs

It’s obvious that many ICO funded start-ups will end badly and possibly quickly.

Eidoo might be around to poke fun at the dinosaurs a while yet though. Start-ups in the crypto world don’t take months and months to prize a couple of million dollars from venture capital funds these days.

“We are delighted that thousands of people already back our vision, as expressed through the €20 million in token sales we generated in the first few hours of the ICO,” says chief executive Thomas Bertani.

Things are moving fast in the cryptocurrency world.

Dimon’s claim at the Delivering Alpha conference was that governments now curious about cryptocurrency will soon shut it down.

“If you’re in Venezuela or Ecuador or North Korea, you’re probably better off using bitcoin than their currency,” Dimon allows. “But that can’t possibly happen in the United States, unless you’re speculating. That’s not a reason to say something has value: that other people are going to speculate.”

Heaven forbid that JPMorgan should ever do anything like that itself or finance anyone else speculating. “That’s tulips,” Dimon confirms.

But if governments are going to close down cryptocurrency, they’d better move fast. There are now close to a thousand such tokens in virtual circulation. At the start of this year the total market value of all of them was $17 billion, Eidoo calculates. By the time of its launch in early October that had risen to $151 billion.

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Ryan Radloff,
CoinShares

“What we have seen happen with all the recent ICOs is that there are now newly minted cryptocurrency millionaires and even billionaires, many of whom have no interest whatsoever in transferring that wealth back into fiat currency, but rather intend to invest in and build out the crypto eco-system, diversifying into more ICOs,” Ryan Radloff, co-principal at CoinShares, tells Euromoney.

Whether Dimon took any notice of that WSJ ad, he should certainly pay attention to CoinShares.

Just days after Eidoo launched, CoinShares took an even bigger step in forging the path for mainstream institutional investors to take diversified exposure to cryptocurrency, launching two new exchange-traded notes on Nasdaq Stockholm. These allow investors to gain exposure to ether, the currency of the Ethereum blockchain that is second in market size now only to bitcoin.

The notes are denominated in Swedish krona and euros, and are structured to derive a value for ether based on an index rate comprising the average of the three most liquid of a select group of exchanges, daily.

Investors know that bitcoin has been used by criminals. The smart ones presumably can sense that some ICOs are if not fraudulent than certainly puffed up like internet stocks at the end of the 1990s. But they are still intrigued and, even after the recent extraordinary bull run, see value.

“Blockchains need a native token or coin,” says Radloff. “As more and more use cases for the technology emerge to run tokenized assets and smart contracts, the utility value of certain tokens continues to grow and becomes a very interesting investment opportunity.

“We are seeing high-net-worth individuals, family offices and increasingly hedge funds in the US, UK, Germany, Switzerland, Sweden and South Africa seeking exposure.”


If you think banks will remain loyal to fiat currency when they see a chance to make markets in, trade and profit from the crypto space, then I think you are misguided 
 - Ryan Radloff, CoinShares

The problem for those institutional funds is that, if they want to allocate 1% to 3% of assets to crypto and ask their custodian banks about holding private keys to crypto accounts, that becomes a tricky conversation.

“So, institutional investors are turning to delta-one securities, with ISIN numbers – instruments that custodians are familiar with and can handle – to take exposure to cryptocurrency,” says Radloff. “And we are designing those products.”

CoinShares takes the view that a cryptocurrency must have sufficient cash-market daily liquidity to properly structure a delta-one instrument that might itself be actively traded.

Only 11 cryptocurrencies have more than $1 billion equivalent in outstandings. Three look significant: bitcoin, with a market capitalization of around $80 billion; ether, with $28 billion; Ripple with around $10 billion. CoinShares now has exchange-traded notes for bitcoin and ether, and regulated bitcoin managed funds.

Helena Wedin, head of ETP Services Europe at Nasdaq, says: “While it is important to acknowledge that exposure to an asset in its early stage of development, such as a digital currency, comes with a risk, trading ether on Nasdaq Stockholm provides investors with the protection provided by a regulated infrastructure, well-known marketplace and accessibility through their ordinary brokers.”

Escape velocity

Euromoney speaks to sources in the fintech and cryptocurrency world who envision these new censorship-resistant currencies expanding so quickly beyond the control of central banks and governments that they become their own decoupled financial system, achieving what the fanatics call escape velocity.

It strikes Euromoney as more likely that plenty of bridges will be built between fiat and crypto.

Radloff says: “If you think banks will remain loyal to fiat currency when they see a chance to make markets in, trade and profit from the crypto space, then I think you are misguided. I would suggest that within the next 12 months we will see large banks adding crypto trading desks and investing in a major way in the associated infrastructure.

“It’s public knowledge that JPMorgan, for example, consistently makes markets for clients in bitcoin-related products.”

Mainstream institutional investors will want more assurance before making strategic long-term allocations to the asset class. There is a short-term, pump and dump flavour to many of the most recent coin offerings.

Radloff says: “Sure, greed is outstripping due diligence in some of the ICOs right now, but we will see the needed investor protection rules emerging. We are working towards a professional, regulated and fit-for-purpose environment in which institutional investors are able to take exposure to this asset class.”

Daniel Masters, co-principal at CoinShares, adds: “CoinShares is committed to delivering world-class research and professional-grade access to crypto-assets.”

Masters should know what mainstream institutional investors and wholesale market participants want and need. He used to work at… look away now, Jamie… JPMorgan.