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It’s something of a truism to say that cryptocurrency has moved beyond its cypherpunk beginnings. What 10 years ago was the plaything of anarchists and maths geeks has now become a required portion of every professional investor’s portfolio.
What percentage of your assets you put into Bitcoin is down to your own appetite for risk.
So the launch of the first regulated Bitcoin bond marks a game-changing moment for the asset class.
Bitcoin-denominated bonds are a way to minimise the risk of volatility, which has plagued the world’s largest cryptocurrency for certain portions of its lifespan.
As Hargreaves Lansdown analyst Sarah Coles notes: “Investors normally invest in bonds because they offer less risk than equities, they deliver a reliable income, and you get your money back at the end. If your bond is denominated in a volatile currency, unless all your outgoings are in that currency, you lose these benefits: the value of the bonds you hold, and the income they return, fluctuates wildly.”
The people behind the project are Luxembourg-registered securitisation firm Argento Access.
Partnering with London Block Exchange (LBX), the two have made available a bond denominated entirely in Bitcoin. You pay with Bitcoin. You get Bitcoin in return. There are no fiat off or on-ramps to deal with. So why is this a significant development?
It’s simple, really. Changing Bitcoin for US dollars or other fiat currency requires issuers to apply fluctuating exchange rates, which means investors lose a portion of their capital every time they make a purchase.
Repeated purchases mean the amount lost to fees goes up. The more you buy, the more you pay. Cutting out exchange rates from fiat-to-Bitcoin and back again means investors get to keep a higher percentage of their gains.
Those who believe in the long-term development of the Bitcoin price can now purchase a Bitcoin bond through the Bloomberg terminal. It comes with all the protections and official support that institutional investors crave, such as an ISIN number.
For this particular product, LBX is the so-called ‘prime broker’. This means they handle all incoming buys and monthly payouts for the Bitcoin bond. Investments are held in custody by LBX, which is regulated by the UK’s Financial Conduct Authority (FCA).
There are three durations of the bond: named HODL, FOMO and LAMBO. Each is a nod to the whimsical phrases which have become commonplace to cryptocurrency investors.
It works in exactly the same way as buying US Treasuries or UK Gilts. The contract is effectively an IOU between the lender (institutional investors) and the borrower (the bond issuer). Investors plug their capital in, and receive a certain amount back every month as interest on their initial investment.
At the end of the term, you get your initial capital back. For those investors who believe in cryptocurrency’s continued ascent, and think in decades, not quarters, this appears to be a sound move.
It’s certainly not the first attempt to bring a regulated Bitcoin bond to market.
Following the right regulatory steps, it appears that any broker-dealer could launch his or her own.
Sovereign Bitcoin bonds are also worth mentioning. Consider the annual spring meeting of the boards of governors of the World Bank and the International Monetary Fund this April.
The heads of the central banks of Uzbekistan and Afghanistan, Mamarizo Nurmuratov and his counterpart Khalil Sediq, both said they were looking seriously at issuing Bitcoin bonds.
For Afghanistan it would mean being able to support its $3 trillion lithium mining market with a fresh injection of capital. The metal is highly prized in making high-performance electric car batteries and could boost the likes of Tesla in growing that sector.
The former Soviet nation, by contrast, could issue a Bitcoin bond linked with cotton futures. Uzbekistan is the world’s fifth largest cotton producer, so a way for the country to access international markets from which it might otherwise be excluded is no small affair.
One example of how not to issue a Bitcoin bond comes out of Japan.
In August 2017, Japanese financial information firm Fisco brought forward the country’s first Bitcoin-denominated bond.
The details sound remarkably familiar. In a press release the company noted how the product was “developed to have the same properties as conventional bonds as much as possible”.
The total value of the bonds would be 200BTC, paying 3% interest per annum with a maturity date of 2020.
Toyko-based Fisco has fallen foul of the regulators in the years since, though,
The Financial Services Agency, which oversees market activity in Japan, raided Fisco offices in Shibuya City in the west of the capital.
In June the FSA ordered Fisco to improve its business management practices after discovering a number of “legal violations”. What was originally reported as a raid on Fisco’s offices was later downplayed as a simple ‘visit’, but the outcome was the same. In an unusual step the FSA publicly declared that Fisco management “did not recognise the importance of legal compliance”.
Stats on this bond’s usage or investment levels are a little tricky to track down. But the fact that Fisco were apparently not on the best of terms with the financial regulator point to failings in the way the company put forward or handled this project.
Regulators must investigate schemes they believe are at risk of being vehicles for money-laundering. As we mention above, LBX are FCA-regulated. And the potential for insecure custody of cryptoassets makes regulators very nervous.
The latest forecasts suggest that the financial services industries across the world will increase to a value of $26.5 trillion by 2022, continuing to make up almost 6% of all global output.
When the professional services that underpin this multi-trillion-dollar sector start to launch their own crypto-focused products, that’s when you know that institutions will ramp up their own cryptocurrency investments.
Registered custodial services are common for mainstream asset classes. The exponential rise of cryptocurrency custody services for large international businesses and investors points to new entry points for institutional investors.
How secure are your securities?
Speaking of new entry points, let’s talk about Security Token Offerings (STOs).
Along with Initial Exchange Offerings, STOs have become a popular vehicle for attracting investment.
Security tokens are simply cryptocurrency tokens which meet the legal definition of a security.
That is: they are investment contracts, backed by an underlying asset, sold to investors on the basis that they promise some increase in future value.
These methods have taken over from Initial Coin Offerings (ICOs) because of one simple fact: they attempt to meet regulators halfway.
Investors have complained about the lack of return on capital offered by the majority of ICOs, and their legal status is somewhat murky.
According to recent research by Hong Kong’s BitMEX exchange, in 2019 the amount invested in ICOs plunged by as much as 97%.
Analysts ICORating.com added that January 2018 saw over 150 ICOs meet their target, with over $1.5bn raised. 12 months later, investment had dropped to a little over $100m with just 25 projects completed. A Q2 2018 report by the same company detailed how the median return on investment was an eye-watering minus 55.83%.
By contrast, STOs are exploding in popularity precisely because they do not attempt to circumvent regulations but instead work within the compliance rules that govern the financial services sector.
Security Token Offerings differ from other forms of capital-raising issuances, like ICOs, in that
meeting the legal definition of a security puts certain responsibilities on the issuer.
One case in particular illustrates this perfectly. The SEC is currently fighting a bombshell test case with tech unicorn Kik, the Canadian messaging app that passed the landmark $1bn valuation in 2015.
According to the SEC, Kik made an ill-judged entry into selling unregistered securities when in December 2018 it launched its Kin token. Kik defends its in-house token by saying it was to be used for peer-to-peer payments on its network.
But the SEC believes that the Kin token meets the definition of a security and should be considered as such.
Crucially, institutional investors will not risk their money or their clients’ money in unregulated schemes.
No asset manager wants to wake up in the morning and have to explain to their board why an investment they recommended is now facing an extremely costly and damaging court case against the most high-powered regulator in the western world.
The point of all this legal wrangling is that regulated Security Token Offerings give institutional investors a relatively safe place to allocate capital.
Without investments promising the potential for a future increase in value, all the cash sitting in bank accounts of pension funds, family offices and asset managers is being eaten away by inflation and the purchasing power of that money decreases over time.
In short, working with regulators is a must for all crypto issuers. Regulated products offer trust. Trust equals institutional funding. This is the way forward for all cryptocurrency products, whether Bitcoin bonds, STOs, or any other financial instrument.
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