Digital Assets: are you compliant?

AlbionVC-Elliptic

by Jay Wilson

Digital asset market cap has grown in excess of 100x over the past five years with consumers, financial institutions and regulators increasingly active in the market. With such rapid growth and increasing global regulatory clarity, institutions are taking critical steps to ensure their digital asset activities are compliant.

Which is why we are delighted about our recent investment in Elliptic!

Elliptic is a leading anti-money-laundering (AML) compliance solution for participants in the cryptocurrency ecosystem. It equips institutions with the information they need to detect financial crime and comply with emerging digital asset regulations.

With several FinTech investments already in the AlbionVC investment portfolio, we are excited to be broadening our horizons into the digital asset space – backing UK-based FinTechs with global potential.

Three core observations about the development of the cryptocurrency market got us excited about our investment in Elliptic

1) Digital assets are becoming mainstream

Depending on which day you measure it, the digital asset market has a market cap of c. $250-$350bn. While this is large in absolute terms, it is still small relative to its potential, especially considering, for example, Apple and Amazon have market caps of c. $700-$800bn, and gold has a market cap of c. $8tn! Research suggests that (considering asset managers only) the potential market for trading digital assets could be c. $25tn in the medium term.

The lines between the crypto ecosystem and the traditional financial system have become blurred. It is estimated that there are already over 13k businesses worldwide that accept crypto in some form and over 4k Bitcoin ATMs across 70 countries. The industry is maturing: year-on-year growth in FTEs in 2017 across the crypto industry exceeded 100% and this growth is understood to have continued throughout 2018.  In 2018, estimates suggest, there were 139m crypto asset users, an increase from 45m in 2016, representing a c. 76% compound annual growth rate (CAGR). And, participation is not likely to slow down – it is predicted that 25% of European consumers expect to own cryptocurrency in the future (vs 9% today) and data from the US suggest similar dynamics.

2) Institutional stakeholders are participating

The dramatic increase in penetration is not limited to consumers. Today there are more than c. 770 institutional crypto funds, and new fund launches have increased every year since the blockchains came into existence (c. 240 launched in 2018). Although assets under management (AUM) is small for most funds, there are more than 40 funds with more than $100m AUM.  

Nasdaq, CME and soon to be Rifinitiv offer institutional grade index and futures pricing, adding transparency and sophistication to the trading market. Many institutions, including EIB, Euroclear, Banco Santander and EY are working to bring to market institutional clearing mechanisms for blockchain enabled assets. J.P. Morgan is supportive of cryptocurrencies being properly regulated and believes their value proposition is strong: reducing clients’ counterparty and settlement risk, decreasing capital requirements and enabling instant value transfer. Goldman Sachs recently suggested that it could follow in the footsteps of the J.P. Morgan Coin, creating its own digital token.

Through partnerships with specialist crypto firms Nomura, Julius Baer, and KB Kookmin (South Korea’s largest bank) are gearing up to offer clients digital asset services including crypto custody, and it appears Bank of America could follow suit with a more direct approach, as it recently filed a patent for a custody system for institutional clients.

Historical activity in the crypto ecosystem had been the preservice of start-ups and specialised crypto firms, however it is now clear that traditional financial institutions are gearing up to further participate in a meaningful way in the cryptocurrency ecosystem.

3) The market needs to become compliant

Regulatory authorities have increased legislation, monitoring and enforcement on crypto activities. Stakeholders in the crypto ecosystem, including banks, exchanges, custodians and payment providers are seeking ways to meet the increasing regulatory burden of KYC and AML compliance.

The market is responding: it was estimated that of the 139m crypto asset user in 2018, 35m were ID-verified, an increase from 5m in 2016, representing c. 165% CAGR. Crypto firms recognise that, aside from regulatory enforcement through fines and even criminal proceedings, reputational damage to the individual firm and the ecosystem is a clear by-product of non-compliance, therefore there are strong drivers to do more than just meet technical compliance.

The regulatory frameworks for digital assets remain highly regional, but regulation is increasing intensity and clarity. All FATF-governed and EU countries are now expected to use specialist crypto compliance tools. In jurisdictions with existing crypto regulations (i.e. USA), regulators have started enforcing the rules, creating urgency among regulated firms to ensure they are not just paying lip service to regulatory expectations.