Since its introduction, cryptocurrency has quickly risen in popularity. Some crypto enthusiasts are hopeful that it will find a place in traditional investing spaces, but Wall Street retains some skepticism about the idea.
Cryptocurrency is still a relatively unstable market, and major financial institutions are hesitant to risk their capital. In addition, Wall Street’s practice of rehypothecation could potentially disrupt the crypto market in major ways.
Why Is Wall Street at Odds With the Crypto Market?
Though cryptocurrency’s notoriety has grown steadily since its inception, it still has yet to be universally embraced—but many crypto supporters see a spot on Wall Street as its ticket to widespread acceptance. A direct crypto ETF is the goal for many crypto investors because that would allow it to enter the traditional investing market and increase its accessibility to retail investors.
Essentially, cryptocurrency investing still works very differently from traditional investing. It’s bought and sold on its own separate exchanges and requires investors to operate a blockchain wallet. This makes it less appealing to those who are already heavily committed to traditional investing. If cryptocurrency achieved mass adoption by Wall Street financial institutions, it could integrate with the traditional investing market, which could potentially open it up to a whole new audience.
There are some signs that crypto may have a shot at breaking into the traditional investment market. In October 2021, the New York Stock Exchange began trading Bitcoin futures. While this type of ETF is not linked to bitcoin price directly, it allows investors to speculate on how Bitcoin’s value will behave in the future.
However, despite this bit of progress for crypto, An ETF directly linked to the current value of Bitcoin remains out of the question for the moment.
The Rehypothecation Problem
Wall Street’s rejection of a crypto ETF is not the only hurdle the currency faces. Whether intentionally or not, Wall Street may be slowly killing crypto by way of rehypothecation.
Hypothecation is the practice of signing assets to a lender as collateral. Equity shares in stock are one type of asset that can be offered as collateral in this way. Rehypothecation is when the lender then uses the debtor’s collateral as collateral for their own debts. In the traditional finance world, rehypothecation is possible, though risky.
However, rehypothecation doesn’t work at all with cryptocurrency because each share of cryptocurrency relies on a unique private key. Once cryptocurrency has been passed down a line of rehypothecation and multiple parties have access to the key, it becomes difficult to determine who can actually claim ownership.
It is also challenging to determine a digital asset’s origins when it has been recorded on multiple balance sheets. By the time the rehypothecated crypto asset is actually needed, its chain of ownership has become so muddled that it’s almost impossible to tell who has the right to claim it.
Potential Consequences For Crypto
Even though rehypothecation is typically a viable process in traditional markets, it does not work with crypto because it could lead to claims of ownership from multiple parties at the same time. Not to mention, the chains of loans that crypto rehypothecation establishes are extremely precarious—if even a single party within the chain defaults, the entire structure could come crashing down.
Rehypothecation in traditional markets is not as common as it used to be because its use played a significant role in the housing market crash of 2008. Unfortunately, the cryptocurrency market now appears likely to suffer as a result of rehypothecation as well.
The fear on many crypto investors’ minds is that the crypto market will find a footing on Wall Street and enjoy unprecedented growth, only to crash soon after as a result of rehypothecation. Much like the 2008 real estate market crisis, a crash could have far-reaching ripple effects that damage seemingly unrelated areas of the economy.
What’s In Store For Digital Currency?
Cryptocurrency may yet find a place at the table alongside traditional investment opportunities, but its relationship with Wall Street needs to improve before that can happen. In particular, rehypothecation is a key obstacle that could be suffocating the crypto market. Hopefully, past lessons will encourage Wall Street to limit or abolish rehypothecation’s influence on cryptocurrency.