The world has become seemingly captivated by cryptocurrencies, driven by their rapid growth, both in terms of the number of cryptocurrencies and their prices. There are now over 1,500 cryptocurrencies with a combined market cap of USD500 billion. The rapid surge has meant that investors globally have started to pay attention.
At the same time, a consensus is emerging that the blockchain technology underpinning cryptocurrencies may be a game-changer for the global economy. The technology has started to be used by innovators in myriad fields looking for greater decentralisation.
That technology has come with its own financing model, the initial coin offering (or ICO). More and more entrepreneurs are turning to ICOs to raise capital to fund the development of blockchain-related products and services. In 2017, it is reported that more than USD5 billion of capital was raised through ICOs and that number looks to be far exceeded in 2018.
Speaking at the Swiss-UK Dialogue in London on 18th March 2018, Mark Branson, the CEO of FINMA, the Swiss regulator, remarked that “there is at least a whiff of religious mania hanging around the blockchain world”, and perhaps it is this mania that is prompting institutions to remain cautious.
Hedge fund managers, traditional venture capitalists and the like are yet to get totally behind the blockchain innovation story that is unfolding but there are those, such as Jabre Capital, one of Switzerland’s best known hedge fund managers, who recognise the investment opportunities in the emerging blockchain economy.
“In 2018 I think we will start to see a shift, with more institutional investors recognising this new asset class,” suggests Leila Khazaneh, General Counsel and Director at Jabre Capital. “We are currently looking to set up a new business division – Blockchain Technology Ventures, to help bridge the gap between the global investment community and the new blockchain economy.”
For institutional investors to become comfortable investing in this new asset class – which not only include currencies but blockchain and crypto-based innovations – there are challenges to overcome. Two of the most important are regulation and the need for more tools to manage crypto investments.
Regulation
Regulatory certainty is essential for this technology to gain widespread adoption. Switzerland has expressed its intention to remain a centre of innovation for the blockchain economy and is, in many ways, taking a lead role in Europe. Swiss financial services regulator FINMA is taking a very proactive approach to all things Fintech and made it a clear priority in 2017.
“One of the key factors in making this asset class stable is having a tech-savvy regulator that is able to provide clarity and certainty. Without that, professional investors will continue to stay on the sidelines, no matter how convincing the investment thesis may otherwise be,” says Khazaneh.
During his speech in London, Branson talked about the anti-innovation bias of current regulation. “At FINMA, we have long advocated the removal of barriers to entry in order to release the potential of technological innovation in finance. Our goal as regulators should be to create an environment where innovation can happen,” he said.
That is not to suggest that FINMA will take a hands-off approach to overseeing crypto currency-related businesses and initial coin offerings (ICOs). Quite the contrary.
FINMA has taken steps to reduce the confusion surrounding regulation, laying ground rules for those seeking to get involved in this field. In February 2018, for example, it introduced ICO guidelines, setting out how it intends to supervise ICOs and the underlying tokens being offered (the blockchain-based units).
In the Guidelines, FINMA set out to define the principles it will use to assess ICO structures. FINMA made it clear that it would base its assessment on the underlying economic purpose of the coin (or token) being offered, identifying three token categories: payment tokens, utility tokens and asset tokens.
Each category comes with its own regulatory obligations, and ICO issuers are encouraged to determine which framework they fall in from the outset. The Guidelines were generally welcomed by the blockchain community, many viewing them as a signal that the Swiss regulator was looking to foster innovation in the nascent blockchain economy.
Tools
One of the biggest challenges for the investment community looking to get into the blockchain economy is the lack of tools to support investment, and crucially, to secure the digital assets being acquired.
A fundamental goal of Bitcoin and the underlying technology was to disintermediate trust and enable people to self-custody their own assets. This ensured assets were controlled by their owners and not subject to external points of failure. Crypto enthusiasts celebrate the ability for people to hold their own assets securely in a digital wallet. Professional investors remain wary however.
“The problem is that we’re not crypto security experts and we‘ve never taken direct custody of any other asset class. We’re also very aware of our fiduciary duty to secure fund assets, so we’ve turned to experts that offer the best service in terms of security and custody. These are institutions that have built highest level expertise in securing digital assets,” says Khazaneh.
Many blockchain projects in 2018 are focusing on building tools and the underlying infrastructure necessary to validate crypto as an asset class; these tools apply to payments, processing, storage, reporting, monitoring and compliance.
One of the main challenges of buying and selling crypto currencies without going through an intermediary is compliance with KYC/AML obligations. In peer-to-peer transactions, tokens can be sent and received from one digital wallet to the other without any identification information being exchanged. Recognising the opportunity in finding solutions to this inherent challenge, many entrepreneurs and blockchain start-ups are fast developing solutions.
Blockchain forensic tools, for example, have become valuable and more widely deployed as the investment community evolves from a mainly retail base to a more institutional one. These tools enable crypto firms to go beyond ‘know your customer’ (KYC) due diligence to ‘know your transaction’ (KYT). Because every transaction is recorded on a public ledger (the blockchain), the transaction history associated with a digital wallet can be analysed to reveal connections to past illegal activity.
“It’s important to fund this innovation and help fuel the ecosystem by supporting entrepreneurs working on bringing this asset class to mainstream,” confirms Khazaneh. She further points out that Jabre Capital will be using some of these tools, such as the provenance tools developed by London-based compliance platform Coinfirm, in managing its investment products.
Martin Palotai, Jabre Capital’s chief compliance officer comments: “Demonstrating compliance with AML obligations is a challenge and remains a key obstacle for traditional institutions, but blockchain analysis tools do exist and can be used effectively. When paired with a risk-based approach to selecting counterparties, the risks can be reduced to levels acceptable to many institutional investors.”
Conclusion
Institutions are now waking up to the significant opportunity set within the new blockchain economy and Jabre Capital is in no doubt that Switzerland is in a prime position to benefit.
“I’m convinced that Switzerland has an advantage. Because of its history of stability and the decentralised, bottom-up vertical process that exists within the Swiss culture, in some sense you could argue that Switzerland reflects the main principals underpinning the crypto asset space,” concludes Khazaneh.
