On the Radar: A look back on 2019 and what is to come

2019 was a formative year for the crypto markets.

Photo by gdtography on Unsplash

2019 was a formative year for the crypto markets.

Just have a look at business models — the pulse of change. From pure-play services to integrated platforms. From single public chains to cross-chain interoperability. Companies and projects are not only focused on building services and shipping products. They are also forming partnerships, acquiring other companies and building out ecosystems. As decentralized finance (DeFi)* matures, projects are finding more ways to leverage the nature of composability: the ability of applications to integrate with one another. Applications are building on top of and alongside one another. New incentive mechanisms are being explored from staking to trade-driven mining. The evolution of business models affects every part of the crypto value chain from mining to trading to investing.

Every once in a while I find it incredibly helpful to zoom out to the 10,000 ft level and reevaluate my outlook for what is to come. Things change, of course. We started 2019 debating the timeline of Security Token Offerings (STO) and launch of STO exchanges and primary issuance platforms. But one year later, the focus on the main stage seems to have shifted almost entirely to topics such as staking platforms, stablecoin use cases, and loan financing activity. In other words, the crypto markets are evolving at a fast pace and it is important to focus on areas of real market activity. 2019 was nothing short of exciting developments and 2020 looks to be even more promising.

Digital asset custody

We saw a significant number of institutional-grade infrastructure emerge in 2019 to support standards like best execution and timely settlement in the name of deeper liquidity, price discovery, and capital efficiency. While we are still far from a reality that includes major banks allocating resources to trade Bitcoin futures and options at scale, many of these institutions are starting to develop internal groups to build digital asset services like custody.

• Last year Fidelity launched their Bitcoin custody services. In 2020, we will start to see more traditional financial services firms like Nomura and possibly State Street (in partnership with Gemini) go live with their custody solutions.
• Expect to see these custody providers (including existing crypto native custodians) focus on vertical integration in order to compete for assets under custody (AUC). Crypto-native custodians such as Anchorage recently launched their agency brokerage service to optimize their custody offering. What is stopping their competitors from launching other value-add services? Will these platforms be able to compete with incumbents like Coinbase who seem to offer a full suite of services for retail and institutional clients?
• Pay attention to custody insurance. We will need more underwriters/syndicates to be comfortable with underwriting hot and cold wallet insurance for digital assets. Gemini recently launched a captive insurance company that will provide additional regulated insurance coverage for segregated assets in Gemini’s cold storage.
• Perhaps this is an area where balance sheet heavy players like commercial banks may have an upper hand. Will we see some M&A in the custody space this year? (e.g. traditional banks acquiring crypto-native custodians)

Crypto financing

2019 saw explosive growth in the borrowing and lending market, primarily for speculative reasons.

• If BTC price increases post-Halving, we will start to see more borrowers come into the market. Miners will have more assets to collateralize and use to secure loans. (If BTC price decreases, many miners whose breakeven is above the prevailing market price will find themselves out of business.)
• We will need an identity protocol to facilitate uncollateralized loans at scale. This is likely to start off as a DeFi initiative. (Zero Collateral and Rocket are two interesting projects to watch.)
• We have seen BTC-backed cash loans drive the financing market. As Genesis’ Q4 2019 report shows, this trend is likely to continue into 2020.
• With more decentralized applications (DApps) supporting cross-chain interoperability, we will see greater cross-chain value transfers and growth in decentralized trading and lending.
• Perhaps 2020 will be the year where we see BTC-backed loans in DeFi.

Exchanges

In 2019 we saw a number of derivatives platforms like CoinFLEX, FTX, and ICE/Bakkt go live, servicing a maturing crypto market alongside crypto derivatives giants like Bitmex and OKEx. We can expect:

• More spot and derivatives exchanges popping up globally.
• Going forward, we are likely to see fewer pure-play spot exchanges;
• instead more spot exchanges will be built as a natural extension of a platform’s prevailing business model (e.g. Crypto.com; BlockFi; Blockchain.com). These platforms realize that trading on-ramp services are necessary to enable customers to directly fund and trade from the platform wallet.
• Diversity in derivatives products with perpetual swaps, options and futures all with different collateral, pricing and PnL mechanisms.
• A global battle for the hearts and minds of retail traders in the derivatives space, with different incentives, fee structures, competitions, and innovative products being offered to entice the existing base of retail traders.
• Competitors like OKEx and Huobi taking more market share and dominance away from BitMEX.

Exchange token models

2019 also saw the creation of new exchange token models. We are presented with interesting questions such as what drives the value creation of the token and how does the token interact with the rest of the platform?

• It is important to remember that token models are not static. They can change as the platforms grow.
• The value creation lies not in the token model itself, but in the benefits derived from using the token. Value is driven by incentive mechanisms. Novel ideas from exchanges such as offering yield pick-up opportunities from staking lock-ups can also bring value to the token.
• It has been said that Binance sometimes looks like a company and sometimes looks like a coin. BNB illustrates how a native exchange token can accelerate network effects and drive platform adoption. With more all-in-one platforms spinning up native tokens to facilitate trading, staking, and lending incentives, the token becomes part of the company’s identity. There is a psychological tendency to correlate or, at least, associate the token price with the company’s performance (e.g. measured by volume). Although there may be high correlations in the beginning (as token adoption is a form of bootstrapping trading liquidity), this may not be the case over time as the platform matures.

