When the top Japanese cryptocurrency exchange bitFlyer expanded to the United States last November, its timing could hardly have been better. Led by bitcoin, digital assets were enjoying a historic bull run.

Almost immediately, despite bitcoin initially being the only asset available to buy and sell, trading volumes on bitFlyer's U.S. exchange shot up to more than $1 million a day.

BitFlyer, which in early 2018 expanded to Europe as well, has caught a wave partly of its own making. Between $20 billion and $30 billion worth of digital assets now routinely change hands every day, and sometimes as much as twice that amount, an exponential increase from this time last year. In February 2017, daily trading volumes across all exchanges were often less than $150 million, according to CoinMarketCap.

In part, the surge can be explained by the inflated values of some digital assets. Another reason is the influx of capital not only from new retail investors — including Japan's much-ballyhooed metaphorical Mrs. Watanabe — but from institutional clients bitFlyer actively seeks to attract.

Attracting institutional capital means accepting government regulation, however. Gradually, some digital-currency businesses are learning to play by the rules in order to get ahead. As other burgeoning industries have done before them, the exchanges are now allowing for checks and controls to develop that banks and other institutions need to normalize digital assets and currencies.

What distinguishes bitFlyer and a few other exchanges, such as Coinbase's GDAX, from the cowboy operations that used to dominate the industry is that rather than trying to duck regulations, they are embracing compliance as a way to establish themselves as front-runners.

"We believe regulation is fundamental to the future of virtual currencies," said Andy Bryant, chief operations officer of bitFlyer Europe.

He is gambling that more compliant firms will be able to draw more clients and dominate the marketplace. The prize for being the best at making hedge funds, investment banks and other regulated institutions feel comfortable in this new market could be huge. More than 100 hedge funds launched in 2017 to trade cryptocurrencies, and insiders say that existing funds are also dabbling in digital assets, drawn by the outrageous volatility and price increases that characterize the asset class. Investment banks and other institutions are waiting in the wings.

Widening the funnel for institutions

One company that has seen the groundswell of interest firsthand is Trading Technologies, which provides high-performance professional trading software and counts 19 of the world's 20 largest banks among its customers. So-called proprietary trading firms, which trade for their own account rather than on behalf of clients, were the first to approach.

"They rang us up and said, 'Why don't you have a crypto solution?' The hedge funds were not far behind," said Michael Kraines, chief financial officer and chief commercial officer of Trading Technologies. "There's a ton of demand."

To unlock that demand, Trading Technologies is partnering with Coinbase to give Trading Technologies customers access to GDAX, a sophisticated platform designed with serious traders and institutional clients in mind. In March, when the integration goes live, thousands of traders will be able to buy and sell crypto-assets on GDAX through the same interface they use to trade futures and commodities.

Michael Kraines, chief financial officer and chief commercial officer of Trading Technologies
Professional trading software firm Trading Technologies is partnering with Coinbase to give customers access to GDAX, said Michael Kraines, Trading's chief financial officer and chief commercial officer.


By widening the funnel for institutions, the partnership could unleash "huge positive benefits in terms of the market's liquidity," Kraines said. "We think it's a seismic shift."

Trading Technologies chose GDAX not only because it is the largest digital-asset spot market in the United States but because of Coinbase's record of compliance. Exchanges like GDAX are regulated not by the Securities and Exchange Commission — bitcoin is a commodity, not a security — but by a patchwork of state regulatory regimes that require companies to be licensed as money transmitters. Coinbase is licensed to serve customers in more than 30 states, including New York, which has adopted more stringent requirements for bitcoin companies than any other state. Coinbase recently sent paperwork to high-volume traders notifying them of their tax obligations, the first time it has done so.

That stance matches the needs of big banks and other firms under heavy scrutiny. "We're focused on serving the needs of institutional clients," said Adam White, GDAX's general manager.

So is bitFlyer, which is already licensed to serve customers in 43 U.S. states and the District of Columbia. It was the first foreign company to obtain a BitLicense to operate in New York.

The company's ambitions called for an "aggressive approach" to licensing, said Hailey Lennon, bitFlyer USA's director of compliance. "Big picture, bitFlyer aims to be a global exchange and allow cross-border trading. This means our various entities' compliance programs need to reflect evolving regulatory requirements both locally and abroad."

BitFlyer has over one million verified accounts globally. By late January, the company was handling $50 billion in monthly trading volume worldwide. That type of money is what has drawn finance types to the cryptocurrency market like sharks to blood.

"Of course banks are going to be prudent, but capital speaks very loudly on Wall Street," said Kraines. "I think you're going to see by the end of this year a very different posture."

Compliance provides 'competitive advantage'

Not all of the new money is coming in through regulated exchanges. Binance, an exchange based in Hong Kong, is open to Americans and doesn't require them to verify their identities unless they want to move large amounts of money. Forbes recently named Binance's CEO Changpeng Zhao to its inaugural list of the richest people in cryptocurrency, pegging his net worth at some $2 billion.

