Why do institutional investors use the exchange Bakkt as the gateway to the world of encryption?

Bakkt, the cryptocurrency exchange initiated by ICE, the parent company of the New York Stock Exchange, has officially announced a global user test (UAT test) in accordance with the original plan. This is seen as an important signal that may drive traditional institutional investors and core players in the financial sector to enter the cryptocurrency market.

Bakkt is a bitcoin futures exchange founded in August 2018 and is led by the Intercontinental Exchange Group. After two acquisitions, one financing and multiple delays due to regulatory reasons, it was finally worth entering the UAT test phase. Last Friday, at the Bakkt Digital Assets Summit held at the NYSE, the exchange’s executives said that Bakkt will be officially launched by the end of September, with two months of sprint time left.

In fact, before Bakkt, there were quite a few attempts to do compliant bitcoin futures exchanges. For example, the Chicago Mercantile Exchange CME and the Chicago Board Options Exchange CBOE, both of which are leaders in the futures industry. However, CBOE decided not to cancel the Bitcoin futures contract products recently because the trading volume is gradually weak; CME is not because of "physical delivery" and cannot be recognized by some investment institutions. Not to mention the BitMEX, the so-called "global cryptocurrency derivatives trading volume" that can't be operated in the US – these are not cryptocurrency exchanges that institutional investors expect.

So what exactly is Bakkt going to launch to meet all the needs of institutional investors ?

On July 18th, Bakkt held a test transaction on the NYSE boardroom. From left: Blocktower Capital co-founder Ari Paul, Pantera Capital CEO Dan Morehead, Bakkt COO Adam White

The influence of ICE on Wall Street behind Bakkt may far exceed your imagination.

Bakkt is sponsored by the Intercontinental Exchange Group (ICE), a company with absolute voice in the financial sector. Its subsidiary, the New York Stock Exchange, is on Wall Street, where nearly half of the daily trading volume in the US stock market is generated.

As the world's highest-value exchange group, ICE's own resources and influence can help Bakkt establish a leading position in cryptocurrency in the traditional financial industry, and also help traditional institutions to access the world of cryptocurrencies more easily and dispel doubts. Concerns about the lack of value for Bitcoin – after all, even the leading player in the financial trading industry such as ICE recognizes the value of Bitcoin transactions.

It is necessary to introduce what the Intercontinental Exchange Group is doing.

Founded in 2000, ICE is a comprehensive financial group with a focus on exchanges and related financial facilities such as clearing houses, over-the-counter transactions and data services. In 2012, ICE spent $8.2 billion to acquire the New York Stock Exchange (formerly known as the “New York Euro-European Stock Exchange”), which means that ICE became the world's third-largest futures exchange with a product line covering crude oil and Energy futures, sugar and agricultural products futures, gold and silver futures, national currency exchange rates and index futures.

Across the many transaction categories, and the liquidity and trading volume of futures trading products, it will have great challenges to the exchange's data, structure and trading system. These technical accumulations and experience have become ICE's Bakkt exchange. Great advantage.

Why do institutional investors specifically need Bitcoin for physical delivery?

Bitcoin futures exchanges are not new, but why haven't anyone said before that these exchanges will promote institutions to enter the cryptocurrency market? The reason is simple, because the previous bitcoin futures exchanges did not use real bitcoin for transaction clearing . In professional terms, what an organization needs is a "physical delivery" futures contract.

The existing bitcoin futures exchanges use the "cash delivery" method. For example, the bitcoin futures contract of CME on the Chicago Mercantile Exchange, the world's largest futures exchange, and the bitcoin futures contract traded by BitMEX, which has a large transaction volume in the cryptocurrency industry, are ultimately not real objects when they are delivered. "Bitcoin" delivers, but only calculates the profit and loss in the form of "cash" as a form of final delivery. This is like the fact that buyers and sellers have no goods, and the price of goods based on the constant flow of air, so it will not have a real impact on the spot trading market.

Bakkt is completely different. After going online, Bakkt's trading products are "physical delivery" of daily and monthly bitcoin futures contracts. It can also be said that if an institution buys a futures contract from an exchange, it will receive a real bitcoin instead of cash and air.

Everything is compliant and reassuring institutional investors

Compliance is the only way for institutional investors to enter the currency circle. For complete compliance, Bakkt must have at least three licenses, which is very difficult for other exchanges.

In order to meet the compliance requirements, it is necessary to independently and hold the corresponding licenses in the three processes of “transaction” , “clearing” and “crowding” . In this way, the transaction speed of institutional investors can be guaranteed, and the delivery process is legal. The funds are absolutely safe.

Specifically, these different processes are different: – "Transactions" are important and efficient, requiring a reliable and stable trading engine, which ICE is good at. – "Clearing" is important for liquidation of positions, security, delivery procedures, In terms of risk control, this is also what ICE is good at. – The "hosting" part is the place to actually save the physical key of physical bitcoin. Since ICE can't host bitcoin, you need to apply for a trust license from New York Financial Services as the host. .

For the "transaction" and "liquidation" sections, DCM and DCO licenses issued by the US Commodity Futures Trading Commission CFTC are required.

