How Goldman's Bitcoin Bid Could Change Crypto Industry

After months of speculation and reports, Goldman Sachs Group Inc. (GS) confirmed its plans to trade bitcoin last week in an interview with The New York Times. (See also: Goldman Hires Former Crypto Trader.)

With its deep Rolodex of clients and heft within the financial services industry, Goldman’s entry into bitcoin trading is fraught with implications for the fortunes of the nascent cryptocurrency industry. Here are three ways in which Goldman’s entry could change bitcoin trading. 

The most obvious consequence of Goldman’s entry might be an increase in the liquidity profile for bitcoin and other cryptocurrencies. While sustained attention from the media last year resulted in a surge of trading volumes and popularity for cryptocurrencies, it also highlighted problems in their ecosystem. This has kept institutional investors and banks away from the newest asset on the block. Wesley Hansen, director of trading operations at The Crypto Company (CRCW), says cryptocurrency investing in its current state is similar to venture capital investing for large investors.

“Beyond the top five cryptos, it is all about taking large risks in the hope that some will pay off and some won’t,” he said. According to him, Goldman’s decision to enter the bitcoin market through futures trading contracts will have a positive effect on volumes in futures trading. “It is the safest strategy for them to enter the market,” he said. “They are entering into the same markets (that they operate in) but trading in a different product.” The company, a digital assets technology provider, boasts on its website that it is one of the first public companies in the cryptoassets sector.

That said, Hansen said traders will “get bored pretty quickly” with available crypto investments and predicts that futures for ethereum and options, including puts and calls on various cryptos, might soon be introduced. In addition, Hansen says “super complex derivative products” will become available to traders after Goldman’s entry paves the way for other institutional investors and bankers to enter bitcoin trading.    

Goldman has not clarified the venue for its bitcoin trading, but industry insiders are hoping that it selects trading solutions and tools from within the cryptocurrency world. “It would be a tremendous signal to the industry,” said Nolan Bauerle, research director at Coindesk. He specifically named LedgerX, a derivatives exchange that has witnessed a bump in trading activity recently, as an exchange that might benefit from Goldman’s entry into the derivatives market. Among others, LedgerX has received funding from notable venture firms, such as Google Ventures and Lightspeed Ventures partners. Some have even surmised that LedgerX has Goldman’s operational fingerprints. For example, John Smollen, executive vice president at the firm, is a former GS executive. 

Rapid trades from full order books could also change operations at cryptocurrency exchanges. “Cryptocurrency exchanges are a weak point in the industry,” said Bauerle and questioned whether normal bitcoin exchanges could manage the thousands of amendments required in regular trading operations. 

His view is echoed by Hansen, who says cryptocurrency exchanges currently have only a limited number of trades available for investors. “Complexity of order types is absent,” says Hansen, adding that their operations are geared toward investors interested in holding onto bitcoin for long periods of time instead of conducting rapid trades with it. 

Traders like Goldman Sachs rapidly move in and out of trades, making profits off small increments in value. “The [crypto] exchanges are not built for quick action,” says Hansen. This absence of quick action has led exchanges to skimp on features that are fairly common in regular trading platforms. For example, Hansen points out the exchanges do not have tools to aggregate and display gains or losses from multiple trades conducted through the day. 

“Right now, anyone who trades more than a few times has to dump all their trades in an Excel sheet and calculate average costs there because there’s no exchange giving you this statistic,” he said. Hansen predicts a consolidation among exchanges in the next couple of years, as liquidity increases due to the entry of big banks and institutional investors.  

According to Bauerle, holding bitcoin in physical custody might be a “seductive” proposition, once they begin trading derivatives. Until recently, Goldman has limited itself to commentary on bitcoin and other cryptocurrencies. For example, in a February note, it predicted that the value of most cryptocurrencies will fall to zero in the near future. 

Even in its foray into bitcoin trading, Goldman has started with futures contracts and avoided direct dealing with the crypto. This is partly due to bitcoin’s custody problem. Physical custody involves ownership of private keys to bitcoin wallets. Due to its digital nature, bitcoin is vulnerable to hacks and custody services have evolved into a complicated exercise that combines offline storage with rigorous access environments with multiple sign-offs at each step. A slew of custody-related services, such as Xapo and Coinbase, have emerged. But Goldman might have to contend with a steep learning curve. Bauerle said physical ownership of bitcoin might result in a crash course into the mechanics of cryptos for the firm. 

Investing in cryptocurrencies and Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns 0.01 bitcoin.