Analysts at Goldman Sachs have highlighted the limitations of cryptocurrency exchanges as a key factor keeping institutional players on the sidelines.
Despite the popularity of Bitcoin and other cryptos, they are still largely traded by smaller retail investors rather than big institutional capital flows.
According to Goldman, that’s largely to do with the large network of small, unregulated exchanges that operate to facilitate crypto trading.
Goldman said trading volume in Bitcoin spot markets reached $US6.5 billion in Q4 2017 — a gain of 7 times on the average of the previous nine months.
And when the crypto frenzy hit full steam in January this year, daily volume spiked to $US12.5 billion as crypto exchanges struggled to deal with demand:
The business opportunity is obvious for exchanges looking to get in on the action by way of transactions fees.
But until crypto exchanges obtain the size and scale to manage liquidity and provide backstops for risk, it will likely keep the big players away for now.
“Specifically, today’s cryptocurrency market structure is very fragmented, with customers taking counterparty risk against the trading venue,” Goldman said.
That differs from, say, trading shares on the Australian Stock Exchange, which performs the function of a central clearing authority for buyers and sellers.
“This arrangement is unlikely to satisfy the risk parameters of most large institutions.”
Goldman also said the myriad number of exchanges creates uncertainty about the true value of the spot exchange rate for cryptocurrencies.
In determining the future extent of institutional investor participation in the market, Goldman did highlight the introduction of Bitcoin futures trading in December last year.
“Unlike spot markets, Bitcoin futures provide exposure to Bitcoin through a well-established product wrapper that trades on a regulated exchange and is centrally cleared, eliminating counterparty risk,” Goldman said.
However, they noted that due to Bitcoin’s high volatility, investors are still subject to much higher margin requirements than traditional asset classes.
“In our view, a futures market alone is unlikely to materially rein in this volatility, which will likely require the establishment of more credible institutional trading backstop — a process that will take time.”
One such backstop would be the introduction of Bitcoin Exchange Traded Funds (ETFs), but Goldman Sachs said the US Securities & Exchange Commission (SEC) has highlighted several concerns that still need to be addressed before ETF approval.
Bitcoin has dipped sharply in recent weeks amid concern about increasing regulatory crackdown.
However prices rallied this morning after US regulators said in a Congressional hearing overnight that they would take a “do no harm” approach towards cryptos .