Bitcoin mining

• Institutional investors will begin to look more seriously at mining as sophisticated/regulated financial products come to market (e.g. mining funds)
• The primary edge for miners is exploiting low energy cost arbitrage. North America is quickly positioning itself to be a strong market. This includes US mining operators and overseas mining operators looking to take advantage of low energy costs in states like Washington, Nebraska, and Texas. Texas will continue to be a hotbed of activity for mining in the US South. The state is incubating new projects such as Layer1 and SBI’s mining facilities.
• Mining operators who are thinking about operating at scale are looking to become vertically integrated, owning the entire span of the mining lifecycle from chip production to hardware manufacturing, energy procurement and perhaps even financial services. While ideal, it is an ambitious challenge. Bitmain spun out Matrixport to create a dedicated financial services arm. Will we see a similar phenomenon from other established mining operations?

On the Halving

• Miners are mixed about the potential effects of the Halving. There is no blanket confidence that BTC price will follow historical price moves post-Halving.
• Funding costs are key to mining profitability. Depending on the funding costs of a mining operator, they may not be inclined to put on hedging options leading up to the Halving despite the volatility.
• The secondary mining market could be a leading indicator for miners’ perception of mining profitability post-Halving.

Macro considerations

Looking ahead, a big focus in 2020 will be on the conversations held within political circles about crypto and blockchain at large. The Chinese government made a surprising top-down decision to support blockchain and is allowing the sector to flourish within the Chinese legal framework. However, this may not necessarily be a positive accelerant for crypto adoption. The US government is being pressured by the efforts of the Libra project and other Central Bank Digital Currency (CBDC) initiatives to take the crypto space more seriously. Talk of Libra dominated attention at many crypto conferences and since the announcement, more governments have come out with their position on CBDCs. Could this be the underpinning for the next “space race” amongst nations?

CBDC: The next “space race”?

• Libra’s mission to create a “generational payment network” will continue to stall until regulators are able to get more comfortable with the idea of a so-called international settlement currency controlled and governed by an association of private entities — the Libra Association.
• Libra has successfully managed the bring the topic of CBDC to the forefront of governmental talks globally.
• Central bankers around the world will be paying more attention to the idea of issuing public digital currency. A new digital currency governance consortium was announced at the 2020 World Economic Forum. The new consortium aims to tackle the (CBDC) challenge with an international, multi-stakeholder approach involving both the public and private sectors.
• According to a joint report by IBM and the Official Monetary and Financial Institutions Forum (OMFIF), we are likely to see the introduction of a (fiat-based) central bank retail digital currency within the next 5 years, either as a compliment to or as a substitute for notes and coins.
• CBDC may disintermediate banks in the future, but not as fast as proponents may argue. The European Central Bank (ECB) has been discussing an ambitious plan to experiment with allowing consumers to use electronic cash, which would be directly deposited at the ECB, bypassing the need for financial intermediaries (e.g. commercial banks or clearing counterparts). This could be very interesting.

CBDCs have been the talk of the town but are still mostly theoretical. If history has taught us anything, it is that change is a process and the ripple effects of CBDC implementation will be gradual, not immediate.

Changes to the prosumer crypto landscape

Changes to prosumer crypto business models are a leading indicator for broader swathes of change in the industry. Prosumer businesses like crypto exchanges and wallet providers serve as the gateway for new entrants into the industry and as a result, thrive on the loyalty of a large user base. Users grow up with the platform and, as a result, these platforms need to constantly iterate and innovate new products to keep users engaged. As users become more sophisticated and active participants, they require additional services to fulfill their needs. In response to this trend, prosumer platforms are modifying their business models to become more ecosystem-like. An ecosystem is an interconnected system whereby the actions of participants affect one another. In crypto, this means leveraging the core service (trade execution, custody, financing etc…) to build other value-add services for consumers. The end goal being to drive enough liquidity to the platform to support a full suite of integrated crypto services.

Beyond Crypto: Trend toward “finance-as-a-service”

Financial institutions like Goldman Sachs and Citi are partnering with tech companies like Apple and Google to offer banking services for more retail users, taking a page out of WeChat and Alipay’s playbook. During the ‘Shaping the Future of Financial and Monetary Systems’ panel at Davos 2020, Jin Keyu — Professor of Economics at the London School of Economics — argued that financial disruption is an advanced economy view. Emerging countries like China have historically had weaker financial systems than developed countries like the United States. Therefore, integrated digital service platforms like Alibaba’s Ant Financial have filled in for rather than disrupted these missing services.

While it is unlikely that Tencent (WeChat) or Alibaba (Ant Financial) will be integrating crypto services any time soon (quite obviously due to China’s capital control restrictions), the marriage of technology companies and traditional financial firms in the US is inevitable and could lead to more innovative financial offerings targeted at millennials. As Angela Strange, General Partner at Andreesen Horowitz, believe, we might even begin to see the AWS phase of financial services come sooner than later from the likes of Uber and Airbnb. Grab, a ride-sharing company in Southeast Asia, is already headed in this direction. In Japan, consumer platforms like Rakuten and Line have long been planning down the neo-bank path. While the “finance as-a-service” trend may not mean integration of crypto into the fintech stack right away, it points to the facelift that is fast underway within the traditional financial services industry.

Whether it is staking or stablecoins, lending or Libra, DeFi or derivatives, 2020 is going to be chock full of innovation developing on the existing crypto blocks and primitives.

• More on DeFi in a follow-up post

The Capital