By Jonny Fry: CEO TeamBlockchain
Institutional investors are increasingly looking to cryptocurrencies, as the returns they generated in 2017 make this new Asset Class difficult to ignore. Initial Coin Offerings (ICO) and the Tokens they generate have been compared to the Wild West, but now we are seeing publicly-quoted firms issue Tokens, while Venture Capital (VC) is being crowded out. It is interesting: cryptocurrencies are being seen as a way to help institutions to manage risk as there seems to be a correlation between Bitcoin and a measure of stock market volatility known as VIX.
There are currently over 600 publicly-quoted companies in the UK that have a capitalization of £2 million to £50 million, but they struggle to raise capital and often their daily liquidity is low. This partly explains why institutional investors like pension funds and banks tend not to buy smaller companies, but get their exposure to this sector by buying funds or using VC.
However, in 2017, arguably one of the most powerful technologies, blockchain, has seen funding from VC dominated by more than 5 times the capital from ICOs:
Fund managers monitor VIX as this gives them a feel for the degree of ‘fear’ or uncertainty in equities, and it is a popular measure of the stock market’s expectation of the volatility of America’s 500 largest quoted companies, S&P 500. When investors are sanguine, not worried, then VIX will typically be low: an environment where the economy is steadily growing, and inflationary pressures are weak.
If we look at the price of VIX over the last 10 years we can see that in 2009, at the height of the financial crisis, VIX was priced at over 44 compared to the price now of 11. We are currently at the low end of the last 10 years’ trading range as the chart from Market Watch below indicates:
Some equity managers and commentators believe that this low-volatility environment is unlikely to continue as we start to see interest rates rise. Uncertainty over corporate earnings will creep in as the cost of borrowing money for business increases, and people with mortgages have less to spend, so potentially the price of VIX will rise. Others are concerned that, after the massive quantitative easing by central banks – money being pumped in to the American, Japanese and European economies – inflationary pressures may rise. This could in turn lead to higher interest rates, a slowing in economic growth, greater uncertainty for equities globally, less demand for commodities, and lower property price: here we would see most traditional assets declining simultaneously.
The unanswered question is: what will happen to the price of cryptocurrencies in this environment? To date, they have not been correlated to other asset classes, as you can see from the table below in 2017:
Cryptocurrencies could prove to be an alternative investment in troubled times.
Traditional investors are now increasingly looking to cryptocurrencies as the returns they have generated are difficult to ignore. While Bitcoin is the best-known and biggest cryptocurrency, in 2017 it was the 14th best performer, rising by only 1,318%.
The best performing cryptocurrency in 2017 was Ripple, which rose by over 36,000% in just one year! Interestingly, Ripple is backed by 100 of the world’s largest banks as they try to harness the power of a technology called Blockchain. Ripple was established to reduce the cost of transferring money between banks and potentially replace SWIFT, which itself replaced Telex.
What is interesting in the above chart is the amount of turnover for the top ten currencies over the last 30 days of 2017. This is important as it negates an often-cited criticism that there is no liquidity in the cryptocurrency market. Really?
Recent research from Deutsche bank has pointed out that “there is a growing relationship between the price of Bitcoin and VIX, the Volatility index”. The chart below shows this correlation over the last 12 months:
Some institutions may not be buying cryptos, but they are studying their price movements to gain an indication of what will happen to the future price of VIX. This is ironic as the price of cryptos is largely driven by private investors. In many cases institutional fund managers are not permitted by their investment mandates to invest in cryptos. So: institutions that manage the majority of money in world equity markets follow the price action of an asset class they themselves cannot invest in!
In 2017, the cryptocurrency market expanded significantly, rising in value to over $700 billion at one stage. Additionally, we have seen over 1,400 companies issue Tokens to raise capital. This is likely to be just the start of a trend as we see global brands, public companies, and even central banks launch ICOs.
In Germany, Naga https://www.nagaico.com was the FIRST European quoted firm to launch an ICO last December and they raised over €40 million from 63,000 participants. This is particularly interesting as, historically, German investors tend to be cautious and this ICO was based in Belize.
Kodak http://www.trustedreviews.com/news/kodak-coin-cryptocurrency-launch-kodakone-blockchain-share-price-3369465 recently announced they are looking at launching an ICO, which has had a significant positive impact on their share price.
Canadian technology quoted firm, Glance, is in the process of potentially preparing for an ICO, having recently acquired a blockchain-based technology App from Ztudium. http://www.nasdaq.com/press-release/glance-appoints-blockchain-advisor-and-ico-consultant-alexander-perkins-to-advisory-board-20171106-00590.
Finally, Nostrum https://blog.icofunding.com/nostrum-will-be-the-first-established-company-in-spain-to-launch-an-ico-for-their-meal-token-on-fc89a93d01d6 have announced their intention to put forward an ICO in Q1 to expand their following, which currently has 800,000 registered people. The ICO will be used to expand Nostrum’s attraction and engagement with their clients. They will run a secondary listing of their shares in Paris later this year to raise further funds, to increase the number of restaurants and meal-making facilities. So here is a company using traditional equity markets to expand their infrastructure by selling shares in Paris and launching an ICO to build its brand, create a digital loyalty program, and further develop its community of customers.
These quoted companies are using ICOs as a source of finance and I suspect we will see brands and other quoted companies carrying out ‘AirDrops’, where Tokens are given away for free, to keep their customers’ attention, tie in their clients, and generate more loyalty.
In a study carried out by KPMG they found “customer retention was cited as the biggest revenue driver”.
We are likely to see ICOs launched to raise capital, but also as part of a firm’s marketing strategy, to engage and reward their existing and prospective customers.
- According to Bain and Company, a 5% increase in customer retention can increase a company’s profitability by 75%!
- Gartner Group statistics tell us that 80% of your company’s future revenue will come from just 20% of your existing customers.
- Marketing Metrics says it’s far easier (by about 50%) to sell to existing customers than to brand new prospects.
Increasingly, organizations understand that they need to look after their existing clients. As the environment we live and do business in becomes increasingly digitalized, companies are adapting and having to engage with us digitally, whether that be by increasing the amount they spend via online media or offering a digital loyalty incentive scheme.
Still have doubts whether customer retention is something to put your minds to?
Bain and Company also report that attracting new customers will cost your company 6–7 times more than keeping an existing customer!
As the chart below illustrates the importance of existing clients should not be ignored.
So why is this important to institutions and how will this impact the cryptocurrency market?
One of the features that deters investors from cryptocurrencies is their volatility and lack of track record compared to companies like Apple or Google. As we see more quoted firms using ICOs to raise capital, or giving away Tokens to create their own digital loyalty programs, we are likely to see the volatility of these Tokens, and possibly the potential returns, become lower. This is coupled with increasing regulation, greater involvement of professional advisors to verify ICO documentation and ensure organizations are compliant, which will encourage more investors to buy cryptocurrencies.
However, ICOs for quoted companies are not without risk, so directors need to understand and then mitigate any conflicts of interest that may occur between shareholders and Token holders. Raising money through an ICO may be attractive as it does not dilute existing shareholders, or increase the firm’s level of debt. Buyers of a Token need to be able to understand why the Tokens will increase in value over time and what underpins their value. These questions are starting to be addressed, as are ways to minimize Token volatility. As the cryptocurrency market matures, the losers are likely to be VC firms. Those private and quoted companies that do not embrace the possibilities of this new Asset Class could be overtaken by their competitors who use ICOs as a method of funding.