More Evidence That Wall Streets Coming to Bitcoin

We wrote the other day that Wall Street and its vast capital is headed towards the crypto space. More evidence piles up daily, but I found one that was prescient.

ReformedBroker.com posted a note on his blog explaining how and why he purchased his first Bitcoin. I’d summarize it as “Bitcoin doesn’t seem to be going away so I best try it out.” He doesn’t offer much insight or new perspective, just seems to be capitulating and accepting that there just could be a future in cryptocurrency.

This guy is a financial advisor with a large blog following. This is how he describes himself:

I’m a New York City-based financial advisor and the CEO of Ritholtz Wealth Management.

We help people align their investments with their financial goals and manage portfolios for them. Our clients range from high net worth households to corporations to retirement plans to charitable foundations. For younger investors and those just getting started, we’ve created the Liftoff automated advisor – a simple, low-cost way to access a professionally managed portfolio selected just for you.

I am also the author of the books Backstage Wall Street and Clash of the Financial Pundits from publisher McGraw-Hill.  In addition, I serve on the advisory board of financial technology firm Riskalyze as well as CNBC’s Financial Advisor Council.

In 2015, I was named to the Investment News “40 Under 40” list of top financial advisors.

Here is the full article, from Reformed Broker:

So you are now free to dump all of your crypto-currencies because this surely marks an all-time top.

But I thought I’d mention it anyway.

For those who are curious about why and how, I’ll just say the following…

I’m old enough to realize that just because I don’t see a use for something, that doesn’t mean I won’t be proven wrong by others who do. At the current moment, I don’t see the financial industry use for Bitcoin other than some marginal activities like settling commodity trades that are very far divorced from my day to day existence. I understand the benefits of these things – the blockchain acting as verification that the counterparty has made payment instantly, etc. I’ve probably read all the stuff that you have. I’m skeptical.

I also think it’s hard to imagine the IRS, Treasury etc allowing anonymous transactions without any reporting becoming a global standard for US persons.

But I’m willing to look beyond that because the goddamn thing won’t go away. I was talking with Justin Paterno (StockTwits) the other day and his attitude toward it is pretty much where I am – “Anytime something just refuses to die, you probably have to pay attention to it.” Bitcoin, if it were complete and utter nonsense, probably should have died already. But 7 years since it burst into the public consciousness – with all of the attendant volatility and criminal activity you’d expect to come along with something so new and unproven – and it’s still here. Despite the hacking and stealing and malfunctions and crashes, it’s still a thing. It’s the f***ing rooster. Ain’t found a way to kill me yet…

Anyway, I’m not a disruption hippie or an early adopter or a visionary or an evangelist. But I’m too curious to not experience Bitcoin ownership for myself. Oh, by the way, I don’t see myself trading it on price swings, more on that in a second.

So I used Coinbase, which from what I gather is the “safe” way to buy, sell and store. We’ll see. I began with a small amount of money so if they hack the site tonight and empty everyone’s wallets, I won’t feel it. The process was fairly simple.

First you create an account and connect it to your phone and email. They text you a code to verify and send you an email to confirm. No big deal. Then you connect a bank account, which only takes a second. From there, Coinbase makes two small deposits into your bank (pennies, don’t get excited) over the next 48 hours. You log back in and report what those tiny deposits were so it can verify the connection to your bank. Once that’s done, you can transact.

I bought some BTC, although ethereum and litecoin were also on the menu. I look at those other two like silver and bronze to Bitcoin’s gold. But I’m just making that up. Ethereum (ETH) might one day be better because it allegedly has some technological advantages, but I’m a newb so I’m starting with the more established fake thing rather than the less established fake things.

Anyway, I expect a lot of volatility and I really don’t know what I will ultimately do with my digital thing. Maybe I will add to it or maybe I will buy ETH also at some point. It went up 8% today I think so already I’m a genius 😉

I think at this stage in the game, it’s important to be open-minded and not afraid to lose money or look foolish. I’ve invested into way dumber things in my life. And as far as what the future holds – if the disruption hippies turn out to be right, and the 21 million BTC that will eventually be the limit are out there in public hands, it’s hard to imagine them not appreciating in price. Especially if they become more institutionalized and embedded into enterprise scale transactions – which is what the banking industry seems to be leaning toward from what I read and hear. I like the idea of scarcity and owning something that is finite by design.

