capital markets

CAPITAL MARKETS: Winners-take-all as CBOE Futures discontinued and 60 Crypto Exchanges shut down

CBOE has decided not to list any new Bitcoin futures, with the last contracts expiring in July. Does this mean that BTC futures are dead? Not at all -- CBOE's biggest competitor, the CME, has simply won the game. You can see in the charts at the end of this entry a competition in volume over the last year, with CME's product steadily taking the lead. Why did this happen? The short answer is product quality and network effects. The decision to use an auction price from Gemini, rather than CME's approach of building a reference rate from several constituent exchanges, was a primary cause of poor product quality. And once traders shifted away from the product, network effects at the other venue kick in, creating lock-in and returns to scale.

More broadly, we have seen network effects around the top 10 crypto exchanges wreak havok on the rest of the industry. Of the 250-500 exchanges out there, 20% had no trade volume of any kind in the last 24 hours, and less than 1% had volumes over $1 billion. Over the last 8 years, 60 exchanges (and likely more) have been forced to exit the industry. While 75% of those exits are due to forced shut-downs by authorities, hacking, or outright scams -- 20% have exited due to a lack of liquidity. A lack of liquidity is a synonym for losing on network effects, akin to a social media app not bootstrapping enough users. Further, 5% of the exited exchanges have been acquisitions for others, like Circle and Coinbase. This again points to the winner-take-all nature of the market.

What's the solution? In social media, the answer was a Facebook, Twitter or Google identity, which created a portable social graph across the Internet. While those companies may no longer allow the full copying of the graph, they do allow apps to quickly connect users that are already entangled. In finance, brokers are the user platforms that provide best execution across exchanges, playing an analogous role. Distributors aggregate consumers, manufacturers create product, and the two functions are integrated through FIX APIs, processing software, and various other value chain intermediaries. If we want portability across liquidity pools in crypto capital markets, and especially over decentralized exchanges, understanding the separation and empowering each function (rather than vertically bundling everything) is the key.

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Source: Trading View (XBT vx BTC), Wall Street Journal (CBOE), Messari (CBOE)

CRYPTO: BitMax and $1.5 Billion in Phantom Daily Volume from Transaction Mining

Once in a while we land on Coinmarketcap's crypto exchange ranking, and choose "Reported" volumes instead of "Adjusted" ones. In that world, everything is topsy turvy. Binance is no longer on the top, and BitMax, Bithumb and other unmentionables float around the meniscus. The answer as to why this happens is called "Transaction Mining", and was a big deal halfway through last year. This practice is not really mining, as much as it is churning. Normally, an exchange charges a fee to the buyer and seller for facilitating a trade on its platform. In this case, however, the exchange also pays the trader a rebate in the form of its own token. The more you trade, the more of the exchange's proprietary token you receive. And some tokens, like Binance's BNB, have become valuable to the tune of $2 billion.

The positive way to look at this practice is to say that it is "growth hacking" the exchange rankings, thereby creating more visibility for high ranking platforms. Imagine you are trying to maximize visitors to your website. Well, you might practice some search optimization techniques, get back links from blogs, and perhaps even pay for some fake ones. Or, you are growing a social media audience, and decide to cheat by buying fake followers to create the impression of engagement. These techniques -- while misleading -- are merely meant to get you noticed, and then real activity can begin. Traditional banks offer $250 rebates to sign up for a new account or credit card all the time! And in the case of crypto exchanges last year, a number of them used transaction mining to growth hack the rankings, spread around their token, and have now switched to more accepted pricing models.

But Bitmax, and its $1.4 billion of mined volume per day, seems an extreme. The negative way to look at this practice is to compare it to churning an account. If a financial advisor with a fiduciary duty directs trades in a client's account in order to generate fees and create the impression of activity, they are breaking the law. In such an example, the financial advisor has full control of the account. You may say that crypto exchanges are optional, and that the decision to churn trades in order to generate/mine exchange tokens is voluntary. Sure. But if bot-driven advertising can swing an American election, certainly misleading financial incentives can skew how people make investment decisions. The belief that the exchange token is worth something -- backed by little other than promises that it will be worth more once other people have it -- leads to destructive financial activity. To us, this looks a lot like a digital-first version of churning driven by a suspect financial promotion. 


Source: Coinmarketcap (Exchanges), CoingeckoBitmax, Crypto Currency Hub (Is transaction fee mining a ponzi scheme)

BLOCKCHAIN: JP Morgan mints crypto JPM-coin, exposed to $10 trillion opportunity

You know by now that JP Morgan launched a crypto asset called JPM coin. You've probably seen the self-satisfied memes showing Jamie Dimon publicly hating on Bitcoin, contrasted with his own massive bank launching its proprietary, closed cryptocurrency (leveraging open source software created by others) within a year -- and claiming it is a meaningful invention. Perhaps you've read that this is a first-of-its-kind symptom demonstrating that banks are finally coming into crypto. Cool, huh! Yet all of these reactions are mostly irrelevant to thinking about what's happened.  

First things first. JPM has started production deployment of an internal blockchain (i.e., for its clients and divisions), which they have been developing openly for years, applied to multiple use-cases from international payments, to corporate issuance, to trading and other capital markets businesses. This is a no-brainer, and the totality of such projects should create $250 billion of industry-wide enterprise value in cost-savings over the next 10 years. The new thing is that they have added a token into this blockchain that carries digital scarcity, and can therefore be used for international value transfer. As an aside, the UBS utility settlement coin pioneered this type of asset over a year ago, led at the time by Alex Baitlin, who has since left to found smart crypto-custody company Trustology (backed by ConsenSys and Two Sigma).

