Cryptocurrencies Are Developing A Lot Like Derivatives in the 1990s

Singapore, SINGAPORE – The 90s were an interesting era — questionable fashion choices (what was with those shoulder pads?) and bubblegum pop, it was also an era that would leave an enduring mark on the financial world for generations to come. Lifted by the easy credit, low tax initiatives of Reagan and Thatcher, the 90s fueled conspicuous consumption and the rise of a little noticed financial innovation that was brewing in the corners of Wall Street — derivatives. To be sure, derivatives are not new — they’ve existed in some form ever since the existence of markets. But the sheer volume, scale and scope of derivatives really started to grow in ascendancy in the 90s. A derivative, as its name would suggest, is simply a financial instrument which derives its price from another asset. For instance, an S&P500 option is an example of a derivative whose price (presumably) is correlated with the value of the S&P500.

In the early 90s, derivatives were understood by the few and who remained on the fringes. To make matters worse, the Long Term Capital Management blowout of the 1990s — one directly caused by the failure to accurately price and weigh the risks associated with derivatives — convinced an entire generation of managers that the instruments were dangerous at best. Yet derivatives form an essential function to any modern economy. They provide the opportunity for economic stakeholders to take up opposing sides of the contract, for profit or as a hedge. Almost three decades later and derivatives are an essential part of any fund manager’s toolkit.

“Like I said, the bathroom’s over there.”

In that sense, cryptocurrencies are developing on a similar trajectory to derivatives in the 1990s. Forget about the hype and the unsustainable run-up in prices of 2017 and early 2018. Instead, what’s more useful is how some of the biggest names are investing in the technology that could potentially convert cryptocurrencies into mainstream trading assets.

Take for instance DRW, one of the biggest proprietary traders in the United States. Earlier this year, the company committed to sell digital tokens, representing ownership of digital securities in a student housing block near the University of South Carolina for US$21,000 a piece, representing a fractional ownership of a real property. The move by Convexity Properties (the DRW real estate arm) brought together real assets even as DRW itself started offering Bitcoin trading last year — a digital share backed by a tangible, real-world asset.

Derivatives started to get complex when he needed a second abacus.

In October, Fidelity, one of the world’s biggest asset managers started a business to facilitate cryptocurrency trading for institutional investors, including hedge funds and family offices. Tech heavy Nasdaq is also rumored to be sticking with its plan to eventually list Bitcoin futures.

Meanwhile, Goldman Sachs-backed Circle is still on track to trade security tokens as is Swiss exchange Six and Bakkt, a venture involving the Intercontinental Exchange, Microsoft and Starbucks.

For some, the prospect of a tokenized world, where all assets of value are digitally tokenized to facilitate trading and access is a financial utopia. Whereas real assets such as property are often prohibitively expensive, especially for Millennial investors, the possibility of a tokenized, fractional share of a real estate asset is not so far fetched. Consider that fractional ownership for private jets, which over a decade ago was a novel concept, has exploded in popularity. The rise of the “sharing” economy, from ride-hailing to accommodation has increased the perceived “divisibility” of otherwise “owned” assets, increasing the potential for digital tokenization.

The extent to which the potential for tokenization will run remains to be seen, but suffice to say that more than one company is betting on that potential.

The writer is Patrick Tan, Partner and General Counsel for cryptocurrency quant trading firm Compton Hughes.