While such exchanges may always exist, they may soon be the exception rather than the rule. In all kinds of industries, incumbents learn to accept or even favor stringent regulations in part because they present barriers to entry for would-be competitors.

The telecommunications and entertainment industries in their early days were "highly scrappy, highly decentralized," said Richie Hecker, chairman and chief economist of Crypto Working Group, a standards organization for digital assets. But over time they began to see the value in complying with regulations. "They want to protect what they have, and regulation done well is a competitive advantage."

Adam White, GDAX's general manager
"We're focused on serving the needs of institutional clients," said Adam White, GDAX's general manager.

Like bitFlyer, GDAX has global ambitions. While Coinbase is headquartered in San Francisco, as befitting its roots as a tech startup, the company is set to open a New York office this spring — a "center of gravity" that will grow with time. "We have plans to expand to Asia, Latin America, the rest of the world," White said.

When institutional traders use Trading Technologies software to access GDAX, Coinbase will take custody of their assets, just as it does for its users today. That could give a shot in the arm to its custody business, announced last November, which safeguards client assets of $10 million or more in exchange for a $100,000 setup fee and a management fee of 10 basis points per month.

But has the recent bloodbath in the cryptocurrency market scared banks, sovereign wealth funds and other deep-pocketed institutions away from digital assets? It seems unlikely, since their extreme volatility is part of what makes them attractive to so-called "whales" in the first place.

"Markets adapt much faster these days," AngelList CEO Naval Ravikant, who is known for his crypto advocacy, tweeted on Feb. 5, during the worst of the recent sell-off. "Crypto went from the 'Netscape Moment' to the 'Dotcom Bubble' to the 'Crash of 2000' in months."

Implicit in his words is what followed the dot-com bust: a thriving industry of robust and battle-tested companies, from Amazon to Google. Ravikant and other die-hards think crypto crashes will lead to the same thing.

But just as the internet has become more regulated the more that online businesses — and their users' actions — have real-world impacts (think Facebook and the 2016 presidential election), so crypto entrepreneurs may have to accept more guardrails as their enterprises grow.

"Our belief is the entire industry will get much more regulated over the next 12 months," Hecker said. "The question is which side, as an exchange, are you going to be on. Are you going to be on the side of the regulators, or are you going to try to fight them?"

Regulators taking a 'sensitive approach'

A hearing on cryptocurrency held earlier this month by the Senate Committee on Banking, Housing, and Urban Affairs gave a preview of what entrepreneurs might be up against. In their testimony, the respective heads of the Commodity Futures Trading Commission and the SEC both evinced respect for blockchain technology while affirming their desire to regulate cryptocurrencies and their derivatives however they could.

CFTC Chairman J. Christopher Giancarlo asked senators to cast their minds back to a more innocent time: the summer of 2017. Many people, he said, then had the impression that bitcoin and other digital currencies were "off the regulatory grid," which made them highly attractive. Since then, the CFTC and the SEC had been working to disabuse people of that notion — and as that reality has sunk in, "you're starting to see that reflected in the price."

It isn't every day a top regulator openly admits that regulatory action caused a market crash. But the CFTC isn't looking to be a spoiler. As it did with the early internet, the federal government should adopt a "do no harm" approach to distributed ledger technology, Giancarlo said. And while cryptocurrencies may deserve stricter scrutiny, he said, the CFTC has less authority over platforms "conducting cash or 'spot' transactions in virtual currencies, or over participants on those platforms" — that is, the majority of cryptocurrency exchanges and users — than it does over derivatives exchanges.

For traders previously worried their money tree was about to be chopped down, such testimony was a godsend.

"The regulatory groups are taking an especially sensitive approach to crypto," said Alex Waters, co-founder and head of technical research at the blockchain consultancy ELM Labs. "There is a lot of pressure to get it right — as crypto could impact our society at the scale of mobile phones or the internet and World Wide Web."

The prices of bitcoin and other major cryptocurrencies rose during and after the Senate hearing, reflecting the widespread sense that it brought the asset class one step closer to mainstream adoption, even if legal strategies around token issuance may have to shift.

"It is in a sense the industry growing up and finding ways to meet the Main Street and Wall Street demand that exists," Waters said.

One possible consequence concerns how companies like Coinbase will need to handle — or avoid handling — digital tokens the SEC may consider to be securities. Last fall, Coinbase CEO Brian Armstrong said he planned to expand the list of tokens on GDAX beyond the big three of bitcoin, ether and litecoin. But the sudden addition of Bitcoin Cash in December was such a fiasco — leading the company temporarily to halt trading and sparking outrage on social media — that it appears to have halted his plans for now.

The SEC chairman indicated that while bitcoin and some of its rivals could be considered "true cryptocurrencies" — and thus fell outside the SEC's jurisdiction — most of the newfangled tokens met the definition of securities. That could complicate any plans Coinbase might have to allow average people to buy and sell such assets.

In the cryptocurrency industry, such curveballs are to be expected. Things move so fast, Bryant said, that "you make a business plan and then two weeks later you need to tear it up."