Who should worry about the inevitable but welcome growing competitive landscape of bankcoins? First of all, consortia players like Ripple and SWIFT (partnered with R3) cannot be happy with the development, since JPM funnels a meaningful portion of the cross-border B2B money movement flow already -- $6 trillion per day. What's odd also is that half a year ago JPM was planning to spin out another proprietary blockchain project (Quorum), since other banks were refusing to use it. The internal value generation within the firm of essentially having a cloud-like solution for value transfer must be sufficiently large to alienate others.

On top of that, let's clarify what bankcoins are. Money supply is divided into M1 (cash and checking), M2 (very liquid cash equivalents), and M3 (more engineered cash equivalents). Bitcoin wants to be cash/M1, which is very hard given that to print money is to be sovereign -- see David Siegel's primer on money in the links below. So in the US, M1 is around $3 trillion. But the delta to M3 is another $10+ trillion, and includes things like money market funds, overnight obligations between investment banks (hey there corpse of Lehman Brothers), repurchase agreements, and other gargantuan liquidity instruments manufactured by banks. In fact, M3 is so obtuse and large that the Federal Reserve stopped publicly tracking it in 2006, and the data only exists on a synthetic basis from ShadowStats. This is what JPM coin is at its core. This is what all stablecoins -- tethered as cash sweep into their respective proprietary exchanges -- can ever become. A paltry $10 trillion.


Source: CNBC (JP Morgan), Shadowstats (US M3), Wikipedia (Euro Money Supply), Medium (David Siegel on Money), Federal Reserve (M3 Data)

CRYPTO: Re-making Traditional Banks with Custodian/Exchange Staking-as-a-Service

2019 has started off with a bang in capital markets blockchain -- (1) a $20 million investment by Nasdaq in enterprise blockchain FX player Symbiont, on the heels of Baakt and ErisX, (2) a Security Token Realized conference well attended by financial services execs from companies like State Street, of which 70%+ owned BTC, (3) and meaningful technical developments and financial products from folks like Tokeny, Securitize, Templum, Atomic Capital and others. But let us shift to another leg of the crypto stool this year, which is staking-as-a-service. We recommend reading the Coindesk op-ed from Michael Casey linked below, which outlines how a transition from proof-of-work to proof-of-stake in Ethereum (if it ever happens) could lead to the intermediation of crypto deposit holding on behalf of consumers. If investors get paid for outsourcing private key management to custodians, argues Casey, we re-create the fractional banking system with its pitfalls, like counterparty risk and incentive trends towards leverage. 

We agree, but aren't immediately put off by the comparison because credit is the lifeblood of inter-temporal economic decision making. Staking reminds us of two things from traditional finance -- capital requirements for banks, and interest-bearing deposits within those banks. As soon as users realize that they should be getting some interest return from their outsourced cryptocurrency accounts at exchanges or custodians, there should be broad competition around this product. If Coinbase offers 3% while Binance offers 4% of staking rewards (or vice versa), the consumer choice becomes more clear. This is exactly what banks compete on in terms of attracting deposits.

Users can already get an interest rate on their crypto for margin lending, up to 7% or so depending on the token. As an aside -- that margin lending may be a bad deal for the lender, since you are powering the short-selling of the capital asset you hold. You could also compare staking returns to dividends that corporations pay to their shareholders, as shareholders buy the equity and commit capital to an asset.  Given that these staking rewards are raw inflation (rather than cashflow earned by a corporation), the dividends become a value transfer between holders that stake and those that do not -- a tax on the unsophisticated user. Also, a dividend by law has to be passed on to the beneficial owner, which is a good thing. But that's not very anarchist of us.


Source: Forbes (Symbiont), Security Tokens Realised (agendavideo), Coindesk (Staking op-ed), Medium (On fractional banking), Token Daily (on staking as a service), Celcius Network (interest on ETH)

CRYPTO: Blockchain lands at $24B in 2018 funding, $1B in STOs coming

Crypto is dead, long live Crypto. We've tried to update our token offerings and blockchain financing figures to see the state of the market. On a monthly basis in December, there continues to be an almost even split between (1) weird internet crowdfunding at $490 million, and (2) traditional venture funding into blockchain-first companies at $310 million. We think the first figure is inflated despite our attempts at scrubbing it, and reserve the right to revise. Quality of the data keeps going down, and several projects self-reported raises in December that they may have finished earlier in the year. If anything, our intuition is that real (rather than aspirationally self-reported) ICO funding is below the venture number. 

As an example, take the largest December self-reported ICO: Jinbi, supposedly raising $47 million for a gold/blockchain token in China. The screenshot is below, but we are pretty sceptical. On the other hand, the $180 million raise from venture into institutional exchange Bakkt is well documented and known. So let that flavor the story for you. Still, when you zoom out on an annual basis, 2018 saw $5.2 billion of venture activity and $19 billion of token offerings -- not bad for a sector in decline. Future activity is indeed trending into Security Token Offerings, with several conferences focused on the space early in the year, as well as players from across industry types competing. Whether you are an equity crowdfunding platform, an ICO developer, or a Wall Street capital markets firm, chances are that tokenizing securities and distributing them globally in a solid regulatory framework is top of mind.

So will this be the saving grace of the sector? Hard to say, but it seems that tokenizing securities is about packaging (1) risky startup equity or (2) a share in some mall in Wyoming and plugging that into the equity crowdfunding theme. That may or may not result in better capital markets infrastructure, democratization and roboadvisor-led asset allocation. Or it may just be left-over junk that nobody else would buy. And second, the crypto economy needs non-financial activity to succeed. People should be building software using the global decentralized computer of Ethereum (or EOS or Dfinity) and paying for it using the global decentralized currency Bitcoin. More crowdfunding ain't that.


