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New Crytpo Exchange “BAKKT” Has an Ambitious Plan to take Full Custody of Bitcoin

Yesterday, the International Exchange (ICE), one of the largest exchange operator and commodity assets trader in the world announced that it will form a digital assets market called Bakkt. This new enterprise will become a new government regulated market for Bitcoin, crypto currencies, futures, and their derivatives. Backed by Microsoft, Starbucks, (and a multitude of silent partners), it offers to take custody of the Bitcoin markets. Its goal is to establish a stable platform for the safe trading of Bitcoin-based mutual funds, ETFs, and other mainstream investments. Bakkt is a project that has been in development for the last 14 months. The news of its launch in November 2018 seems perfectly timed to match the growing interest of a securitized Bitcoin.  However, a new approach will still face a path to mainstream adoption mined with a myriad of obstacles.

The promise

Bakkt attempts to optimize the mainstream adoption of Bitcoin by reducing costs and providing custody. Jeff Sprecher, is the founder and CEO of ICE. He correctly believes that a major obstacle to adoption is the conversion cost of fiat into Bitcoin. He faults the existence of over 200 different exchanges, each with a different price, and a shared trading volume. This spreads liquidity and increases competition. Thus, it makes it difficult for investors to buy and sell crypto currencies efficiently. By becoming a ‘hub’, Bakkt will lower prices and a larger pool of traders. Thus, reducing trading fees which hinder the overall growth of the market.

Custody

Bakkt is a play on the word “backed”, intending to assure interested institutional investors that their investments are safe. Part of that assurance is the fact that ICE’s founding and likely shareholders in this venture are some of the largest financial players in the world: Goldman Sachs, Morgan Stanley, BP, Shell, Deutsche Bank and Société Générale. The basic premise is to provide secure trading and cold storage of crypto currencies using in house, secured warehousing and clearing facilities.

Once custody is achieved, the markets will be open for large investors and their capital influx will provide liquidity. Scalability’ of transactions will occur by implementing an off chain system akin to the “Lighting Network.”  Where all the trading and settling transactions will be conducted off chain using payment channels and only the recording of the transactions will touch the blockchain.  After achieving a stable trading and storage infrastructure, the company will move into the mainstream adoption of Bitcoin for everyday and international banking, and offer futures markets. However, this road to riches remains filled with technological problems.

The problem

In developing the infrastructure, Bakkt will still face the same unresolved obstacles which prevented the Winklevos’ ETF from realization. These are market volatility, price manipulation, scalability, security, and the elephant in the room – no tethering.  Fortunately, ICE has apparently been working on this problem for over a year and may have worked out some of these bugs.

Volatility: Their solution is to increase the number of users which will increase liquidity; by augmenting the size of the trading field, demand should naturally stabilize and volatility will decrease.

Price Manipulation: there is reason to believe that ICE has open communication with the SEC and CFTC and is likely a partner in developing strong regulation that will stem speculators.

Scalability: Bakkt relies on its parent company ICE’s established trading ystems and experience. One of its overambitious goals is to establish the largest repository of Bitcoin for ALL users; individuals, banks, institutions, companies, etc. Whenever these entities transact with each other using Bitcoin, they will use the ICE exchanges to conduct the transactions. And the amount will settle, record, and the currency will remain within Bakkt’s storage without any Bitcoin ever having to leave the warehouse. This system will speed up transactions by using payment layers and only use the blockchain to record the transaction.

Security: The exchange plans to store user’s private keys offline in “heavily guarded” digital warehouses composed of “super safe lock boxes” coupled with multiple layers of cyber-secuirty.

The last major hurdle is the lack of Bitcoin’s tethering to any form of value. Unfortunately, Bakkt offers no real solution and most likely relies that the proposed measures will satisfy the public’s belief that the shared commitment and investment will provide some form of value.

The Opportunity

The creation of Bakkt is based on the understanding of the current disconnect between Bitcoin supporters and opponents. And the opportunity to bridge the two. The enterprise will tune into the positive outlook new generations have on digital currencies and their distrust of the banks. And will clarify (to the banks and apprehensive Wall Street investors) that with a solid trading platform, established clearing houses for insurance, strong security measures, and stringent legal compliance, the crypto market offers great potential.

To further address institutional investor’s concerns, the exchange will comply with regulations of the SEC and CFTC. In fact, since Bitcoin was deemed a commodity and not a security, it is ideally placed to be traded thorough ICE’s system. This is because ICE operates the two of the largest commodities futures exchanges on the planet—ICE Futures U.S., and ICE Futures Europe. And through its NYSE, ICE holds the perfect position to trade future crypto currency ETFs.

Conclusion

The creation of a centralized, regulated, compliant, and fully functioning crypto exchange may check all the boxes for institutional investors. But its lack of diversity may not pass SEC scrutiny; and this was a cause for rejection of the first Winklevos’ ETF. However, serious questions remain; most apparent is the fact that Bakkt does not offer any real innovation. The company simply plans to use ICE’s existing infrastructure to replace Mastercard’s payments with Bitcoin’s payment. The company is taking the easy road; it’s capitalizing on the existing audience, technology, and hype of Bitcoin instead of re-creating the process from scratch.

And herein lies an underlying problem; it is entirely dependent on a process bogged down by its design shortcomings. For example, mining (which is myriad in controversy), block production rate, or the ever present danger of 51% attacks. All of which could easily bring Bitcoin minting to a halt. In addition, in order to pay with Bitcoin, individuals must also earn Bitcoin. Lastly, there isn’t enough Bitcoin to cover all the present or future global transactions. There is approximately $80 trillion in cash, in circulation in the world. Bitcoin will only EVER have $21 million by 2140. Nevertheless, the Bakkt exchange offers the best short term solution and with a little bit of time and experience, it may prove a strong custodian and open the market to the masses.

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