People who believe in cryptocurrency hope that institutional investors may hold the key to the next bull run of the bitcoin. They wish for Wall Street to be another eager investor. They believe it will be ready to pump money and enjoy returns similar to what the retail traders saw in 2017. But this projection misses reality in two ways.
The first is that Wall Street is already toed to neck into the cryptocurrency market. Secondly, it does not intend to ‘pump’ its own capital into the precarious market.
There are numerous opportunities for institutional finance to make money in the space of cryptocurrency. Yet, there is a change to note. As the influence of cryptocurrency is spreading, the market is also transforming. Whether with an intention or as a byproduct of its own flaws, it seems that Wall Street is slowly but surely killing cryptocurrency.
How can the Wall Street kill Crypto?
If you wish for a one-word answer, it’s hypothecation. It is a phenomenon when a firm which is the owner of equity shares in a company sigs away the same shares as collateral to a lender. Rehypothecation falls into effect when the lender refuses the collateral in its own business operations. It is easy to do in the traditional financial world.
We say this because the shares are not physically settled. Instead, they are written as certificates of ownership, making passing them easier as ‘IOU’. Another reason is that the tax laws and accounting allow the attribution of the same asset to different parties. It holds as long as both parties have a different amount of debt on their balance sheets. In this system, there is a significant increase in counterparty risk. Yet, it is necessary for granting heightened flexibility to the brokers and banks.
Why does this matter for Cryptocurrency?
Consider the trading of many major cryptocurrencies on centralized exchanges. They claim to rely on a hard-coded proof of stake or proof of work. Yet, if a bitcoin is rehypothecated six times as the collateral, exchanges trade debt and brokers, who can claim the custodianship in an event of need. At the end of the day, who is the owner of this cryptocurrency? If multiple parties have the private key, is there a real owner?
Due to an excessively long collateral chain, the ownership of the bitcoin is highly questionable. Additionally, this complex transient ownership model simply does not work in case of ledger-based assets and may result in multiple parties hoping for remuneration at the same time. There is hence, a devastating chance of a meltdown in this scenario.
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