Morgan Stanley released a report late last year that described their take on Bitcoin and made passive mention of the crypto ecosystem in general. The report was widely reported on and it seems that the headline of choice was Morgan Stanley proclaiming that Bitcoin isn’t as much a store of value as it is an institutional asset class set to take on trading, and presumably, volatility needs at big banks and family offices across the globe.

While this language is and should be offensive to Bitcoin maximalists and anyone who believes in the original mission of Bitcoin – it certainly isn’t a surprise. If institutional (and a plurality of retail) clients ask enough times for something these institutions are going to give it to them, pure and simple. There is serious money to be made by creating expensive structured products wrapped around the guise of crypto volatility. The key words there are expensive and volatility. Expensive and volatility.

Morgan Stanley doesn’t have any interest in building out a warehouse facility or cold storage vault to house private keys and racks of hard wallets. There isn’t any money in it. At least not the kind of money that Tier 1 institutions have an interest in earning on that type of investment.

Instead, they are focused on several structured product initiatives that we’ve been made aware of that should be of interest to anyone attempting to get an understanding about how a powerhouse global investment bank is attempting to meet client demands.

Based on extensive discussions yesterday afternoon and again this morning we’ve heard three specific initiatives that are being *discussed* at Morgan Stanley (FYI – much like Goldman Sachs is in *internal discussions* regarding an Ethereum product to satisfy demand) and could come to market in 2019:

1. A dedicated institutional trade desk that handles futures, OTC transactions, NDF like products that clients traffic across other Tier 1 institutions (Goldman, Citi).
2. Internal discussions are ongoing as to whether Morgan Stanley uses Bakkt infrastructure *exclusively* with respect to Bitcoin futures transactions or using every resource that exists by 2019 (Bakkt, ErisX, CME, CBOE).
3. Leadership in Morgan Stanley’s trading divisions are discussing whether or not to go all in on a Bitcoin NDF as well as an Ethereum product that has yet to be given a trading classification.

**Not included in the above list was a less prominently mentioned discussion point that included where does Morgan Stanley fall once a Bitcoin ETF product is created, as well as other SEC approved products throughout 2019. Discussions remain active as to whether or not Morgan Stanley creates their own branded products that are functionally identical to competitor products, or simply offer competitive products and whatever premium fee structures are inherent in the products themselves.

The discussions moving through trading rooms and in strategy sessions at the firm is not whether or not crypto is sustainable or a ‘flash in the pan’ bubble that will eventually fade. The discussion is focused on regulatory approvals and guidance, strategies to benefit from those new rules, and how to best position Morgan Stanley’s crypto products (should they choose to create native structured products) and services to its largest clients.

Which leads us to the dialogue in the Morgan Stanley research report making the rounds today. It adds context to the discussions internally as the firm positions itself for 2019; a year that those we spoke to believe will produce massive adoption, new (and relatively tame) regulations in the US, and trading volumes set to skyrocket.

The ‘money quote’ in the report, as it was told to us (to pay particular attention to) is this:

The net dollar amount in crypto hedge funds in 2016 was $380MM. Today it stands at over $6B.

You don’t need any other explanation for Institutional ‘fomo’ than those hard numbers. Those are funds that are eschewing fiat based products and diving into crypto, even in the midst of a bear market.

Morgan Stanley wants to be a real player in this market. They are working overtime to figure out just how to do it. Regulatory and legal hurdles need to be appropriately approached and handled, but when that happens they are planning to be at the forefront of what they believe will be a highly profitable new ‘super asset class’.

New York, one of the first states to adopt virtual currency rules, has taken a relatively strict approach in the regulation of virtual currency activities. The rules, enacted on 24 June 2015, established a regulatory framework for virtual currency businesses that requires operations related to transactions involving any form of virtual currency to obtain a “Bitlicense” from the state.

The strict licensing requirements favor large virtual currency firms and financial institutions. The BitLicense application and licensing process is likely overly burdensome for small companies with limited access to capital and legal resources.

Overview of Bitlicense

Subject to certain exceptions, anyone engaging in any of the following activities is required to obtain a BitLicense from the New York State Department of Financial Services (“NYSDFS”):

• Virtual currency transmission

• Storing, holding, or maintaining custody or control of virtual currency on behalf of others

• Buying and selling virtual currency as a customer business

• Performing exchange services as a customer business

• Controlling, administering, or issuing a virtual currency.

Out-of-state businesses that engage in virtual currency activity involving New York State, or with persons within the state, must obtain a BitLicense to conduct their business.