Source: Autonomous NEXT data sets, ICO Rating, Kepler Finance,, Inwara, among several others.

CRYPTO: 190 Exchange License applications in Japan, $183 million in funding for ICE's Bakkt

We'd love to write about all the interesting decentralized applications that the crypto community has scaled to millions of users. But we can't, because it hasn't. So instead, the news cycle is still stuck on the financialization and securitization of tokens in the far reaches of the Internet. At least it is a re-thinking of capital markets from the bottom up -- and this being a financial technology newsletter, we will oblige with the theme. But what may seem obvious on the surface is really not. Blockchain-based exchanges are not about better systems today (they may be in the future), but about finding cash flow to survive the nuclear winter and later expand into adjacent verticals (e.g., Coinbase, Binance).

The first story is about Japan, where a crypto-friendly regulator has received 190 cryptocurrency exchange license applications. Pause on that. Financial instrument exchanges are not this popular organically, with just 16 stock exchanges accounting for 87% of total stock exchange market cap (see chart below). In Europe, a similar fervor is in place about starting up new banks -- something about the power of the Crown in the palm of your hand. So seeing a wave of small, uncoordinated capital markets infrastructure teams try to bootstrap into a licensed, centralized/monopolized venue for financial exchange across the world isn't a sign of positive progress. It is a sign of a meme echoing across Twitter.

Second, we point to the $182.5 million funding round just raised by Bakkt, owned by the Intercontinental Exchange (also owner of the NYSE). Microsoft, BCG, Galaxy, Pantera and others chipped in. This is a fat raise, and it reminds us of R3's bank consortium, Digital Asset's trading systems, and a bit of Telegram's $1.7 billion venture capital black hole. Wall Street is building infrastructure for Wall Street, expecting to be the owner of all crypto OTC and institutional flows -- the blue ocean opportunity is now gone. Yet Asian exchanges like Binance continue to be the life-blood of retail crypto finance, built for users trained on video game money. Dressing this stuff up in a suit and trading a lot of it is a meme as well.


Source: Cointelegraph (Japan), Japanese FSA (Virtual Currency report), Visual Capitalist (Stock Exchanges), Coindesk (Bakkt)

2019 FINTECH PREDICTION: Real Autonomous Organizations Take Shape

Source: Images from Pexels,     2019 Keystone Predictions Deck

Source: Images from Pexels, 2019 Keystone Predictions Deck

The last 5 years have seen fundamental innovation in crowdfunding, regulatory technology, the digitization of financial services, blockchain native organizations, and automated propaganda bots to attract human attention. 2018 brought with it sobriety and a back-to-traditional regulatory treatment of financial assets and their structures. In particular, the crypto asset movement (and its crypto-anarchist community construction) has been put into a well-understood, regulated box by most national regulators. While many interesting lego pieces exist, none of them have yet to fit together. Still, regular people have gotten a taste of both the distribution and manufacturing sides of financial mana.

2019 will re-combine these pieces to instantiate functional autonomous organizations that work in a constrained market environment and perform useful services. Unlike the failed experiments of the DAO or BitShares, these new DAOs will have a clear corporate form, a regulatory anchor, and will focus on delivering products and services to regular people, but scaled through machine strategy. The automation of company formation (Stripe Atlas) will combine with the outsourced human/machine assembly line (Invisible Tech) and distributed governance (Aragon) to create companies that scale frighteningly quickly.

Such creatures need a safe environment in which to operate, with a narrow set of functions and constraints. We see labor platforms like 99Designs or Upwork as useful sandoxes to test whether software-based organizations can compete in a human market. Such experiments will require a re-thinking of the tokenized approach, leveraging the micro-economic discoveries but avoiding the need for a poorly adopted crypto wallet or token. Designers will need to reduce friction, not just lump together coding ideas. But the timing and soil for this could be just right.

BITCOIN: ETP launches on Swiss Exchange, while Chinese miners go out of business due to price collapse

What a weird crypto week. This market moves in conflicting directions at once, in large part because the execution speed of the actors is very different. A billionaire selling on a whim is instantaneous, while an enterprise team's process to build a product can take 18 months. So we simultaneously get to see (1) Switzerland's SIX stock exchange listing a crypto index product composed of BTC, XRP, ETH, BCH and LTC and (2) the long tail of miners starting to shut down their machines as BTC crashes below break-even range. Financialization and speculation up, infrastructure and hash power down. Would this be different if the timing was better synchronized?

This isn't the first exchange traded product, the honor for which goes to Coinshares (Bitcoin ETP at $500mm+ in assets on Nasdaq Stockholm). But it is meaningful. The underlying index comes from VanEck, a mid-size traditional asset manager which had tried to get a US ETF going and failed. And it is also a basket -- broadly speaking, diversification is a strict good, putting the arguments around inclusion of BCH and LTC aside for now. We hope now to see at least some family offices and Swiss private banks allocate 1-5% to crypto in liquid, regulated wrappers.

Right, so the second point is that Bitcoin mining pools across China are slowing down activity, with certain devices (Antminer S7, S9, Canaan Creative's AvalonMiner 741) becoming unprofitable at prices below $5,000. We have pegged the range of break-even somewhere at $6,000 for individuals with regular access to electricity, and $2,500 for large scale players inside a hydro-electric dam. Regardless of scale, this is bad news for Bitmain and several other Chinese hardware manufacturers. But, BTC was designed for this eventuality -- as price drops, miners will exit, and the probability of rewards to the remaining players goes up. 