DCM is the full name of Designated Contract Markets, "Designated Contract Market." Literally, this is a license that allows traders to trade on the futures exchange's contract market. Bakkt is trading in the Bitcoin contract market using a DCM license from ICE Futures US, Inc., a company of ICE.

The full name of DCO is Derivatives Clearing Organizations, "Derivatives Clearing Organization." The institution holding the license can provide services such as clearing transactions and standard delivery procedures. Bakkt is a Bitcoin transaction clearing process using a DCO license from ICE Clear US, Inc., a company of ICE.

For the "managed" part, you need to apply for a trust license from NYDFS.

Bakkt's Bakkt Warehouse has applied to the New York Financial Services Department (NYDFS) to become a "limited purpose" trust company, which is to run only part of the trust company's business, so that it can administer bitcoin in compliance. In the specific hosting plan, Bakkt mentioned the use of “very many means and security risk control measures” to ensure the security of funds, including:

  • a separate architecture using hot and cold wallets;
  • Most of the assets are stored in cold wallets, and the world's leading insurance companies provide $100 million in insurance for this portion of the assets;
  • Use the Hardware Security Module (HSM) to store the private key of the hot wallet;
  • Secure the cold wallet by means of multiple signatures, and store the multi-signal private keys in different geographical locations;
  • Physical vault protection, all private keys are stored in bank-level vaults and data centers, and are protected by 24-hour security personnel.

And in April of this year, Bakkt acquired the Digital Asset Escrow Company (DACC), which integrates one of the most powerful external hosting technology solutions.

Although Bakkt has the ability and attempt to provide a bank trust-level hosting plan, there is currently a lack of a trust license at the compliance level, which is the biggest uncertainty for whether Bakkt can be officially launched in the third quarter.

In addition, since Bitcoin has been excluded from the definition of "securities", Bitcoin is a commodity, and the Bakkt Futures Exchange only needs to be regulated by the US Commodity Futures Trading Commission (CFTC) without being required to be regulated by the United States. Securities and Exchange Commission (SEC) regulation .

If some of the encrypted assets listed by Bakkt are classified as securities in the future, then SEC joint supervision may be required.

In addition to the exchange, a complete ecosystem is needed.

It is useless to set up an exchange only. What's more important is to build an ecosystem around the upstream and downstream of the exchange. Like the stock market, the NYSE needs to work with his brokers, brokers, proprietary traders, market makers, etc. to provide complete and comprehensive trading services to users.

By accepting investment, Bakkt draws strategic partners, eco-collaborators or resource partners to bring teammates together to serve the exchange or even the cryptocurrency market.

Looking at the details, at the end of last year, Bakkt announced the first financing data, from the 12 companies to obtain financing of 180 million US dollars, the investors are not small:

  • Boston Consulting Group, a Boston consulting firm, serves companies, governments and institutions, covering a wide range of industries, from energy consumer products to financial insurance.
  • CMT Digital, focusing on the cryptocurrency industry, including proprietary trading, investment funds and compliance consulting
  • Eagle Seven, whose main business is proprietary trading, specializes in providing liquidity to financial markets in the US and globally.
  • Galaxy Digital, an investment bank in the field of crypto assets, was listed on the Growth Enterprise Market of the Toronto Stock Exchange in mid-2018.
  • Goldfinch Partners, an investment company
  • Alan Howard, UK Billionaire Hedge Fund Manager
  • Horizons Ventures, Victoria Harbour Investment, is a venture capital company founded and held by Li Ka-shing
  • Intercontinental Exchange, Intercontinental Exchange Group
  • M12, a venture capital subsidiary of Microsoft
  • Pantera Capital, an investment fund focused on blockchain
  • PayU, a subsidiary of Naspers, provides payment technology for online merchants
  • Protocol Ventures, a combined fund (FOF) focused on cryptographic assets

It can be seen that the areas that Bakkt's investors focus on, in addition to ICE, are selected institutions that can cooperate in depth, including proprietary dealers and liquidity providers in traditional financial verticals, hedge funds, and crypto assets. Various investment funds, financial technology, such as payment technology related companies.

These multi-dimensional, multi-domain investors can establish a complete trading ecosystem with Bakkt, and provide brokerage service providers, proprietary dealers, market makers, and liquidity providers to various types of users.

Ambition is far more than one futures exchange

In order to build a complete and comprehensive exchange, Bakkt not only did the above mentioned efforts, but there are more.

For example, at the beginning of this year, Bakkt acquired some of the assets of Rosenthal Collins and some employees. As an independent futures broker with nearly 100 years of history, Bakkt can also obtain valuable assets from this acquisition.

Of course, Bakkt's ambition is more than just a futures exchange. After the bitcoin futures in kind, let Bitcoin generate the value of the entity transaction, Bakkt can obviously consider other areas, such as payment.

This may also be why Bakkt specifically pointed out cooperation with Starbucks. The complete payment solution provided by PayU, the high-frequency payment usage scenario of Starbucks and the triple combination of Mike Blandina, who is responsible for Google Wallet as the chief product officer, may be one of the breakthroughs in increasing the practical value of Bitcoin. This is also the future that everyone in the cryptocurrency market would like to see.

Author: Pan Zhixiong