And yes, I am aware of the possible split in the community, I have no opinion about it and nothing worthwhile to add. I’ve factored this risk in mentally. The resolution of this scaling problem may turn out to be a powerful upside catalyst just as easily as it could lead to a panic. Brexit-esque.

One other thing. On the Silk Road two thousand years ago, you needed gold to settle transactions. Because from Korea to the Asian Steppe to the Mediterranean, there had to be one thing whose value was never questioned. Gold facilitated trade and liquidity from one end of the known world to the other. My opinion is that this property of the element – it’s universal acceptance – remained in force for centuries…until it was disrupted by the internet. Once computers arrived, we had instant access to values and prices of goods around the world. Gold’s role in global liquidity and verification suddenly mattered less. No one realized it at the time, but gold as a currency had been permanently disrupted by the microchip and the operating system.

The Information Technology Revolution began in the early 1980’s when the computer became first a ubiquitous business tool and then eventually a household appliance. It should come as no surprise when I tell you that this moment also was the inflation-adjusted high for gold, still unsurpassed almost 40 years later.

Blockchain technology may have just permanently disrupted traditional currencies. It’s obvious to me that even if this is true, we will not know it for sure until decades have gone by.

Bitcoin Bloodbath – But a Reminder: Wall Street Is Coming

Todays Bitcoin and Ethereum bloodbath was more or less expected ahead of the (potential) coming Bitcoin “Segwit” event. While this is causing major moves in the short term I think its prescient to remind the cryptocurrency community that Wall Street is on its way.  In the past we posted about what some of the roadblocks are, but with todays Bitcoin and cryptocurrency bloodbath we thought maybe some positive predictions were due.

Yesterday we posted some concrete evidence, but there are some other speculative indicators.

First, trading in “traditional” (stocks, options, bonds, etc) Wall Street products is flat, at best. There is nothing indicating that those traditional volumes will pick up either. (See JPM trading revenues, weak). [Note, other areas of banking appear to be strong – I am referencing the trading sector specifically]

Take a look at US stock and options volume for example. Yes, there is some deviation month to month but its been flat for years.

US Daily Stock Volume
US Daily Stock Volume
US Exchange Options Volume
US Exchange Options Volume

Its no secret that Hedge Funds are having a hard time. They are a major source of banks trading revenue. Why, well multiple studies show that buying and holding over time crushes Hedge Fund performance. Vanguard is the poster child of this, and is growing at a ridiculous pace offering investors low cost ETFs. Whats my point? This is good for investors but terrible for Hedge Funds and Banks.

Trading desks on Wall Street need a new revenue source. Enter Bitcoin, Ethereum and cryptocurrencies.

All of this is could be brand new business in a market that is expanding rapidly.

Crypto Volume is Exploding

High volumes mean dollar signs for brokers. All evidence points to volumes that rival US Stock Exchange volume.

Below is Bitcoin 7 day average volume. I’d suspect most would argue that this volume will continue to grow over time – if not in Bitcoin than certainly in other cryptocurrencies such as Ethereum or Dash.

Bitcoin Volume
Bitcoin Volume

Just a few days options trading in Bitcoin was approved by the CFTC (US Commodities Futures Trading Commission). This means that regulators are starting to turn positively on Bitcoin and crypto. This is great news for banks in particular as they can more easily move into cryptocurrencies when the regulators are approving.

This offers opportunities not just in trading – but in services for trading:

  • Cryptocurrency clearing and storage
  • Research and Analysis
  • “Smart Routing” and algorithmic trading

It would be easy to argue that as more large entities enter the space, more technology is built and more capital flows in. While today Bitcoin prices are getting hammered, we’re in the first inning of a game that most likely will not end in our lifetimes. Reminder: this isn’t investment advice, just an offering of perspective.

Whats Wall Street Waiting For?

Why Is Wall Street Slow to Move into Crypto?

  1. Regulation
  2. Clearing

Not the sexiest topics, so we’ll keep it short.

Hedge funds and Wall Street firms have been slow moving into trading and investing in cryptocurrencies such as Ethereum and Bitcoin. There are some

Enterprise Ethereum Alliance
Enterprise Ethereum Alliance

indicators that sentiment is shifting such as JP Morgan (and others) joining the Enterprise Ethereum Alliance and Goldman Sachs initiating research coverage of Bitcoin.