Source: FT (Switzerland pay wall), Coin Telegraph (Swiss ETP), South China Morning Post (Mining), Amun/VanEck (Index Sheet -- which we neither hold nor endorse)

CRYPTO: The $1 Trillion market where Stablecoins will succeed and why most will fail

Last week we talked about the value of having a bag of cash in a down-market, using Circle as an example. This week, the news broke of Coinbase raising $300 million from Tiger Global (which had also invested in roboadvisor Wealthfront, among others). Circle and Coinbase earlier joined efforts to popularize their stablecoin USDC, their version of crypto cash pegged to the US dollar, which has reportedly had over $125 million in circulation since September. Meanwhile, USDT (Tether) associated with Bitfinex has been seeing outflows and general anxiety about whether the currency is a fraud -- with the total market cap falling by over $1 billion. Tether just released a statement from a Bahamas based bank that claims the firm has $1.8 billion in portfolio cash value; however, this statement was not signed by a named officer and disclaimed all liability. So at the very least, we can say that Coinbase+Circle seem to be forming a more credible stablecoin alternative than Bitfinex+Tether in the short term.

But what should we think about the usefulness of stablecoins in the first place? The core thesis is that BTC has not been used as a currency because of its volatility, and therefore merchants and individuals would not rely on it as a unit of account or medium of exchange. This premise is not entirely true -- volatility is only partially explanatory of why BTC is not being used by consumers. In our view, the main barrier is not volatility but ease of use and form factor. It's just too hard to figure out how to actually pay with BTC or any other digital currency for real (i.e., non digital) goods and services. Second, volatility in Bitcoin has actually subsided over the last 6 months -- that's not enough for long term company planning, but if it were the problem in commerce, then we would have seen a spike in economic activity correlating to this volatility damper. 


Any floating currency needs to be collateralized, whether or not it is printing money algorithmically or has bots arbitraging itself against exchanges. Otherwise you cannot fund redemptions (and if you can't fund redemptions, then you are just printing specious moneys). Holding the peg to your desired currency basket, whether USD, yuan or Euro, requires being able to defend the currency with capital reserves. Any private capital reserve can be broken by a larger private capital reserve -- or even by a government actor. Consider Soros and the Bank of England. As a result, these coins are fragile and ripe honeypots for attack and manipulation. In the case where the reserve becomes so large as to be unbreakable, and where the currency is meaningfully used as a medium of exchange, it becomes a threat to the world's actual reserve currency, the USD. The US sovereign is unlikely to allow private parties to issue and own a digital dollar at scale -- though the Treasury may be catalyzed to mint digital dollars as a result.

Here's what we think will work -- private company networks that ride the blockchain rails with the equivalent of a Cash Sweep account or a Money Market Fund. Imagine opening up a Schwab brokerage account. Your free cash in a portfolio -- let's say 1.5% -- would get invested into a cash sweep vehicle, which could be a money market fund, or a trust company cash account, or something similar. For a crypto financial company, you are unlikely to want to hold a financial license for traditional banking or investment services. But you still need to manage the cash somehow. So efforts like UBS settlement coin, or any of the exchange-backed stablecoin projects, could fill in the gap of moving USD around within a limited size network in order to reduce friction between going in and out of fiat. If the network gets so big as to include the entire economy, then it again pops up on the Treasury's radar. That's not to say it's a dead end -- MMF assets were nearly $1 trillion for retail and $1.8 trillion for institutional investors. And banks print money by issuing credit all the time, levering up the economy many times over, they are just heavily regulated to do so.


Source: Cointelegraph (Coinbase), Bitcoinexchangeguide (USDCCirculation), Centre, Medium (Bitfinexed), Bloomberg (Tether), Coindesk (Tether Bank Statement), Investopedia (Sweep account), ICI (Money Market Funds), Bitcoin Volatility 

VENTURE CAPITAL: What Goldman-Backed Circle, VaynerMedia and Social Capital have in common

There's a feeling brewing out there, up in the atmosphere. Symptoms are starting to coalesce. And the feeling is: cash is king, venture capital is mis-configured. Maybe something about endless growth in the economy, or maybe a 10 year bull run in the financial markets makes people pause about the current environment. Here are 3 examples: (1) an interview with former Facebook exec and Social Capital billionaire Chamath Palihapitiya, (2) a video by media entrepreneur and centa-millionaire Gary Vaynerchuk, and (3) Goldman's crypto investment Circle. Let's start with the personalities.

Chamath talks about his increasing disillusionment with the VC world, pointing to the current model: encouraging founders to take highly niche bets, then overlevering them with equity capital, forcing unprofitable growth in order to create the narrative of growth, and leading to wild paper gains that subsidize the success of the money manager. Looking at the fintech IPO market, the fall from grace of the American digital lenders comes to mind. Or the private valuations of Robinhood or Acorns. His advice instead is to grow slow but consistently, instead of trying to grow fast.

Gary is not as down on the venture industry, but he does discuss why he is building a media agency rather than a tech company. VaynerMedia runs at several hundred million of revenue, which would be valued much higher at a tech multiple. But his plan is to capture market share in the coming downturn in the cashflow business, and then use that cash to go on an acquisition spree for assets that are now private and over-priced, but will desperately need cash and exits in a drought. A tech garage sale if you will.

