Article by Rakeesh Sharma, Investopedia

A major reason for the phenomenal growth of cryptocurrency markets in recent years has been the absence of regulation. That might change soon. Increasingly, the U.S. Securities and Exchange Commission (SEC) is providing broad hints of its intent to regulate the space.

For example, SEC Chief Jay Clayton has told reporters that most tokens were security tokens, meaning that they were to be traded like stocks and fell under the agency’s regulatory purview. After it was subpoenaed by the agency for insider trading, Coinbase, North America’s largest cryptocurrency exchange, fell in line and is said to be in talks to register as a regulated brokerage. Observers expect the SEC to announce regulations for crypto markets as soon as the end of this year. (See also: $9 Million Lost Each Day in Cryptocurrency Scams.)

The entry of SEC will fundamentally change the way in which cryptocurrency markets work. Here are three ways in which they might do so.

Reducing Volatility In Crypto Markets

As they have gained mainstream traction, cryptocurrency markets have also gained a reputation for volatility. Average daily price swings of more than 20% are not uncommon. That volatility has kept large institutional investors away and created a vicious cycle in which investors stay away due to crypto market volatility and vice versa.

SEC regulation could change that dynamic

According to Shane Brett, CEO of Gecko Governance—a company that has developed regulatory compliance tools for blockchain, institutional money is waiting for regulatory clarity of the sort already implemented in other industries, such as hedge funds. This clarity is expected to take the form of SEC rules for reporting requirements and audit trails. “Until they get that (regulation clarity), institutional investors will have to sit on the sidelines,” he says.

SEC regulations will pave the way for their entry and provide much-needed liquidity to cryptocurrency markets. From a perspective of the global financial ecosystem, the sums involved are not large. As an example, Brett says even a 1% allocation from a global manager like Fidelity (which manages trillions of dollars) could translate into millions of dollars in cryptocurrency markets. A measure of the difference that this amount could make can be gleaned from current valuations for coins. As of this writing, only 21 coins (out of the more than 1,500 available in crypto markets) have valuations greater than a million dollars.

Institutional money will prevent individual actors from manipulating crypto prices, as has been alleged in earlier reports, and lower volatility. “The days of massive returns in cryptocurrency markets are probably coming to an end shortly,” says Chris Housser, CEO and co-founder of Polymath, a startup that provides services for issuing security tokens to organizations. According to him, the introduction of regulations will narrow volatility and returns for crypto markets will mirror those from conventional venues, such as stock markets.

There were many trends which emerged last year with the increase of the inception of cryptocurrency hedge funds being one of them. Last year saw 167 cryptocurrency hedge funds come into existence with the rise of Bitcoin’s value that really brought the cryptocurrency world into the mainstream.

It is estimated that at the current state of affairs, barely fifty of the cryptocurrency hedge funds will actually be able to raise enough capital funding to remain a sustainable option for the institutional investors who have staked a claim in them.

Most of the rest are not going to to be able to make it. Those that were cautious about entering the space and exercised caution on the other hand could find themselves looking at “once in a lifetime” entry levels. That is assuming the expert opinion that blockchain technology and digital assets become the next big disruptive technology as expected. But with any market or new technology.. time will tell.

Seasoned Managers Patience Could Pay Huge Dividends

 

shutterstock_710867092While so many of the hedge funds that rushed to open doors in the second half of 2017 were crushed, those that exercised caution while many carelessly entered the space may very well present investors with an incredible buying opportunity.

The general consensus from the experts- at least the ones that called the sharp drop in Bitcoin prices (and took a lot of flack for suggesting the digital currency could drop 50% or better when it was trading near all time highs) are now calling for the next bull run to resume possibly in the 2nd to 3rd quarter this year. Pantera Capital Management says that Bitcoin has found it’s ultimate low at $6,500 in this bear market predicts Bitcoin will rise to and surpass it’s previous $20,000 price high by the end of the year.

