Initial cryptocurrency offerings (ICO) have been used by a lot of startup firms to raise capital. They have been successful, and they have failed. One that has been interesting for WLV to watch is Ripple. Their token is pretty transparent in how it is traded and the amount of liquidity available. Currently, the value of Ripple’s token in aggregate is $18.83 Billion.
When I first started examining cryptocurrency, I thought that instead of equity, firms might issue crypto for strategic reasons. I hypothesized that GE could issue a token which was part of the overall strategy for the firm.
Accounting for crypto is similar to straight equity. You raise the value of one side of the balance sheet and increase the current asset account on the other. As the value of the crypto fluctuates, you could account for it in the notes to financial statements. But, because the company the transaction at the first value, it doesn’t matter if the crypto goes up or down in value unless the company holds a lot of it.
I don’t think the value of the crypto is the true economic value of the company. It will change the accounting value.
I want to illustrate that in an idea that has been ruminating in my mind. I am very familiar with CME’s business having been a part of a group that took the company from a $182 million enterprise with only $5M in the bank to a multi-billion dollar company. CME is worth $41 billion in enterprise value today. Back in 1999 if it doesn’t radically change its business it’s probably out of business.
Strategically, I think issuing a CME cryptocurrency is a good idea and pairs well with what the company is trying to do.
Here are some structural issues that still sit inside CME.
- Trading rights. Each one of the exchanges under the CME Group umbrella has a trading right or many trading rights associated with it (NYMEX, COMEX, CBOT, CME)
- In order to trade at an exchange for lower fees, a trader has to lease or buy trading rights at that exchange. They are restricted by division, contract or exchange.
- To clear CME, you have to hold several combinations of trading rights depending on the business you want to do.
- Fee schedules are archaic and hard to understand
- Memberships are arduous to trade and lease.
- Trading rights used to be able to be used for margin, not anymore.
- CME management wanted to eliminate B share members from its corporate board
Another wrinkle. CME is being sued by some B shareholders that could become a class action lawsuit. Whether the suit has merit or not isn’t my concern. It’s a fact of life and it’s a risk, albeit a small one.
If we examine broader trends in the world, one that is very strong is the unbundling of everything. Big centralized vertical silos are being unbundled by startups. Big businesses are being built off that unbundling. Another trend is that decentralized networks beat centralization.
A quick look at CME’s business shows that the HFT firms it relies on for the bulk of its trading volume are consolidating. That’s a danger. Another sign of the health of the breadth of the business is trading permit values and lease values. Both of these have dropped by large percentages over the past few years, although recently some have ticked higher. The bid/ask spread on seats is wider than it used to be because there is a lack of liquidity and transparency. Trading permits themselves could be considered a centralized vertical silo.
However, there is unlocked value in the trading permits just like there was in the old mutualized membership model.
What if CME were to convert the trading permits to an ICO?
There are numerous benefits. First and foremost, they could list the ICO on Globex attracting a new cadre of traders to their platform. CME would recognize some clearing revenue from the ICO and from the continuous trade.
Bid/Ask spreads should get tighter since it’s a lot easier to make a market electronically on a cryptonized token than it is a cumbersome seat. An ICO should attract more traders internationally to CME and could be a strategic part of setting up a decentralized international network.
The aforementioned lawsuit would evaporate.
CME could get rid of its membership department, and its leasing structure saving costs benefitting shareholders. It could also revamp its fee structure and requirements for clearing. Instead, it could designate how many tokens an account has to hold in order to get the lower costs on fees. Doing that should spur new volume as it is easier for new traders to enter markets at cheaper costs.
Potentially with the issue of cryptocurrency, CME could eliminate B shareholders from its board since the B share would cease to exist. It would also eliminate conflicts between exchanges it has bought. A trader would just be a trader instead of segmented by an old mainline exchange. That should be comfort to equity shareholders.
It also brings CME into the 21st Century at the bleeding edge of cryptocurrency. In the 1970s, the beginning of financial futures unleashed a storm of creativity and innovation at CME. The introduction of an ICO for trading permits might do the same thing for corporate culture again.
From a trading permit holder perspective, an ICO with paired with the right corporate strategic vision will unbundle and unlock value locked into the trading right. For example, say I am a Lean Hog trader only. Why do I need a B-1 trading right that gives me the lowest fees on every CME listed contract when I only want the lowest fees for one CME contract?
Instead of a multi-tiered pricing structure, CME could streamline fee schedules based on how many cryptocurrency tokens an account held. It could also adjust based on where the exchange wanted to incentivize increased trade. Even within contracts like the Eurodollars that have lots of permutations and combinations, it could segment the market to increase volume and participation.
CME might be able to eliminate all the conflicts of interest between clearing firms, hedge funds, prop traders, CTAs, IBs and independent traders.
CME would hold a bunch of its own crypto on its balance sheet thereby eliminating any fear about market manipulation. Because it’s a transparent ledger, everyone would know who owns what and how many.
Ask yourself this question. If Ripple’s cryptocurrency is worth $18B, what would a cryptocurrency issued by CME be worth? To give you some idea based on the last trades CME B share rights are worth in aggregate about $566M. They aren’t reflected on CME’s balance sheet. An issuance of cryptocurrency would be reflected on the balance sheet or at least in the notes to financial statements. You’d need to add the other exchanges trading rights to CME’s number to find out the starting point for an ICO. They might be worth as much or more than the current enterprise is worth.
That’s how an old mainline business could use an ICO to revamp its core strategy and business model.