Which brings us finally to Circle. We think that historically Fintech has been pretty disadvantaged: cash-cow incumbents were incented not to innovate, disruptors had no cashflow and were highly targeted bets at remaking particular products, mostly pivoting into partnerships. Non-incumbents could not afford to go full stack and remake the industry. Crypto has changed that by making some businesses -- like OTC trading, derivatives, exchanges, media -- incredible cash-cows with billion dollar revenue lines. These revenues won't stick, because they rely either on inefficiently high prices, or unusually high demand spikes. But the risk assets that smart operators -- like Circle and Coinbase -- buy with that cash, really matter. Circle has just bought SeedInvest, an equity crowdfunding platform that it will mash up with its other acquisition, crypto exchange Poloniex, to beef up its STO prospects. Cash is king! Maybe that's why Circle is also pushing that stablecoin with Coinbase. 


Source: Youtube (Chamath PalihapitiyaGary Vaynerchuk), Bloomberg (Circle), Websites (Circle, SeedInvest)

WEALTH MANAGEMENT: Fidelity launches Crypto custody, has won this game before

Everyone knows: Fidelity has made its move into crypto custody. The firm has been toying with an offering into the space since starting to mine Bitcoin since 2015. The product itself is exactly what institutional investors, i.e., fund manufacturers, have been complaining about over the last year: (1) a custody platform, akin to Coinbase / Xapo / Bitgo / Kingdom Trust, and (2) an order routing system that creates best execution across exchanges, independent versions of which also exist (e.g., XTRD). But to package it and make it accessible for the traditional financial services industry is a massive leap for the asset class.

Here's what many people don't know. Fidelity is one of the top 4 investment advisor custodians in the United States -- including BNY Mellon Pershing, Schwab, and TD Ameritrade. Together, these firms control about $2 trillion in advisor assets, with another $1 trillion in independent RIA assets sitting on smaller players or self-clearing firms like LPL. These custodians know (1) how to service a long tail of small independent money managers, (2) throw annual conferences attended by thousands of people to look at investment products, (3) enable hundreds of wealth tech companies to sit on top of their core services, and (4) deliver performance reporting and other tools helping regular people access their assets. That is not something any of the crypto players come close to doing or understanding.

To moderate our excitement, we highlight that serving a manufacturer (i.e, a crypto fund) is not the same as serving a distributor (i.e., a financial advisor). Still, we believe the software is transferable to some extent, and the entire world of digital wealth management awaits open APIs here. Second, we think best execution will be a real boon to the space, unbundling what an exchange should do from what a broker should do. If regulators like the NY Attorney General continue to find bundling and conflicts of interest offensive, some US firms will have to be broken up into component parts and spun off. Not Fidelity -- which will benefit from being impartial. And further, with enough volume and a good routing system, perhaps arbitrage bots and crypto market manipulation may start to fade out of the ecosystem. Fidelity's entry -- though long time in the making -- is a clear win for crypto.


Source: BloombergCNBC, Fidelity (RIAsCrypto)

INVESTMENTS: New York on Crypto Exchanges, Robinhood and the Ethics of Trading

The Attorney General of the New York State just released a report on the integrity, traditionally speaking, of the crypto asset markets. The exchanges surveyed included Bitfinex, bitFlyer, Bittrex, Coinbase, Gemini, HBUS, itBit, Poloniex and Tidex. Notable, it excluded Binance, Huobi, and Kraken who refused to participate -- as well as another 100+ crypto exchanges that operate globally but steer clear of New York. Kraken is known for having rebuked the questionnaire from the Attorney General as overbearing and disrespectful, and at first glance we had agreed that perhaps it was overreach. But after reading through the report, we changed our mind entirely. It has great information and provides transparency around best practices, or lack thereof, helping investors focus on the right concerns and conflicts of interests.

Let's snooze the questions about KYC/AML, poor security or service, and instead focus on conflicts of interest. Unlike in traditional online brokers, crypto exchanges are both a venue connecting parties, broker/dealers that represent trades as agents, proprietary traders for their own accounts, large owners of the underlying traded assets, and also issuers of their own tokens. Why do we care about conflicts of interests like this? Because misalignment leads to rent seeking, corruption and manipulation. Think about the separation between equity research and investment banking that came about after the DotCom collapse (e.g., Henry Blodget). Or something simpler, like an exchange giving better pricing to large institutional traders that can trade ahead of retail sentiment.  Or worse, an exchange using its own large capital to trade, creating the impression of volume or price movement. We care about things like this because the retail investor is literally having value transferred out of their pocket into that of an arbitrage robot, unknown and unpoliced so far.

Let's now take a 90 degree turn into Robinhood, the free trading app with millions of Millennial customers eyeing an IPO in the billions. A recent take down article on Zerohedge walked through the start-up's business model. How can you give away something that has hard marginal costs, other than burning venture money? Freemium and selling your customers. On the freemium side, Robinhood does have the margin offering and can earn interest on cash sweep. But on the latter, it certainly does get paid for the activities of its customers in the aggregate. How? By directing order flow (i.e., those millions of little trades for AAPL) to quant trading firms like Citadel (70%) and Two-Sigma (16%). In turn, those firms can use the retail sentiment to make directional bets, or to mask large block trades without moving the market, or perhaps to find another pricing advantage. Robinhood users don't see the costs, but they could be in the execution -- though we note that Robinhood has released a statement re-affirming they deliver best execution. Tense!


Source: New York State (report), Zerohedge (Robinhood), Medium (Robinhood privacy arbitrage), Robinhood (statement on orders)

ROBO ADVISOR: JP Morgan plans to starve Robinhood (and all other Fintech) of Oxygen


JPMorgan is taking on fintech unicorn Robinhood. The bank is launching a service branded You Invest, directed at their 47 million digital/online banking clients, which includes (1) 100 free trades/year, $2.95 thereafter, (2) free investment research, (3) unlimited free trades if a Chase Private client (typically $100k in holdings), (4) portfolio construction tools, (5) and following up with a roboadvisor in January. This comes on the heels of its announcement of Finn, the mobile-first neobank for its customers, which preempts Revolut and Monzo from doing too much damage in the States. Sounds like a bunch of proprietary Fintech offerings, all priced to blow up the venture capitalists.

