High Returns Drive Demand for Crypto-Linked Financial Products

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Dubai has always distinguished itself with its willingness to adopt innovative technologies in order stay ahead of the curve in the fast-paced Middle East region. A recent announcement by the local government on the launch of its own cryptocurrency emCash is a testimony to this commitment, and a step towards Dubai’s firm positioning as a strong global player in the world of cryptocurrency finance.

The flexibility and convenience of cryptocurrencies coupled with the government’s support of the paradigm changing blockchain technologies have opened a new era in the dynamic regional financial markets. Nonetheless, there are a number of challenges this relatively young, nine-year-old industry is facing in spite of the unparalleled opportunities on the horizon. One of these is the fact that it is now seen as both a competitor and potential partner for the ‘legacy’ financial industry.

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Currently cryptocurrencies have a total market capitalization hovering around $150 billion. In the past four years they have seen an enormous growth in value and in variety. According to Evgeny Xata, CEO of Luxembourg-based CyberTrust, demand for both securitised crypto as well as crypto derivatives in the next five years is expected to skyrocket, and are predicted to capture at least 1% of the total derivatives market worldwide, which is currently estimated at $500 trillion.

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Nonetheless, thus far it has been difficult for institutional investors to take advantage of this growth. Numerous barriers currently hamper them from capitalizing on the unique opportunities presented. These include a lack of titled and auditable ownership of cryptocurrencies, the abnormally high clearing and settling risks, a lack of legal framework to enable judicial recovery in case of disputes, and of course the risk of theft risks due to security breaches.

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Thus far not a single crypto-derivative product has completed the ISO 6166 certification process resulting in an International Securities Identification Number (ISIN). Cryptocurrency price quotes cannot be found in the financial sections of most major newspapers. These are important facts, because they are reminders that despite impressive growth in cryptocurrency asset value thus far, the level of awareness and participation on the part of institutional financial markets is still quite limited.

The Ethereum story is a good reminder of the aforementioned issues. In 2016, Vitalik Buterin, the creator of the Ethereum blockchain, met with the Chairman & CEO of the largest banking group in Central Europe. This meeting led to the CEO showing an interest in blockchain technology, and particularly in Ethereum. He was contemplating a substantial institutional investment into the Ethereum ecosystem. Nonetheless even after a 40x explosion in the value of Ethereum tokens, the deal remained unfinished. Simply put, legal requirements, accounting restrictions, tax regulations, due diligence and the like made the investment deal unrealistic for any large institutional investor.

At this point the only option available is the $1.3b Grayscale fund, which currently charges a hefty 84% premium for its services.

With this in mind, what could be done to bring the cryptocurrencies into the institutional banking world and allow the more traditional, institutional investors to take a full advantage of the cryptocurrency revolution?

According to Scott Freeman, CEO of cryptocurrency exchange C2CX.com, there are several ways to do this: “One is to create a cryptocurrency fund, as Grayscale did, but with the downside of being of limited quantities and flexibility. Another – arguably better – approach would be to create a channel to transform ‘raw’ cryptocurrency into a titled form. This kind of approach would provide not only more flexibility in terms of the underlying assets, but it also would provide them in the quantities that the market demands.”

Time will tell which models will win out, but with crypto-based funding in 2017 for the first time exceeding funding via the more traditional avenues of IPOs and private equity, one thing seems certain: cryptocurrencies are here to stay.

Photo courtesy- CyberTrust

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