Assume for a second that sentiment is suddenly 100% positive and that all the “scam” and “crime” stigma has left the building. So, whats the problem?

Regulation of Bitcoin, Ethereum

Party of the beauty and attraction of crypto is the decentralization and lack of regulation. There are many reasons why this is beneficial. But if you’re a big bank or managing billions of dollars, regulation matters. First, Bitcoin is not “legal” in all countries. Just look at what China did a few months ago when they started “regulating” Bitcoin. As per wikipedia: “While private parties can hold and trade bitcoins in China, regulation prohibits financial firms like banks from doing the same.” Not only is there  (outside) risk of the US doing this, but if you’re a fund thats has Chinese investors or does business with China this clouds the water.

Most assets are also considered collateral. If I have $10 million in gold I can bet that the bank I deal with would consider that an asset against which I can borrow. Does every bank see Bitcoin in that same light?

What about tax treatment – the IRS has made some comments but I’d say nothing is set in stone. Just this month the IRS is talking to Congress about strategy.

A lower risk, but still foreseeable is the risks of regulators such as the SEC or FINRA coming after you for engaging in (for example) an investment used to launder money. Maybe you buy Monero and build up a large position and

Bitcoin SEC Regulation - image courtesy CoinDispatch.com
Bitcoin SEC Regulation – image courtesy CoinDispatch.com

those assets are seized because the FBI thinks they were used in some hacking blackmail scheme. Probable? Probably not. Possible? Sure.

The facts are that until a regulator “green lights” Bitcoin and/or Ethereum its going to be tough for large institutions to trade or invest.

When Might Regulators Weigh In?

I’ve been watching the SEC’s ruling on the Winklevoss Bitcoin ETF launch. Its taken years for a ruling, and earlier this year it was initially rejected. However in April the SEC decided to take another look. I think its a bit underestimated the impact that approval would have to the price of Bitcoin. This would give not only a regulatory stamp of approval, but paves the way towards clearing and settlement of Bitcoin at an institutional level.

Clearing and Settlement is a Major Problem

Take stock or ETF trading as an example. When funds (or anyone as a generalization) trade publicly listed stock that stock clears through a central clearing house called the DTC. If I am a hedge fund and have my assets at say, Goldman Sachs (your “prime broker”), I can trade stock with JP Morgan. JPM sends the stock to my account at Goldman through the DTC. Its a pretty seamless process and universal to US stock trading.

Now, lets say I’m a hedge fund and I want to buy $1 million Bitcoin. Buying is easy enough – you go to one of the exchanges, wire money and buy your Bitcoin. The problem is there is no way to get your Bitcoin back to your prime broker. No, a wallet even with vaulted cold storage wouldn’t work. The risks associated with that are high, but the mechanics of trading in and out are a huge hindrance. If the fund needs to immediately raise assets by selling Bitcoin they need to have immediate access to those coins. While yes, you can work out the mechanics if you are a small fund or “crypto” is your dedicated business. But for large institutions who want to simply invest in crypto this is a major hindrance.

How Could Clearing Change?

One possible way is for clearing houses/prime brokers like Goldman or Morgan Stanley to have some type of central clearing wallet. Linked to that wallet would be “sub-wallets” for each fund that owns Bitcoin. Therefore if I go to Gemini Exchange and buy 1000 Bitcoin, I tell Gemini to send that Bitcoin to Morgan Stanley on my behalf. Morgan Stanley then has custody and can allocate the Bitcoin to my funds sub-wallet. This “sub-wallet” concept seems to peripherally exist and I’d imagine banks could pay someone to hash it out rather quickly.

If the Bitcoin ETF launched this would circumvent all of this, because you could just buy the ETF and it would clear via the DTC like all other stocks and ETFs. (Yes, I am aware the GBTC exists, but the premium on that product is absurd). To this point I think this clearing/custodial aspect is probably one of the problems the SEC is having with the product.

In the End

I’m confident these issues will be worked out. The fact that they haven’t yet makes (in my opinion) Bitcoin and Ethereum such an interesting investment at the moment. The door is currently cracked open to big investors, but eventually we could see a real flood of assets.