And JP Morgan isn't the only one. Remember, Fidelity just recently launched an ETF that costs 0 bps in management fees.  They can afford to do this the same way that Schwab can give roboadvice away for free -- bundling. If the firm doesn't make money on investments, it still has cash sweep; or if it doesn't have commissions, it has assets under management; or if it gives away the core, it can still charge you for satellite. Such mega-banks with diversified business lines are going to fight Fintech companies by starving them of oxygen. It is essentially reversing the strategy of the unbundling Fintechs, who use venture capital funds to price undercut incumbents. But in this case, the incumbent copies an innovation and gives it away for free.

The competitive response from the start-ups has been to also rebundle. calls this the "super robo". See for example microinvesting app Acorns, partnered with PayPal, offering its 1mm+ users a debit card with a checking account. Or look to SoFi, a student lender with roboadvice and insurance offerings. Over the pond, German neobank N26 has every permutation of financial product a Millennial may want to buy on their phone. All these firms will need to have payments, savings, wealth, and insurance under one roof, powered by artificial intelligence, customized to perfection. Can they outspend JP Morgan's $10 billion per year? And did we mention that Bank of America, Wells Fargo and Citi are in the game too?


Source: JP Morgan (CNBC), Financial Planning (Super robo)

CRYPTO: 80% Down, Ethereum and Crypto Fund Performance.

Ether, the second largest cryptocurrency by marketcap and enabler of $20+ billion of ICO issuance, got beat up quite conclusively this week. At one point, it was down over 82% off the year's high, recovering to 78% off the year's high. Yeesh, for anyone who wants this Crypto thing to do well. And for many, Ether's fall is confusing because (1) the number of developers building on top of the platform is increasing, (2) the number of ICOs on the platform has not meaningfully slowed down, (3) ConsenSys has dozens of enterprise and public projects that move the ecosystem along, and (4) it has a first mover advantage. The underlying qualities of the systems are, in theory, better than same time last year.

One driver is the negative sentiment in the Crypto fund community. We point you to the sources below, particularly a Tetras Capital paper that uses the store of value / money velocity argument to short Ether, and a strong-willed rant from the CEO of a crypto derivative exchange about the weak hands of Venture investors entering the trading game. While we agree that sentiment is a major driver, especially as funds buy and sell together, we disagree with the money velocity arguments. However, the ICO phenomenon did hurt Ether's function as currency. To use a project on the Ethereum platform, users have to buy and pay with a third party token that was issued primarily for fundraising. They don't use ETH to pay for the service. This in turn makes ETH less versatile, and less useful as a unit of account or medium of exchange. And second, ICOs that have raised ETH as their currency of choice have to sell it to fund operations.

Sure -- Ethereum could have scaled faster, traditional banks could have opened their doors instead of putting up regulatory walls, the SEC could have approved an ETF earlier. But investor sentiment now seems to disregard the steady and positive contributions by developers and entrepreneurs. Maybe this is because most of the 370+ crypto funds formed at the middle of last year, and missed out on the early boom. Looking at the self-reported performance of some funds in our database shows the extent of the damage. We have two samples: July 31st and April 30th. In each case, we compare them to the BITA 50 index, which tracks the top 50 liquid coins. The first chart shows both the returns and the index, the second chart just shows the difference. The reported outperformance averages around 20%. Given the BITA 50 index is now down about 70%, we expect that most crypto funds are at least 50% underwater for this year. No wonder so many are rushing to hedge through shorting.


ROBO ADVISOR: Digital Drives Fidelity Fund Prices to $0, Morgan Stanley to Pay Advisors for Digital Engagement.

Roboadvisors have failed, you say. Hedgeable is closing down. Robos barely made a dent in assets under management -- crossing $200 billion, as compared to the full market of $40 trillion in US wealth management, or even when compared to the $3 trillion of assets that sit with independent RIAs. Further, when looking at where those assets sit, Schwab and Vanguard hold the lion's share, with the top 3 independent B2C contenders floating at $10-15 billion each. Well, not so fast. First, we point you to a great report from Backend Benchmarking on the space, which shows that from a pricing and features perspective, the fintech startups are still doing a great job. Betterment and SigFig each are eclipsed only by Vanguard out of incumbents, while still holding on to the capacity for quick innovation, thereby defining the path of the maket.

Second, companies like Morgan Stanley are fairly desperate to implement digital wealth in existing client books. The wirehouse just launched its digital tools -- goal based financial planning and account aggregation (i.e., Personal Capital in 2012). To incentivize advisor adoption, the firm is increasing payouts to advisors by up to 3% if clients use the software tools that show external assets, and leverage internal banking and lending products. The latter part is Wealthfront's and SoFi's playbook. Imitation is the sincerest form of flattery. From a broader perspective, remember the recent mega deal: Financial Engines acquired by a private equity firm for $3 billion, merged with Rick Edelman's massive RIA, distributed through the footprint of the Mutual Fund store. All of this is digital wealth.

As a final symptom, we leave you with Fidelity. As Autonomous analyst Patrick Davitt highlighted earlier this week, Fidelity will (1) offer free self-indexed mutual funds to their brokerage clients, (2) eliminate minimums to open a brokerage account, competing with Robinhood, (3) eliminate account and money movement fees, (4) remove minimum asset thresholds on Fidelity mutual funds and 529 plans, and (5) reduce and simplify pricing on its index mutual fund product suite. On the latter, the average asset-weighted annual expense across Fidelity’s stock and bond index fund lineup will decrease by 35%, with funds as low as 1.5bps. But to say it again -- Fidelity is rolling out index mutual funds with a $0 price. That's a price that works in a digital wealth offering.