Some of the regulatory requirements include:

• Minimum capital reserves

• Records of transactions must be kept for at least seven years

• Quarterly financial statements must be submitted within 45 days of the close of a quarter

• Background checks on all employees must be performed by an independent investigatory agency

• Appointment of a dedicated compliance officer

• Enforcement of written anti-fraud, anti-money laundering, cyber security, privacy and information security procedures

• Prior written approval from the superintendent of the  NYSDFS before the company introduces a “material change” to their business model, such as a new product or service

• Prior written approval from the superintendent of the NYSDFS before any merger with or acquisition of any company holding a BitLicense.

The application fee for a Bitlicense is $5000 and the applicant must complete a 31-page application form.

The one-size-fits-all” licensing process does not provide any exceptions for small virtual currency companies.

Application Approval Process Slow, but Improving

The 2015 rules do not impose a deadline on the NYSDFS for completing the licensing process.

Since the enactment of the rules, the NYSDFS has approved only eleven charters or licenses for virtual currency companies.

The license for Genesis Global Trading was not granted for nearly three years, and a license for BitFlyer USA, Inc. was not granted for over a year.

The number of licenses issued will likely increase over the next 12-24 months.

Focus Remains on Consumer Protection: The 2018 New York Attorney General Report

In September, the New York Attorney General (“NYAG”) issued a report that concluded crypto trading platforms vary significantly in their risk management strategies and in the ways they fulfill customer responsibilities.

The NYAG identified three broad areas of concern: potential conflicts of interest; lack of serious efforts to impede abusive trading activity; and limited protections for customer funds.

The NYAG also referred three virtual currency exchanges- Kraken, Binance and Gate.io-to the state’s financial regulator for possible legal action and raised concerns over price manipulation and conflicts of interest on trading platforms.

The report concludes that “virtual asset trading platforms have yet to implement serious efforts to monitor and stop abusive or manipulative trading.”

Draft Virtual Currency Legislation Introduced into the State Assembly

Virtual currency bills have been introduced in the State Assembly this year. New York, however, will not likely amend existing rules or introduce major virtual currency legislation until 2020, after the State Assembly is able to review a task force report that must be completed by December 2019.

• Bill on the Creation of Virtual Currency Task Force: The bill proposes the creation of a digital currency task force to provide the governor and the legislature with information on the potential effects of the widespread implementation of digital currencies on financial markets in the state. If passed, the bill would establish a group consisting of nine members which would be called on to submit a report to the governor, temporary president of the senate, and the speaker of the assembly by December of 2019. Additionally, the task force would be required to provide the number of digital currencies and exchanges operating in the state, information about large investors in the field, and the energy consumption necessary for coin mining operations. The task force would also provide a review of laws and regulations on digital currency used by other states, the federal government, foreign countries, and foreign political and economic unions to regulate the marketplace.

• Bill on Virtual Currency: The bill proposes eliminating the BitLicense and licensing fees. In addition, the bill mandates that any virtual currency business or entity be subject to routine audits by a public or third-party depository service. Any entity in full compliance will receive a digital New York Seal of Approval to reassure consumers that the outlet is trustworthy and secure.

Bakkt has been the talk of the crypto water cooler for nearly six months now. Conversations about it being a “bear market buster” abound, and it just may be. But it has to be approved by the CFTC before that can happen. And as of today, the lights are a bit dim in CFTC offices in Washington, DC – per the US government shutdown.

But that reality isn’t slowing down the inner workings of Bakkt, its staff, and the teams built around the global commodities exchanges controlled by Intercontinental Exchange. The ‘buzzing’ that can be heard amongst those connected to the Bakkt launch is loud and growing. Work is being done and preparations are in full gear.

The clear expectation is that CFTC approval will follow shortly after the reopening of operations at the CFTC following the end of the shutdown. And the Bitcoin initiative known as Bakkt, partnered with Microsoft and Starbucks, will launch like a rocket.

Take a step back and consider the huge venture capital names committed to Bakkt at the moment. A few names connected to their first round of funding read like an All-Star team of sorts: Fortress, Galaxy Digital, Horizon Ventures, M12 (Microsoft’s own venture fund), and a host of others.

The investment is not necessarily a play on Bakkt trading volumes or the price of Bitcoin, but rather on adoption and daily use that Bakkt plans on pursuing. Here is a portion of that case stated by Maria Smith, Vice President, Partnerships and Payments for Starbucks:

“As the flagship retailer, Starbucks will play a pivotal role in developing practical, trusted and regulated applications for consumers to convert their digital assets into US dollars for use at Starbucks. As a leader in Mobile Pay to our more than 15 million Starbucks Rewards members, Starbucks is committed to innovation for expanding payment options for our customers.”

