One of the giants in the crypto ecosystem got a little bigger today. Coinbase Inc announced today that it has the green light from the SEC and FINRA to proceed with a series of acquisitions that will (among other things) allow it to be the first federally regulated venue for trading digital securities.
The trio of companies included in the acquisition are Keystone Capital Corp., Venovate Marketplace Inc., and Digital Wealth LLC. The purchases will allow the San Francisco-based platform to advance one step closer towards their goal of being a conduit for institutional capital to flow into crypto assets.
The move will allow Coinbase to act simultaneously as a licensed broker dealer, an alternative trading system, and as a registered investment adviser. More importantly for crypto as a whole, the move will bring one of the largest exchanges of digital assets under federal oversight and potentially offer some much needed regulatory guidance. So why does this matter?
What Crypto is Missing
Contrary to popular opinion (including BlackRock's Larry Fink), good evidence suggests that there's plenty of interest from institutional investors around gaining exposure to crypto assets. Coinbase's Brian Armstrong estimated the total amount of capital sitting on the sidelines at $10 billion back in November. So why haven't we seen any investment activity?
Part of the reason is education, or lack thereof. Asset managers that control billions of dollars of wealth aren't likely to take a gamble on a nascent, highly volatile asset class they know nothing about. Especially one that has received such inconsistent and often negative media coverage.
Even for investors who are open to the idea of investing in crypto, it doesn't help that most of the information comes from twitter accounts with names like like "Crypto Whale." Imagine being asked by an MD with hundreds of millions of dollars under her control about the basis for your investment thesis, and you had to respond, "Well, as you can see from Crypto Bobby's latest post...'
An important issue that's given far less attention outside of the blockchain community is the insufficient market infrastructure and liquidity required to support institutional levels of capital.
For crypto to become a mature, invest-able asset class for institutional players there are three key infrastructural requirements that need to be met: trading venues, custody, and prime services. Custody in particular is a pressing and tricky issue. If investors can't find someone they trust to hold their assets, they aren't going to invest. Period.
Finally, crypto is in desperate need of regulatory guidance and supervision (sorry crypto anarchists, but it is). Right now, there are a number of regulatory bodies issuing mixed guidance because no one can figure out how to classify these crypto assets.
In the US alone, we have the SEC, IRS, and CFTC (to name a few) in apparent disagreement over whether or not crypto assets are securities, currencies, properties, or commodities. In an Indian parable, six blind men touch an elephant touch different parts of the animal like its tusk, leg or torso and produce different accounts of what that animal is - a spear, a snake, a tree, etc... And so it is with crypto assets for the time being.
The bottom line? We aren't going to see institutional capital flow into crypto until investors understand what the hell crypto is, the market infrastructure supports investment, and there is clear regulatory guidance.
Why Coinbase's Acquisitions Matter
Coinbase is making progress on all three major roadblocks. And yes, this is good for Coinbase as a company, but it benefits the entire crypto ecosystem as well. Let's review the problems they're solving and why they matter.
1. Education - Even in its early days, Coinbase has endeavored to partner with Wall Street players to bring them into the fold. Adam White, General Manager at Coinbase Institutional, has stated that the primary focus of his job is education. In White's words, "We spend a lot of our time partnering with our clients, and we look at them much closer to members or participants than we do to customers." This includes everything from providing an overview of the landscape and technology as well as facilitating development of investment theses. More informed investors means more capital flowing into the ecosystem which means more good projects get funded. Good for everyone.
2. Market Infrastructure - Coinbase has rolled out several new suites of products recently geared towards helping build out much needed market infrastructure. As it turns out, custodying a digital asset is very different from a traditional financial instrument, so custody has become one of the most hot topic issues in the crypto space. Perhaps most crucial is 'Coinbase Custody,' a custodial solution aimed at bridging the gap between large investors and the crypto market through a combination of their existing cold-storage solution, institutional-grade broker-dealer and reporting services, and comprehensive client coverage. Coinbase has also announced the roll-out of its prime services solution called 'Coinbase Prime,' which offers sophisticated trading and data tools to large investors. In particular, a custodial solution will allow the institutional levels of capital to enter the space and provide price support. Also good for everyone.
3. Regulation - This one's a biggie. Coinbase's acquisition of Keystone Capital allows it to act as a registered broker dealer, which means the exchange can provide a trading venue for assets that the SEC may rule as securities. This is the closest thing the crypto space has gotten yet to a federal agency's blessing to trade in assets that will likely be ruled securities. It's a massive development because it will allow investors to feel comfortable that they won't run into trouble down the line from the SEC. Thus, Coinbase has the potential to provide a much needed conduit for institutional capital to flow into crypto assets. Good news for investors looking to buy, and new projects looking to fund the creation of their networks. Generally, more resources = more talent = better products.
The Big Question
The crypto space is still small and chaotic enough that a win for one player is (in most instances) a win for everyone. Any development that brings regulatory clarity and additional capital to the space is a step in the right direction. Crypto assets need the support of Wall Street and institutional capital if they are going to survive and flourish, and Coinbase's acquisitions should be viewed in the light of progress.
But there's something else that the big money is looking for as well, something that even a player like Coinbase may find itself unable to provide: a credible name. Institutions like BNY Mellon and State Street have been trusted for over 200 years to custody financial instruments that represent tremendous amounts of wealth. Trust, it turns out, is not only the basis for how we conceptualize money but an integral factor in who we decide can manage it.
Once the crypto ecosystem matures to a point that Wall Street becomes comfortable, will it place its trust in the players that have built the space up? Or will it wait for the inevitable Goliath's that it's trusted for so long to make their move? Will Coinbase (or Circle, or Xapo) become the custodial solution of choice, or will they become acquisition targets?
Time will tell, but in my opinion the State Streets of the world will likely win out. Ironically, they have the advantage of what the whole blockchain movement is based on: trust. And as the blockchain community is finding out, building trust involves more than a couple of clever lines of code. It takes time, and people are slow to change. Despite how fast organizations like Coinbase is moving, Wall Street custodians have time on their side because they have a track record of fidelity.
Now maybe that'll change. Progress is rarely linear, so it's possible that we take some steps in the wrong direction before the blockchain ecosystem aligns on meaningful paradigm shifts. For the time being though, congrats are in order for Coinbase.