BlockWealth Capital Founder Matt Siebenthal received a lot of flack in December when he mentioned Bitcoin could drop below $7500 while it was trading above $19,000 and euphoria for the digital currency was at an all time high. The former professional trader and hedge fund manger postponed plans to launch a crypto hedge fund in 2017- citing concerns for valuation and awaiting regulatory clarity.  Siebenthal has stated that “the institutionalization of this space is coming quickly” and believes this could be a catalyst for the digital currency. Siebenthal is said to be planning a soft launch in May-June 2018 with some personal money. Other investors include high-net-worth individuals and family offices.

Michael Novogratz, the former macro manager who’s turned into one of the biggest champions of bitcoin, also shelved plans to start his cryptocurrency hedge fund and was one of the first to publicly predict that the digital money could plunge to $8,000 or lower. Novogratz still believes they’ll be a disruptive force in finance and is calling for Bitcoin above 25,000 by year’s end.

Tech investor Tim Draper predicts bitcoin will reach $250,000 by 2022. “It sounds crazy,” Brian Kelly, founder and CEO of BKCM, an investment firm focused in digital currencies, told CNBC on “Fast Money” Friday. “But think about it this way: that’s four years from now. That’s a 3,000 percent return from here. But over the last two years bitcoin has had a 4,000 percent return. It would be a continuation of that trend.”

Compliance Costs Could Take Down Crypto Exchanges 

From a smattering of exchanges back in 2014, the number of crypto exchanges has mushroomed to 191 and counting within the last five years.

There are two reasons for this. First, creating a cryptocurrency exchange is not a capital-intensive task. Second, the absence of regulation or guidelines for creating one has significantly reduced the hurdles for launching one. This also means their operations are largely opaque and hidden from government and public scrutiny. They have benefited by generating profits without being accountable to customers and remaining outside the SEC’s purview.

SEC regulations, which run the gamut from recording trades to establishing technology systems that are audit-compliant, will inflate costs for exchanges. “For cryptocurrency exchanges, to start recording requirements, you have to question whether costs are worth it because they (requirements) are quite resource-heavy and expensive,” says Rachel Lam, vice president of regulatory strategy at Polymath.

While it is difficult to form a ballpark figure, the steep costs for compliance can be gauged from spending in another industry. Hedge funds, which had a similar growth trajectory as crypto markets back in the 1990s, are estimated to spend as much as 7% of their total operating costs on compliance. Brett from Gecko Governance posits that compliance costs are a significant reason why the average fund size has increased. “The size of hedge funds has ballooned from $100 million to a billion because they need that critical mass to be successful and cover compliance costs,” he says.

Lam says it is “very possible” that some cryptocurrency exchanges might be forced to close down or curtail their operations. “For any business owner, you have to accept what risks are acceptable to you and what resource commitments you are willing to make,” she says.

They Could Make ICOs a Viable Investment Option 

Their stratospheric growth notwithstanding, initial coin offerings (ICOs) have become synonymous with scandals and broken promises. This is because there are no disclosure or reporting requirements for ICO listings. Even whitepapers, which provide project details, are not mandatory. Not surprisingly, then, a recent report claims that 81% of all ICOs are scams. (See also: Issuing An ICO: Don’t Skip This Step.)

SEC regulation could clean up the space and make them viable investment options for investors by ensuring accountability and disclosure. Regulatory clarity will also help entrepreneurs. As an example, consider the case of Josh McIver, CEO and co-founder of ULedger—a Boise, Idaho-based enterprise blockchain company. He began researching ICOs but shelved the plans after reading about SEC crackdowns.

“We’ve seen the SEC make examples over and over again of companies that are doing ICOs and are doing it wrong,” he explains. The SEC’s silence on the investment opportunity has further complicated matters for entrepreneurs like McIver. “We don’t know what they are thinking,” he says. ULedger is largely self-funded and already generates revenue, thanks to a customer roster that includes the likes of consulting firm Deloitte and government agencies in Idaho.

McIver is reversing his earlier thinking about ICOs after the SEC’s recent actions. He is dusting off the ICO plans in anticipation of regulatory specifics later this year. “ICOs are a unique way to raise capital and grow your network,” he says.

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Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.

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