In other words, the play for flagship institutional investors is not the volatility associated with Bitcoin, but rather the real world application of it when you walk into Starbucks and order a Grande Cordusio. With a swipe of a finger and a push of a button, Bitcoin is deployed and used for purchase at one of the largest retail chains in the world.

So what is happening today as Bakkt prepares to launch an entirely new asset into the commodities space?

The Bakkt team is working furiously as they prepare for a marketing and execution blitz that they believe will produce tremendous volumes and attract all manner of institutional clients very, very quickly.

One source familiar with Bakkt’s preparations had this to say about what they expect once CFTC approval occurs:

“Take a close look at the increased public dialogue that Bakkt is having with the crypto and financial community. Whether it is a Medium post by Kelly (Kelly Loeffler, CEO of Bakkt) or social media posts meant to continue to build a Bakkt narrative, the PR and marketing ramp up is preparing for launch and all that comes with it.”

“Once launch occurs you can expect Bakkt leadership to be all over the airwaves and in front of TV cameras preaching the Bakkt gospel. And that can be characterized as the safety, custody, and daily use case ecosystem that Bakkt provides to investors. Kelly is uniquely qualified to tell that story and will be a media darling.”

More color on where Bakkt is headed once approval is finalized from sources we spoke with familiar with the firm. The Starbucks initiative is a 2020 project and will be carefully talked about in conjunction with reps at the behemoth coffee company. ‘Message discipline’ will be important with respect to Starbucks so as not to fall into the trap of overpromising and underdelivering.

At launch much more will be made of Bakkt’s familial connection to ICE and their technology partnership with Microsoft. Those will be highlighted early and often as they are trusted names amongst institutional investors and global investment banks.

Further, you can expect Bakkt to be more an more visible at larger financial and technology conferences of note. Also expect the Bakkt message to be spread in the largest of media organizations like the Wall Street Journal, New York Times, CNBC, Bloomberg and the like. Bakkt wants to build a lock-tight institutional seriousness around digital assets and the safety they plan to provide to investors. They believe keeping messaging to legacy outlets will send that message.

Messaging, optics, partnerships, adoption, safety, real-world use cases, ICE, Microsoft, Starbucks, and ‘more digital asset products to come’. Maybe Bakkt is the bear market slayer we all hope it to be?

Bakkt isn’t resting on its parent company laurels and hoping that the ‘largess’ associated with ICE will bring institutional customers by the buckets full. Instead they are continuing to smartly acquire customers via acquisition as well as staff – as per a Medium post made by their CEO, Kelly Loeffler.

Via Medium:

“To advance that effort, I’m pleased to share that we have entered into an agreement to acquire certain assets of Rosenthal Collins Group (RCG), an independent futures commission merchant with nearly 100 years of earning clients’ trust. In December, RCG announced the sale of all its customer accounts to Marex Spectron, one of the world’s largest commodity brokers. As part of that transaction, our aim was to purchase certain valuable assets related to developing our platform. We expect to close the transaction in February, and are excited to welcome members of the RCG team to Bakkt.”

“How does this advance our work? First, it will enhance our risk management and treasury operations with systems and expertise. Other aspects of the transaction will contribute to our regulatory, AML/KYC and customer service operations as we help enable digital asset acceptance by bringing more choice and control to buyers and sellers.”

“This acquisition underlines the fact we’re not standing still as we await regulatory approval by the CFTC for the launch of regulated trading in our crypto markets. Our mission requires significant investment in technology to establish an innovative platform, as well as financial market expertise to deliver the most trusted fintech ecosystem for digital assets.”

It is not entirely clear what Bakkt has really purchased here, other than mention of ‘customer accounts’ in the dialogue above. That would be an interesting move to drive scale upon launch and provide the markets with volume from day one on their platform.

The staff that comes along with the acquisition will be on interest as to how many were acquired, who stays, and who does not.

A note (as we always do when reporting on Bakkt) as to what Bakkt is set to launch, and why it is seen as a potential bear market buster:

“Bakkt is designed to enable consumers and institutions to seamlessly buy, sell, store and spend digital assets. Formed with the purpose of bringing trust, efficiency, and commerce to digital assets, Bakkt seeks to develop open technology to connect existing market and merchant infrastructure to the blockchain.”

“As an initial component of the Bakkt offering, Intercontinental Exchange’s U.S.-based futures exchange and clearinghouse plan to launch a 1-day physically delivered Bitcoin contract along with physical warehousing on December 12, 2018, after receiving CFTC review and approval. These regulated venues will establish new protocols for managing the specific security and settlement requirements of digital currencies. In addition, the clearing house plans to create a separate guarantee fund that will be funded by Bakkt.”