ISSA Reports on the Crypto-Infrastructure

ISSA Reports on the Crypto-Infrastructure

This has been a terrible year for cryptocurrencies. Bitcoin, the flagship for the asset class, peaked in the middle of December 2017 at a value of above $17,000. By the end of January this year, it was below $10,000. By September BTC had settled into a price range of $6,500. People were thinking, “Well, at last it has found its floor.”

Sorry … wrong. The price fell sharply again in November, and as I write these words its value is below $4,000, less than one-quarter of its peak value a year ago.

The other major cryptocurrencies have suffered equally. Ethereum peaked at close to $1,400 early this year and fell to $403 by April, and it is now at $110, still looking for that fabled floor.

Beyond the Doomsayers

Nonetheless, only a few hardy doomsayers expect that the whole market sector will go away, like a bad dream goes away once the dreamer has a cup of coffee. A much more common view is that the sector will have to transform itself and BTC may no longer be the flagship.

The aforementioned numbers might be ascribed to growing pains.  As one blogger puts it, “bitcoin has died 328 times to date and counting.

Expectation of Survival

In the spirit of the sector’s survival, the International Securities Services Association has recently put out a paper on the infrastructure of crypto assets. ISSA says that “the provision of services to participants in the crypto-assets markets … should be seen as a target market by major participants in the securities services industry.”

The report is especially targeted at custodian banks, payment market infrastructures, central securities depositories and counterparty clearing houses. ISSA considers it likely that over time infrastructure components will grow around trading on crypto assets that will be “not unlike the financial market infrastructures that service the securities market of today.” The digital wallets that are out there represent only an early step on a long journey.

Most crypto-asset trading depends on distributed ledger technology (DLT), which was designed largely to allow trading to dispense with intermediaries. Paradoxically, though, the absence of such intermediaries is itself a contribution to the distrust of them among many institutional investors, which keeps theme the domain of the retail investors. Given the well-publicized instances of hacker attacks on crypto exchanges, and the fraudulence of some initial coin offerings, some level of distrust is to be expected. The inference of ISSA is that as more intermediaries enter the picture, investing institutions will feel some element of reassurance, and only then may crypto-assets really come into their own.

ISSA cites a Swiss law firm MME Legal, which in a report issued this spring classified tokens by their so-called “Blockchain Crypto Property,” to distinguish three types of tokens: those which aren’t backed by any legal counterparty against which claim might be made; those backed by an individual or legal entity; and those which confer outright property rights in an asset. ISSA considers this classification system an “indication of the nature and extent of the rights conferred on investors by the various types of token.”

Settlement of Transactions

One of the core roles of market infrastructures is delivery against payment (DvP), that is, the settlement of transactions. In the case of crypto assets, this entails buying or selling tokens for fiat currency (the stuff we in ordinary parlance call money).

The report says that “market infrastructures can reduce the costs [of such transactions] by netting offsetting trades.” This isn’t a substitute for the sort of legal certainty that will someday be provided by the development of central bank digital currencies, but it can remove any confusion around the ultimate transfer of ownership.

Given the present relative immaturity of support services, the issuers of crypto assets are on their own. They must write their own prospectus “without clear direction from company law or regulation.” This is a situation that will over time come to be provided by intermediaries, also known as infrastructure service providers. In nascent form, these services are known as incubators or accelerators.

What’s the bottom line? “Crypto-assets are on an evolutionary path.” The way to profit, as a service provider, is to get out in front of the evolution.

 

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