If you stay up-to-date with the cryptocurrency news cycle, a recent trend you may have observed is the widespread excitement at the prospect of large, traditional financial institutions entering the space.
We’ve seen a wave of institutional news lately, from NYSE-affiliated Bakkt launching custodial and trading infrastructure, through to up-for-approval Bitcoin ETFs and large 401k retirement plan service providers such as Fidelity opening crypto trading desks. In parallel, startups born of the cryptocurrency generation such as Coinbase are increasingly pivoting their businesses towards institutional investors in hope of being able to compete with these Wall Street behemoths.
While many cryptocurrency enthusiasts express blind enthusiasm at the notion of positive price impact associated with this money flowing in, it’s important to take a step back and analyze what this phase of the cryptocurrency lifecycle actually represents, and how far it lands the movement from its original goals.
|| WHAT WERE WE BUILDING AGAIN?
To analyze the shifting landscape of cryptocurrency, we can tie the current state back to three broad benefits that decentralized, digital currencies originally aimed to provide:
1. Censorship resistance
2. Trustless transactions
3. Verifiable history
Decentralization remains a spectrum, and projects may occasionally eschew some decentralization in the name of efficiency while still providing a subset of these attributes. But the end-game for cryptocurrency to succeed is ensuring that all three core tenets are maintained.
If you view what is happening with the Bakkts, Fidelitys and Coinbases of the world through the lens of these principles, a concerning trend emerges.
|| CENSORSHIP RESISTANCE
Censorship resistance implies that a user’s ability to interface with the currency should never rely on a potential single point of failure. In Bitcoin, public nodes can go down, but many exist to quickly fill their place. Thanks to decentralized consensus via Proof of Work, there is also no single entity who can censor your transactions from reaching the ledger.
The shift back to reliance on a single corporation (essentially a bank) as your window to a cryptocurrency network introduces a clear single point of failure. If Coinbase.com is hijacked or taken offline, a user relying on that provider essentially loses their access to the decentralized Bitcoin network.
Furthermore, if Coinbase or any centralized service provider simply find an account “suspicious” by their standards, they can block or severely limit a user’s access to their account or censor transactions from being broadcast.
|| TRUSTLESS TRANSACTIONS
For a digital currency to be be “trustless” in nature, a user should not be required to trust a central custodian, facilitator, or even fellow user in order to transact securely and reliably. In a system such as Bitcoin, if a user is holding their private keys, they have complete ownership and authority over their funds.
A common theme across Bakkt, Fidelity and Coinbase, however, is their push towards offering “custodial services” for users storing cryptocurrency with them - a practice antithetical to the premise of trustless financial transactions.
In offering custodial services, these companies seek to centrally control and manage the wallets containing Bitcoin, Ethereum, etc. of both their large institutional and retail customers, obscuring away the notion of private keys in the name of convenience.
When users are transacting with the Bitcoin network via an ETF or Fidelity 401k plan backed in cryptocurrency, they own the cryptocurrency purely on paper and not in reality as the provider is simply moving balances around in a centralized database. Broadly speaking, if you aren’t holding your private keys, you aren’t holding cryptocurrency.
Additionally, as we saw with the Mt. Gox disaster, large sums of centrally managed cryptocurrency paint an enticing target for hackers to try and exploit.
|| VERIFIABLE HISTORY
Much of Bitcoin’s original success was fueled by a reaction to the allegedly corrupt practices that resulted in the 2008 financial crisis. The promise of blockchain was that through a publicly verifiable ledger, users would have confidence in the issuance and flow of the money supply, and that banks could not secretly destroy this new economy behind closed doors. With Bitcoin a user was able, at any point time, to securely verify the entire history of transactions which led to the current state of balances on the ledger.
But as huge sums of the digital money supply begin to pool in the vaults of institutional service providers, transactions increasingly exist outside of a public blockchain and are instead processed “off-chain” using private databases.
While many companies market this approach as offering faster speeds and lower transaction fees, the side effect is a regression to a state where a large portion of Bitcoin or Ethereum movement between owners is no longer cryptographically verifiable across time.
|| WHAT ARE WE LEFT WITH?
The challenge with institutional entry into cryptocurrency is that it tears down all three core value propositions the technology aims to offer.
If a user is accessing their account through a centralized website, handing custody of their private keys entirely to a trusted third-party, and is unable to verify a ledger of how their funds are being handled by that third-party, are they really using a cryptocurrency?
At this point in the debate, many argue that cryptocurrency provides a core benefit which has not been specifically outlined here - that cryptocurrency simply represents an asset class that is not issued or controlled by a government. While objectively true, we can paint a picture that some may find scarier than government issued fiat.
As institutional involvement in cryptocurrency expands, it will undoubtedly become enticing to the bankers and firms running billion dollar custodial services to issue their own crypto tokens which they can centrally control, collect fees on, and build monopolies around.
Given the seemingly enthusiastic response of the cryptocurrency user base to what already marks a re-centralization of the technology, I gravely fear that we are heading toward a future where Wall Street bankers control not only the services atop a currency, but centrally issue and manage the currency itself.
While this prediction may sound far-fetched, it has already begun with the issuance of highly centralized “stablecoin” crypto-tokens such as USDC managed by corporations like those we’ve already discussed.
|| WHAT COMES NEXT?
A glimmer of good news here is that, out of the spotlight, work continues at the protocol level to maintain a degree of resistance to institutional dominance over cryptocurrency. From initiatives that offer non-custodial scaling such as Lightning or Plasma, to the increasing availability of secure hardware wallets, through to projects supporting user privacy like Zcash and Grin, there is some hope that cryptocurrency can fight back and stick to its roots.
The real question becomes whether the industry en masse will prioritize this resistance over the allure of market expansion and wealth that institutional re-centralization may offer. My extended observation of sentiment in the space suggests to me that this unfortunately may not be the case. At a macro-level, there is no denying that the institutions are coming - but for a movement previously described as “the real Occupy Wall Street”, cryptocurrency now sadly resembles a community that instead wants to be occupied by Wall Street itself.
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