Source: Roboadvisors (Daily FintechThe Robo Report), WSJ (Morgan Stanley), Bloomberg (Fidelity), Think Advisor (HedgeableEdelman), Morgan Stanley (GPS Screenshot)

CRYPTO: EOS liquidation of Ether reserves impacts markets


ICOs were the reason the crypto prices shot to the moon last year, and they are also (part of) the reason why we are now seeing a prolonged weak market. Maybe this is obvious to some of you, but it's worth pointing out the dynamic. When consumers became excited about token crowdfunding last year, they allocated cash and their Bitcoin capital gains to buying Ether, which allowed them to participate in token sales. This year, new consumer demand for Ether has been weak in light of regulatory and execution uncertainty. But the need to sell Ether has skyrocketed because of all the ICOs that have raised crypto assets, and now again need cash to pay staff in the real world.

The $16 billion or so of ICO proceeds, if not more when adjusted for market fluctuations, is a large chunk of Ether's $45 billion market cap. The asset has shed about $90 billion of value since its peak at $135 billion. Assuming ICO liquidations of $5 or so billion led to the continued pressure on the Ether price, the negative impact has been magnified 10-20x via sentiment and illiquidity. Again, this is not the only variable at play as correlations to Bitcoin and other large coins are around 90%, and speculation still prevails. But it is important to note the structural dynamics. If you have any idea how we can test this hypothesis, let us know!

As an example, take EOS and it's $4 billion of crypto currency. The project has hit community issues almost immediately out of the gate, needing to re-write the governance structure and creating negative sentiment in the space. But more damaging is when $100 million worth of Ether is sold by EOS in a single day on Bitfinex. The lack of institutional liquidity matters because the price is far more sensitive to large blocks in response. And when a company is able to raise money in the form of its top competitor's token, and then create ongoing selling of that token across thin markets, we don't think this create good market dynamics. Further, as more large ICOs are done privately -- see Tatatu's $575 million or Telegram's $1.7 billion closed pre-sales -- the demand to buy Ether in order to buy the ICO token is simply not there.

Source: Coinmetrics (chart), EOS (CoindeskCryptoslateTrustnodes), Coindesk (Tatatu)

BLOCKCHAIN: Circular references in Crypto markets as exchanges: Binance and Huobi launch new ecosystem funds


Towards the end of last year, we noted that there was a circularity in the crypto, private and public markets. Large ICO launches were inspiring private companies to follow as well (e.g., Kik), public companies changed their names to blockchain pretenders (e.g, Long Island Ice/Chain), crypto companies pointed to this as progress and Bitcoin went up. It wasn't purposeful market manipulation, but a hype cycle reverberating in a small room. What we're seeing now is, well, kind of worse.

Tezos raised $232 million when the price of Ether was about 50% or less than it is today, so about $500 million now. The result is a lot of lawsuits, no product, and the formation of a $50 million venture fund. Binance raised $15 million through its ICO, which now trades at over $2 billion. The exchange is launching a $1 billion venture fund. Huobi raised $300 million, and though the token trades at a discount, it is also launching a $93 million venture fund. EOS, the largest ICO ever at $4 billion, is committing $1 billion to venture through partners like Galaxy Digital. Another example stuck out at us from a recent Coindesk article, where Meltem Demirors described this cycle -- "[Blockchain Capital invests in Ripple, which owns XRP currency]. Ripple took some of that XRP and gave it back to Blockchain Capital. Blockchain Capital then turns around and invests it in Coinbase ... Coinbase now created a venture fund investing in startups Blockchain Capital is also investing in, who are then turning around and investing in startups with ICOs."

This is billions and billions of capital that were invested for one purpose -- to help the fund-raising team build software products that investors want to use -- that are being re-purposed into another direction entirely. Hey, maybe you hired me to program this website, but I decided manage your retirement portfolio instead. One result is a skill mismatch: lucky coders are not professional investors. Another result is the loss of focus. And the last is the systemic risk to the whole ecosystem. If the investment returns are based on financial engineering and memes, rather than some real economic activity to underpin our excitement, then a regulator pulling hard on one thread will unwind the entire experiment.


Source: ICOs (Binance ICOHuobi), Venture funds (TezosBinanceHuobiEOS), Coindesk (Quote)

CRYPTO: 2018 ICOs at $9 Billion, But Definitely Slowing


Well, there doesn't seem to be another way to say it -- ICO activity is absolutely and unequivocally slowing down. We were optimistic that token offerings were independent of crypto currency prices -- in part because early stage technology venture activity should be separate from late stage market dynamics. But it was only a matter of time before the slowdown in crypto prices was reflected in a slow down of ICO funding and crypto fund formation. In fact, offerings as a function of crypto market cap, and especially as part of Ethereum's market cap, seem to be fairly stable as a percentage.

The numbers: if we look at all token offerings above $1 million in funds raised, 2017 saw $6.6 billion and 2018 YTD has seen $9.1 billion. So far so good, right! But, if we pull Telegram and EOS out of both numbers, we land at $5.9 billion 2017 YE and $4.1 billion for 2018 YTD. That's still a higher pace than last year, so let's drill down into the monthly figures. In particular, if we pull out Telegram ($1.8 billion) and EOS ($4.1 billion) on a monthly basis, the monthly trend look severely down -- to $560 million from a high of $1.5 billion in December 2017. So unless you believe in the continued presence of mega deals, token offerings have indeed been dragging due to continued regulatory uncertainty, tax overhang, and a lack of tangible progress in software adoption by the mainstream consumer.


