Propelled by high valuations and the widespread adoption of blockchain, trading in the crypto industry is changing rapidly, opening an uncharted path for traditional corporate finance.
Over the past year, banking powers have begun providing financial support to innovative crypto companies looking for fundraising and consolidation, overcoming their initial skepticism of a volatile industry. and mostly unregulated. the 2020 total, with each of the top 10 deals valued at over $1 billion, according to a PwC report. The average M&A deal size more than tripled to $179.7 million in 2021 from a year earlier, while the total value of crypto fundraising deals soared 645%. The momentum will continue into 2022, the report also says.
“The increased demand we are seeing from our clients shows that institutional investors are increasingly interested in entering the digital asset market,” Drew Forman, head of Cowen Digital, told Global Finance.
Blockchain advocates guide companies through a regulatory maze. “Digital assets are different from debt or equity and therefore represent a new frontier in terms of building financing structures and valuations,” says Timothy Spangler, partner at law firm Dechert. “Lawyers working on these transactions today must anticipate the positions that regulators and courts will take in the years to come.”
Loans to crypto companies are the next step for traditional financial institutions that already offer custody and management of digital assets. This was unthinkable just a few years ago, when decentralized finance (DeFi) and traditional finance had well-defined boundaries.
In March, New York-based financial firm Cowen launched a digital asset division to offer trading and custody solutions to institutional investors. The company said it spent 15 months building the fully integrated, institutional-grade platform. Cowen Digital says it plans to offer lending capabilities this year. “There is growing recognition that digital assets are here to stay and institutional clients want to be securely exposed to them,” Forman says. “In 2022, we plan to offer lending capabilities and also aim to launch swaps and derivatives.” Cowen also intends to deploy algorithmic technology and plans to expand into the United States, Europe and Asia.
After launching its Bitcoin desk last year, Goldman Sachs in March became the first major investment bank to execute an over-the-counter cryptocurrency trade. The bank says it recently extended a secured lending facility where it lent fiat backed by bitcoins owned by the borrower.
“The interesting piece for us was the 24/7/365 risk structure and management,” a Goldman spokesperson said.
The question of guarantees
Traditional financial institutions with institutional-grade platforms claim an advantage over DeFi lenders when it comes to financial risk. “In the past, the challenges for regulated companies have always been to ensure that there is strong custody and that they can access this new asset class in the same secure and transparent way that they would access any other asset,” says Forman of Cowen Digital. .
Collateral, however, remains a concern due to the volatile nature of crypto assets, as seen with the selloff following the collapse of stablecoin TerraUSD and its sister coin Luna in May.
“Recent declines in crypto asset prices will prompt many to approach this with caution and set high collateral requirements,” says John Garvey, head of PwC Global Financial Services. Traditional players will be watching any large liquidations and margin calls from borrowers who took out loans during the bull market and are facing a drop in the value of their collateral, he explained. “For some, this could also be a time to build and refine models and collateral levels, so that when market conditions turn, they are prepared and stronger than ever,” he adds.
The Bank for International Settlements (BIS) in its latest annual economic report warns of the “deeper structural limitations” of crypto and DeFI “that prevent them from reaching the levels of efficiency, stability and integrity required for an adequate monetary system”.
The deals will shift to geographies where regulations are more advanced and user-friendly than the United States, experts say. The United States has been a catalyst for crypto M&A deals, accounting for 51% of the number of deals in 2021, up from 41% the year before, according to PwC. However, Europe, the Middle East and Africa saw the highest value of M&A deals last year, helped by SPACs, including the $8.1 billion bull deal .
“I know for a fact that some really big investors, some of the biggest family offices, have been investing in the United States, in bitcoin and bitcoin mining, and have started pressuring regulators to leave them alone.” , says Ralf Kubli, a Swiss. executive specializing in blockchain, cryptocurrency and decentralized technology.
Kubli seems confident that globally there will be more clarity in future regulations. “The problem in the United States is that you get clarity through litigation,” he says. Countries like Switzerland are attracting parents of crypto exchanges like FTX, which has opened its European headquarters there.
“We see a number of jurisdictions establishing specialized regulatory regimes with the aim of providing better regulation but also attracting mobile crypto businesses internationally,” says Garvey. Market players are actively establishing a locally regulated presence in markets where they expect to attract larger customers, such as the United States, parts of Europe, and Japan. “We expect this trend to continue as more and more locally regulated entities are established,” he adds.
The risk factor
According to PwC, new money is flowing into crypto and blockchain transactions from traditional and crypto-focused venture capitalists and funds, which combined have become the largest source (38%) of M&A activity in 2021.
Kubli warned that there could be an overvaluation problem as venture capital and funds need to deploy large amounts of cash. acquisition of CoinMarketCap in 2020, says PwC. “The reason why there is so much chaos and so much risk in finance is that the cash flows of these financial instruments are not properly defined and standardized,” says Kubli, a member of the association’s board of directors. Casper, which oversees the Casper Network, a modular blockchain designed to issue and manage crypto-based financial solutions.
Kubli believes that the digitization of traditional finance requires standardized, digital and algorithmic financial contracts that define cash flows between parties. Without such contracts, it will not work: “We are building capital markets the right way, from scratch.”