When Bitcoin first began making headlines a few years ago, I was intrigued, but skeptical that it would grow beyond a narrow fad. The markets seemed to turn more to the development of blockchain, Bitcoin’s underlying distributed ledger technology, for its potential to fix the inefficient plumbing of our financial system. But clearly there is more to the bitcoin story.
In the past year or so, the market for cryptocurrencies has taken on a different character. Institutional investors are buying bitcoin for their own accounts and creating funds dedicated to investments in this sector. Leading international banks are exploring ways to use the underlying technology and some are even developing their own digital currencies. And regulators are beginning to set some ground rules around the edges of this new market. All of which suggests that cryptocurrencies may be approaching mainstream adoption. As our cover suggests, a new market structure is beginning to emerge.
At one point this summer, CNBC reported that Bitcoin's value had risen by nearly 400% since the beginning of the year. The rush of investors into this market has all the hallmarks of what Alan Greenspan famously called irrational exuberance, and many experienced observers are drawing parallels to speculative manias of the past. On the other hand, cryptocurrencies in one form or another have legitimate uses in the real economy as a medium of exchange and a store of value without the need for financial institutions or government backing. For example, many believe the use of Bitcoin for peer-to-peer transactions could be revolutionary for huge segments of the developing world who don’t have access to banking. We are just beginning to imagine the potential for this type of innovation.
I leave it to the collective wisdom of the markets to find the right price for these new currencies. From my perspective as the head of the FIA, the key question is whether this innovation presents an opportunity for our industry. In this issue of MarketVoice, we address that question in three ways.
First, we look at an example of DRW, a Chicago-based trading firm that set up a trading desk three years ago to provide liquidity for this market. All markets need liquidity, and no one understands that better than Don Wilson, the head of DRW.
"They know that many of these new and emerging companies will fail, but they are willing to take that risk, and their capital is funding the next wave of innovation in how we conduct our business."
Second, we look at the opportunity to create new types of derivatives based on cryptocurrencies. Several leading derivatives exchanges have begun exploring this opportunity, and one new exchange, LedgerX, has just won regulatory approval to offer options on bitcoin. Given the exceptional volatility of cryptocurrency prices, the introduction of futures and options to manage risk seems very timely indeed.
Third, we look at how the underlying technology might deployed through an interview with Lee Braine, who is spearheading several initiatives at Barclays to use distributed ledger technology. Barclays has been at this for several years, and Lee has some important insights on both its potential and its limitations.
As these three articles show, firms in our industry are seizing the opportunities created through technological innovation. Distributed ledgers, machine learning, augmented reality, cognitive computing—all of these technologies and more are coming into financial services. Fintech is the term that everyone is using for this trend, and in our fourth innovation article we look at the flow of venture capital investment into the specific subsector of fintech that relates to capital markets. According to CB Insights, a technology market research firm, a record amount of $2.3 billion of equity capital was invested last year in fintech companies that focus on things like trading and clearing, and this year is on track to beat that record.
What I find especially interesting about this trend is the signal it sends about the future of technological innovation in our industry. These venture capital investors are the proverbial "smart money." Their willingness to put their money to work in capital markets fintech indicates they see great opportunity in the application of technology to the core functions of capital markets. They know that many of these new and emerging companies will fail, but they are willing to take that risk, and their capital is funding the next wave of innovation in how we conduct our business.
Before I conclude this month's Insight, I want to touch on the two hurricanes that recently hit the shores of the U.S. I'm sure you have seen the photographs of the damage and destruction in Florida, Texas, Puerto Rico and the entire Caribbean region. What you might not know is that many firms in our industry have contributed significant amounts of money and resources to the recovery efforts. ICE gave more than a million dollars to the Red Cross. The OCC supported volunteer efforts by allowing its employees in Dallas to take up to three days of paid time off. OTC Global Holdings, a leading broker in the U.S. natural gas markets, organized a charity day and persuaded sports stars, media personalities and musicians to act as "guest brokers" in its Houston office. There are many other examples of people in our industry who are helping the areas affected by these historic storms.
In times of crisis, our industry—time and again—has stepped up to the challenge and shared our resources to help with the recovery. The coming years will be full of change, but I am confident that one thing will stay constant: our willingness to help those in need.