That said, the uncertainty will get resolved. Even if Western regulators constrict the space into a narrow box, there are many legitimate jurisdictions that want to be crypto Delaware. Look at Japan: from Rakuten tokenizing $9 billion of loyalty points, to Mitsubishi bank talking about launching a cryptocurrency. Fear is worse than truth. And, we may indeed be entering the era of mega deals. Many of last year's token projects were built by new teams, like Seed stage venture. This year, more mid-stage companies (e.g., 50-250 employees) are tokenizing some asset of their existing operations. And next year, we may start seeing late stage companies bringing their own DLT projects to the market, and marrying them with public crypto. Just look at the Internet wave: March 2000 was the peak value share a percentage of market capitalizations. Despite the crash, the web has never been more present or important than today. Will crypto follow the same hype cycle curve?


Source: Autonomous NEXT (aggregated ICO data), Kleiner Perkins (IT as %)

BLOCKCHAIN: Scams in Crypto: 20% of ICOs, 5% of Twitter


Getting a wrap around just how much scamming and fraud there is in the crypto ecosystem is a challenge -- but not impossible. As the industry continues to put up impressive fund-raising figures (with new issues at about 2% of Ethereum market cap per month), just how much of this will become valuable projects? We've written before about how creative destruction is natural for startups, and that failure rates in the mid 90% are a reasonable outcome. We've also pegged hacking of Bitcoin and Ethereum to have been responsible for about 14% of money supply in those pools. But what about outright theft and lies?

Two ideas. First, the WSJ analyzed 1,450 ICOs and found that 271 or 18% of them are just total raw scams. Fake copied white papers, team member photos taken from stock photo websites, nothing behind the project but malfeasance. Yikes. And another version of the same was The North American Securities Administrators Association going after nearly 70 ICO issuers in a coordinated action of regulators across the US and Canada called "Operation Cryptosweep". Which is a totally sweet name, for what is a really regrettable but required clean-up of the crypto ecosystem. A 20% chance to lose your money, for no philosophically meaningful reason, is the wrong price to pay for good financial technology in our opinion.

And second, don't forget the propaganda bot armies. Sure, they can influence elections and spread misinformation, but we didn't expect that they would be used for financial warfare this quickly. The practice in question is copy-cat accounts on Twitter that look like a Twitter influencer claiming to give out free crypto currency, if only you send them money first. This is hacking of the human kind and we monkeys fall for it all the time. As a comparisons: (1) email phishing maxes out at 0.70%, according to Symantec, and (2) bot automation is at approximately 10% of all activity on Twitter. Given that the crypto ecosystem is more prone to Internet memes and bounty programs, we would expect the rate of phishing to skew higher, say up to 5% for crypto-related conversations. So watch where you point that digital wallet.


Source: WSJ (18% scams), NASAA (Operation Cryptosweep), Bloomberg (Bot PhishingHacks at 14%), Autonomous NEXT (Failure rates)

ROBO ADVISOR: Can Robinhood and Acorns grow into their Valuations?

Source: Learnvest

Source: Learnvest

Microinvesting apps got a massive boost last week in credibility and funding. We've written before about the difference in model between web-born roboadvisors and mobile-born microinvesting apps, with the key being a focus on attention versus a focus on assets. How do you monetize $500 accounts? You get millions and millions of them. How do you do that? Give out free candy.

Take Robinhood, the free trading app just reached a $5.6 billion valuation, based on a $363mm round. Autonomous partner Vincent Hung looked at the stats: Robinhood has 4mm users, which is higher than E*Trade’s customer number of 3.7mm. But so far, the company's focus on Millennials, and potential for these accounts to eventually become lucrative, does not seem to have impacted any of the large e-brokers in terms of growth metrics or industry economics. This implies that Robinhood is comprised of low asset value / high turnover accounts. We also wonder whether the 4mm user figure is also the active account number.

The investment was led by DST Global, Sequoia and Kleiner Perkins. These are smart venture capital names, but we are starting to have doubts. Robinhood has been raising money like it's their only business, burning through that cash to fund growth, and raising again. This is the social network  growth strategy -- burn until you become a monopoly, and then control the market. But is that worth $1,400 per user, nearly all of which pay nothing to consume services that have positive costs to manufacture? If premium subscriptions costs $10 per month, then it will take more than 10 years for a user to justify the acquisition cost. Or perhaps this investment is just a probability-weighted bet on finding the next Coinbase, which runs at a $1B+ in revenue

Another example in Acorns, with 3.3 million users, which just received a $50 million investment from BlackRock. BlackRock has been explicit about building out a digital wealth platform of the future. They are owners of FutureAdvisor and part owners of European roboadvisor Scalable Capital. So it's not a surprise they continue to invest in digital wealth solutions that could distribute their products. Today, much of that distribution is done through advisors and financial planners, but this investment suggests they want to get closer to the consumer, directly through an app. It's a hedge in case Millennials change behavior and rely on apps and chatbots, instead of advisors. 

Source: Acorns

Source: Acorns

We like Acorns and the behavioral hack of how it helps people save intelligently, but such an investment has to be analyzed in context. And this context is the shut-down of Learnvest inside Northwestern Mutual -- several years after Northwestern bought Learnvest for $250 million. Attempts at changing investor behavior are difficult and expensive, as are attempts to integrate innovations into large financial institutions. So while the Acorns deal is not as absurdly priced as Robinhood, it still highlights the need for Fintechs to grow up and build out their own business models. Because raising money isn't it.