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EOS Uncertainty

Challenges of Institutionalizing Crypto—And Why We Need to Solve Them

Challenges of Institutionalizing Crypto—And Why We Need to Solve Them

From its early days, crypto has been something of a “wild west,” with its “white hats” and “black hats;” norms being created on the fly; and all the associated ambiguity that accompanies volatility. But that’s all changing as mainstream financial firms see the promise and possibility and thus bring legitimacy—and oversight—to the space.

The latest champion is professional services firm KPMG, one of the “Big Four” auditors, which is building a service around working with organizations to design the infrastructure and capabilities that will enable them to scale crypto.

In a recent report, “Institutionalization of Cryptoassets,” created in collaboration with online platform digital currency Coinbase, it outlined the existing state of crypto, the challenges it sees and a framework it has developed to help a crypto business scale. It defines Institutionalization as the “at-scale participation in the crypto market of banks, broker dealers, exchanges, payment providers, fintechs and other entities in the global financial services ecosystem.”

As KPMG notes, crypto cannot be ignored as an asset class as it competes for investment dollars along with stocks, bonds, commodities and derivatives.

The Current State of Crypto

While initial coin offerings (ICOs) are an important new way to bring money into the market—as of this writing, 1,227 ICOs have raised more than $7.5 billion in 2018—they also raise controversy along with capital. Unlike IPOs, they currently they have an air of speculation about them, with a lack of governance, protection or accountability.

Crypto is often criticized for its volatility, but the fact remains that the whole sector is still in its infancy and suffers from fluctuating demand, an issue that will likely become progressively more stable as it matures. Look no further than the internet to see how an innovative new technology will pivot and morph as it develops

Crypto offers the promise of revolutionizing the financial sector as it creates an open global financial system through a more stable, accessible, efficient system that doesn’t rely on one country or company, Coinbase explains. “Blockchain technology can do for value what the internet did for information,” says Chief Compliance Officer Jeff Horowitz and Vice President of Finance Eric Scro.

The Crypto Journey

According to the report, Coinbase sees three stages for crypto: First, investment and speculation, the current state; second, institutionalization; and finally—and potentially concurrently—utility.

One of the reasons that crypto feels unregulated is that unlike most financial products, it began in a retail rather than institutional environment. In order for institutions to adopt crypto, the space needs to adhere to institutional requirements, which include:

  • Compliance
  • Transparency
  • Governance, including regulatory oversight.

However, crypto aficionados are clear that this cannot come at the expense of security and consumer protection.

Challenges That Crypto Faces

The report details the key challenges that will hold crypto back from being institutionalized if they are not addressed. These are:

  • Compliance with regulatory obligations, including an overhaul of how crypto is currently governed through a patchwork of federal and state regulations and governing bodies.
  • Fork management and governance, specifically how a business manages the implications and strategic and risk concerns of a fork, which is when a single cryptocurrency splits into two.
  • KYC (Know Your Customer) and cryptoasset provenance, which can be extra challenging given the inherent (and coveted) anonymity and privacy associated with crypto.
  • Securing cryptoassets against cybercriminals, an ongoing issue since cryptoassets are an appealing—and vulnerable—target, given their digital and often high-value nature.
  • Accounting and financial reporting, an emerging area that lacks clear guidance, as cryptocurrency has various characteristics that are covered by different accounting norms. Specifically, crypto would currently fall under the definition of an intangible asset as defined by “Generally Accepted Accounting Principles in the United States” (U.S. GAAP), which doesn’t seem as intended.
  • Tax implications—a topic uppermost in our minds—and an area that is murky for investors considering there is minimal guidance, except the position that the IRS treats crypto as property, rather than currency so you have to calculate your Crypto Taxes and Accounting by using any Crypto tax service

However, not everyone realizes they are legally compelled to pay Crypto Taxes and Accounting and often struggle with determining cost basis in order to file.

While these challenges are real, they are certainly not insurmountable, with many in the industry working on thorny issues, and companies such as ours cropping up to address and mitigate associated challenges. Creative approaches are vital in order to help the crypto industry move forward.

“As crypto matures, it remains to be seen if it will be a safe haven asset such as treasury bonds, a commodity such as gold, or a risk asset such as equities, or something else,” says KPMG chief economist Constance Hunter.

“The answer to this question lies in the level of trust crypto is able to garner from the market. Cryptoassets have the potential to increase trust via the immutability feature of the underlying blockchain technology. However, this alone may not be sufficient to generate trust without also embracing institutionalization.”

Muhammad Jahanzaib