Bakkt is on hold again, but when it does launch, how will it enable traditional investment firms to onboard their institutional clients — and are there alternatives to Bakkt for retail investors?
On December 31st Bakkt announced that its launch would again be pushed back – this time until ‘early 2019’ (originally Nov 2018, then Jan 24th 2019). While this may have been disappointing to those counting on a ‘Bakkt Boost’, the project did offer some consolation — announcing the next day that it had successfully completed a $182 million first round seed raise from 12 partner investors and is continuing to work closely with the CFTC to cross final regulatory hurdles.
This article illustrates why institutions have needed such an onramp like Bakkt to onboard their clients, the effect the project will likely have on the market, and how retail investors can already access what Bakkt should achieve without needing a centralized party in the first place.
The impact of physical settlement
After a postponement from its 12th of December start date, Bakkt now aims to go live on the 24th of January, offering daily Bitcoin futures contracts that will be cleared by the financial and technical infrastructure of ICE.
Physical settlement is one of the many reasons Bakkt has been eyed as the catalyst for the next phase of market evolution. As opposed to the futures contracts currently offered by the CME and CBOE, which are settled in fiat (USD), Bakkt will physically settle its contracts in Bitcoin. This is a game changer for institutional investors looking for exposure to the market. Currently, the CME and CBOE Bitcoin futures merely allow one to speculate on whether the price of Bitcoin will rise or fall, receiving fiat as profit and loss. While this may be beneficial to traders, it offers nothing for those who believe in Blockchain technology long-term and want to ensure they secure a share of Bitcoin’s 21 million fixed supply before it is too late.
If Bakkt does attract institutional money to crypto, the current market capitalization of Bitcoin is likely to be dwarfed if institutions such as Fidelity, JP Morgan and Goldman Sachs (who have all set up cryptocurrency trading desks), enter the market. For example, just 10% of Fidelity’s 7.2 trillion in customer assets would be enough to push Bitcoin above a trillion dollar valuation — let alone once the JP Morgan and Goldman Sachs clients enter the mix. So how might Bakkt achieve what so many have failed to do previously?
Centralized custody solutions
Currently, on unregulated centralized exchanges such as Bitmex and Binance, users pass over their private keys to the exchange when they ask them to store their cryptocurrencies in order to trade. Leaving their money on the exchanges (which is often stored in ‘hot’ wallets) is far from security best practice, but the often high transaction fees and time it takes to store coins offline in personal "cold wallet" devices deters many traders, as it is simply too inconvenient. Unfortunately, unregulated centralized exchanges are prone to hacks, exit scams or government seizure — and 2018 saw little in the way of improved exchange security.
As such, money managers at large institutions have had no option to buy Bitcoin on a federally regulated exchange or the ability to store purchased digital assets in an industrial grade secure location. For reasons like this, institutional investors have been reluctant to enter the market given the risks posed to customer funds on unregulated and uninsured centralized exchanges.
With the introduction of Bakkt, such big-name institutions will now be able to buy Bitcoin using the regulated and well-respected ICE infrastructure and most importantly, they will be able to store Bitcoin in a far more secure manner than currently possible on centralized exchanges.
So how will Bakkt achieve secure enough centralized custody to meet institutional client’s standards? Simply, instead of entrusting funds to an unregulated exchange wallet, which is managed as the exchange sees fit and not disclosed to the public, Bakkt will store private keys offline in a heavily-guarded digital warehouse.
This is akin to the safe deposit box procedure used in traditional banking systems and thus is familiar to institutional clients. When fund managers decide they wish to withdraw Bitcoin from Bakkt’s digital warehouse, they will confirm their identity and Bakkt, which possesses the private key of that party in the secure warehouse, will release the funds.
Alternatively, money managers will be able to deposit Bitcoin to the randomly distributed warehouse locations using their public key for a specific account. When Bitcoin transactions occur between parties utilizing the ICE exchange infrastructure, profit and loss will be allocated accordingly to the parties’ "offline" wallets which are housed in the digital warehouse.
A trusted party
What Bakkt is proposing is far from revolutionary, it is simply reconstructing a tried and tested method of keeping important information safe that has been used for over a century. Nonetheless, this is exactly what traditional financial institutions need for crypto, as familiar concepts can be easily sold to their clients.
Moreover, the well-regarded name behind the brand is just as important. ICE’s regulated exchanges have been operating for 18 years around the world without any hacks. Similarly, exit scams or government seizure are basically redundant once an exchange becomes regulated in the US. The familiarity of the brand to money managers instils trust and enables them to comfortably utilize the service.
Alternatives for retail Investors: Decentralized custody
Whilst Bakkt will cater primarily for institutional investors, there are still ways retail investors can engage with a system that is far more secure than unregulated centralized exchanges and are also not centralized.
One solution is the hybrid decentralized trading model. Here retail traders get to possess sole control of their private key, whilst enjoying the user experience, reliability and speed of centralized exchanges. For example, BBOD will allow users to trade cryptocurrency pairs without funds ever having to leave their personal smart contract wallet. Instead, parties will be able to remain in control of their private key at all times by trading directly from their decentralized wallet. No need for an elaborate digital warehouse, just store your funds on a "cold wallet" yourself, such as Ledger, and allocate funds to your trading account when deemed necessary.