The Surprising Catalyst Behind the Sudden Resurgence in Cryptocurrencies

Last year, cryptocurrencies dominated in a way that Wall Street had never seen before. In just a span of 12 months, the aggregate market cap of all virtual currencies soared by more than 3,300%, or almost $600 billion on a nominal basis. At no point in history can I recall an asset class gaining more than 3,300% in value in just 12 months, and I doubt we'll ever witness it again.

Of course, this year has also been a wake-up call for digital-currency investors, who've learned that investments, including cryptocurrency tokens, can move in both directions. Following a brief move to an all-time-high market cap of $835 billion on Jan. 7, the combined value of the more than 1,600 investable cryptocurrencies fell to just $247 billion on April 6, 2018, per

Cryptocurrencies are surging, once again

But something interesting has happened over the past month. After this roughly 70% tumble in cryptocurrency market cap, virtual currency bulls have returned with a vengeance. As of early morning on May 5, the combined crypto market cap was back up to $471 billion. That's a trough-to-peak gain of about 91% in roughly one month.

"What gives?" you ask. Part of this renewed optimism can likely be pegged on a few of the usual suspects. For example, there's the rise of blockchain technology. Blockchain is the digital, distributed, and decentralized ledger that underlies most cryptocurrencies and is responsible for logging transactions in a transparent and unalterable manner. Blockchain has been stuck in the proof-of-concept stage for years, but we're finally starting to see a few brand-name businesses taking the reins off of it to see what it can do in a real-world scenario.

To build on this point, we're also seeing a pretty steady stream of partnership announcements involving proprietary crypto-blockchain projects and brand-name organizations. The Enterprise Ethereum Alliance, which is the largest open-source blockchain initiative in the world, now has more than 500 members. For context, it only had around 50 when it was first established in February 2017. Meanwhile, Ripple, the financial-institution-focused crypto company, continues to add new financial institutions to RippleNet in an effort to expedite the validation and settlement of cross-border money flows.

This isn't your typical catalyst this time around

However, the impetus for this most recent rally appears to extend far beyond these typical factors. It would appear that the bulk of this rally is tied to the expectation that institutional investors are finally ready to enter the cryptocurrency space.

Until recently, virtual-currency investing had pretty much been all about the retail investor. That's because nearly all digital-currency trading occurs on decentralized cryptocurrency exchanges. As the Securities and Exchange Commission (SEC) has previously cautioned, this trading often can occur outside the confines of the United States, leaving the SEC with little recourse to recover funds should there be instances of fraud or wrongdoing. This concern, along with the unregulated nature of the virtual-currency marketplace and unreliable liquidity, didn't exactly incentivize institutional investors to make the leap into digital tokens.

But times have changed, the virtual-currency market has matured a bit, and institutional investors have had a means to bet on the crypto market in a more traditional sense over the past couple of months. By this, I mean that both the CME Group and CBOE Global Markets (NASDAQ: CBOE) have offered bitcoin futures on their trading platforms since December, providing a more traditional avenue for Wall Street to place its bets.

Now it appears the stage is set for Wall Street to meet Main Street in the cryptocurrency arena.

Here's how we know institutional activity is picking up in the cryptocurrency space

How do we know institutional investors are behind this latest resurgence? While nothing is concrete, there are three major clues that Wall Street is ready to get involved.

First, bitcoin futures contract trading volume has really begun to pick up. According to a report on April 28, daily bitcoin futures trading volume on the CBOE recently hit a 24-hour record of nearly 19,000 contracts traded. That's roughly three times the CBOE Global Markets' daily average for bitcoin futures, and it's pretty indicative that Wall Street is getting involved.

The thing to understand here is that these futures contracts require the buyer to cover one or five bitcoin per contract. With bitcoin valued at $9,800 per token, each contract runs $9,800 or $49,000, depending on the platform. That's often a bit pricy for retail investors, but well within the wheelhouse of institutional investors.

Secondly, popular cryptocurrency-exchange Coinbase announced in a letter last week that it was investing heavily in the tools needed to expand its capacity to execute trades. Since the third quarter of 2017, Coinbase has doubled the size of its full-time engineering staff, rewritten most of the platform's code, and increased its transaction capacity by 1,000%.

What's more, it expects to double its transaction capacity again within the months to come. Coinbase also noted in the letter that $150 billion in assets have been traded on its crypto platform. In short, it seems unlikely that Coinbase would make these investments in capacity expansion if the interest from institutional investors wasn't there.

The final piece of the puzzle also came last week when the New York Times reported that investment-banking giant Goldman Sachs (NYSE: GS) plans to set up a bitcoin trading operation. Initially, Goldman Sachs plans to use its money to trade in futures contracts linked to the price of bitcoin. However, if it can gain regulatory approval and minimize the risks associated with trading in bitcoin, Goldman Sachs might actually get involved with directly buying and selling the world's most popular cryptocurrency.

Before you get too excited...

Understand, though, that the entrance of Wall Street into the cryptocurrency space isn't necessarily a positive thing. Yes, it will improve liquidity and perhaps reduce the wildly volatile swings we've witnessed in virtual currencies at times. But having skeptical investment bankers enter the virtual-currency arena may also put pressure on a space that was once dominated by optimistic retail investors who often lacked the means to bet against -- i.e., short sell -- cryptocurrencies. Wall Street certainly has the funds -- and now may have the means -- to bet against cryptocurrencies in the near future.

I'd suggest avoiding virtual currencies, as has been my stance for some time.

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Sean Williams has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool owns shares of and recommends CME Group, but has no position in any cryptocurrencies mentioned. The Motley Fool recommends Cboe Global Markets. The Motley Fool has a disclosure policy.