The Institutional Illusion

Institutional Illusion cryptocurrency

Institutional Illusion

The daily announcements of “institutional” involvement in Bitcoin and the broader cryptocurrency market offers a titillating possibility: massive gains for crypto speculators. “Hodlers” salivate longingly at the explosive possibilities of billions, or perhaps trillions of dollars being injected into the comparatively tiny cryptocurrency market.


But is it all just an illusion?


As major market forces the likes of Morgan Stanley, Goldman Sachs and other behemoths dip their toes into the turbulent waters of crypto, one key detail is overlooked — or for those in the know — willfully ignored. It boils down to a single word that many either do not understand or would prefer not to think about:




Derivatives are an illusory mechanism that allows for the virtual holding of assets without any true custody of said assets. It’s an institutional freebie that allows these larger entities to enter the game, creating an image of control and custody, without any need to hold the genuine physical asset.


Put simply, a derivative is a “share” distributed by some central entity to shareholders that is intended to represent an actual asset in one way or another, often in the form of future bets. Granted, this is an extreme simplification of only one kind of derivative, but the main gist of it is that this share is not the actual asset — it is merely a side bet that pays out to the shareholder depending on the bet that has been made. For example, if I hold a futures derivative for gold, I could bet “long” that gold will increase in value. If it does indeed grow in value, I win the bet and get paid. But I don’t necessarily hold any gold at any point in this process.

Gold Bitcoin

Gold Bitcoin

When it comes to digital blockchain currencies like Bitcoin, it’s easy to muddle this concept because Bitcoin itself is not a physical object one can touch. It’s important to understand; only the holder of the cryptographic private keys actually controls and has custody of this object — this is what makes it a physical asset. With the private key in hand, it is indeed a hard asset; it cannot be duplicated, counterfeited, or faked.


This problem can be circumvented, however, if one can successfully create the widespread notion that holding a derivative or entrusting a central entity to hold assets on one’s behalf, is just as good as holding the actual Bitcoin asset.


The current monetary system relies on the concepts of trust and permission. You must entrust banks, regulators, government, and other authorities to maintain a certain degree of integrity in the financial system in order to ensure economic stability and to allow for growth in wealth. On a simpler level, you entrust banks to hold your money, to keep it safe, and to avail the funds to you as needed when you go to the bank and withdraw a few dollars, for whatever reason.


There’s a big problem with this. You need permission from the bank to use your own money, and you need to trust the bank with your money. If you want to send money to a particular recipient, you must do so with the permission of your bank. If the bank does not want you to send money to a particular recipient or to a region that is off-limits for whatever reason, you cannot send it. You need permission. And you need to trust the bank to safely hold your funds and to allow access to your own money when needed.


This begs the question: if the money is sitting in your bank account, is it actually your money?


Not really. In fact, the bank is free to lend out your holdings to other bank account holders. It only needs to keep a tiny reserve of your funds in the bank at any given time, and can freely use your money to make more money for itself. In the meantime, it charges multiple clients interest for the lending out of your money, many times over.


This can and does sometimes end badly with a “run on the banks”, whereby account holders, in an economic downturn, rush to withdraw their funds from a bank only to find that the bank does not actually have enough money in its custody to make it available to all the users who had entrusted their funds to the bank. At this point, the client is left without the funds they had trusted the bank to hold securely.


Derivatives are one of the favorite ways for banks to play with your money. Banks can take money held by account holders, entrusted to them, and literally gamble this money on derivatives. This is what happened during the economic meltdown of 2008, mostly with mortgage derivatives, resulting in banks collapsing and enormous bailouts that saved most of the banks, but cost Americans on a large scale and caused damage to global markets; resulting in massive debts to be paid by present and future generations around the world.


The big wigs at major institutions like Morgan Stanley and Goldman Sachs are wrestling with this problem right now; how to set up secure custody of digital assets for their trading on a large scale. In order to move forward, these entities must have a trusted third party that can safely hold digital assets like Bitcoin for them to expand on trading it via mechanisms like ETF’s and the like.


And that’s where we again find ourselves running into the problem of trust and permission. Again, just like the banks, if an entity other than yourself holds the custody of your Bitcoin assets, you do not own the actual asset. This is merely a return to a banking system that must be trusted and must grant permission to its clients in order for said assets to be spent or received.


It’s an ironic problem. Bitcoin, and distributed ledger technology in general, allows for trustless and permissionless financial independence that can not be stopped by a central entity. Yet, so many participants in the cryptocurrency market eagerly await the arrival of these very entities. Bitcoin was, in fact, designed and created in spite of these corrupting forces, yet, in a Stockholm syndrome-like twist, many are awaiting their would-be oppressors’ approval in order for this revolutionary financial tool to gain “acceptance”.


While institutional investors would prefer to play on the derivative sidelines with the money entrusted to them by their clients, gambling in an effort to steer market forces in their favour, be aware of the real truth that cannot be denied or concealed. If you do not have custody of the actual asset, whether it be gold, oil, old-fashioned fiat money, or Bitcoin, you do not own the asset. You are merely holding an illusion in your hands.

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1 Comment

  1. Reply

    Laurie Dunn

    This was such a thought provoking piece Darren. Thank you for explaining this in such a clear way – has definitely given me food for thought.

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