The crypto sector is seeing an increase in M&A

In the past year, banking powerhouses began providing financial support to innovative companies in the crypto sector looking for fundraising and consolidation, overcoming their initial skepticism of a volatile and mostly unregulated industry. The total value of crypto M&A deals in 2021 grew over 50 times the 2020 total, with each of the top 10 deals valued at over $1 billion, according to a PwC report. The average size of M&A deals more than tripled to $179.7 million in 2021 from the previous year, while the total value of crypto fundraising deals rose by 645%. The report also states that the momentum will continue in 2022.

“The increased demand we are seeing coming from our clients shows that institutional investors are becoming more and more interested in entering the digital asset market,” Drew Forman, head of Cowen Digital, told Global Finance.

Blockchain lawyers guide firms through a regulatory maze. “Digital assets are unlike debt or equity and therefore represent a new frontier when it comes to devising financing structures and valuations,” says Timothy Spangler, partner at law firm Dechert. “Lawyers working on these transactions today must anticipate what positions regulators and courts will take in the coming years.”

LOAN SUPPORT

Lending to crypto companies is the next step for traditional financial institutions that already offer custody and management of digital assets. This was unthinkable just a few years ago when decentralized finance (DeFi) and traditional finance had fixed boundaries.

In March, New York-based financial firm Cowen launched a digital asset division to offer trading and custody solutions for institutional investors. The company said it took 15 months to build the fully integrated, institutional-grade platform. Cowen Digital says it plans to offer lending options this year. “There is a growing recognition that digital assets are here to stay, and that institutional clients want safe exposure to them,” says Forman. “During 2022, we plan to offer lending opportunities and also aim to launch swaps and derivatives.” Cowen also intends to roll out algorithmic technology and plans to expand in the US, Europe and Asia.

After launching its bitcoin desk last year, Goldman Sachs in March became the first major investment bank to carry out an over-the-counter cryptocurrency trade. The bank says it recently extended a secured lending facility where it lent fiat backed by bitcoin owned by the borrower.

“What was interesting to us was the structure and 24-7-365 risk management,” says a Goldman spokesperson.

The security issue

Traditional financial institutions with institutional platforms claim an advantage over DeFi borrowers in terms of financial risk. “In the past, the challenges for regulated firms have always been around making sure that there is robust custody and that they can access this new asset class in the same secure and seamless way that they would access any other asset,” says Cowen Digital’s Forman .

However, security remains a concern due to the volatile nature of cryptoassets, as seen with the selloff that followed the collapse of the TerraUSD stablecoin and its twin coin Luna in May.

“Recent falls in crypto asset prices will cause many to approach this with caution and place high collateral requirements,” said John Garvey, head of PwC Global Financial Services. Traditional players will monitor any high-profile liquidations and margin calls from borrowers who took out loans during the bull market and face a downgrade in the value of their collateral, he explained. “For some, this may also be a time to build and refine models and security levels, so when market conditions turn, they are prepared and stronger than ever,” he adds.

In its latest annual economic report, the Bank of International Settlements (BIS) warns of the “deeper structural limitations” of crypto and DeFI “that prevent them from achieving the levels of efficiency, stability and integrity required for an adequate monetary system.”

Barriers to regulation

Dealmaking will shift to geographies where regulation is more advanced and friendlier than the United States, experts say. The US has been a catalyst for crypto M&A deals, accounting for 51% of transaction volume in 2021, up from 41% the year before, PwC shows. However, Europe, the Middle East and Africa recorded the highest M&A deal value last year, helped by SPACs including the $8.1 billion Bullish deal.

“I know for sure that very big investors, some of the biggest family offices, have invested in the US, in bitcoin and bitcoin mining, and have started to push the regulators to leave them alone,” says Ralf Kubli, a Swiss. -based manager specializing in blockchain, cryptocurrency and decentralized technology.

Kubli seems convinced that there will be more clarity in future regulation globally. “The problem in the US is that you get clarity through litigation,” he says. Countries like Switzerland attract the parents of crypto exchanges like FTX, which opened its European headquarters there.

“We are seeing a number of jurisdictions establishing specialized regulatory regimes with the aim of providing better regulation but also attracting internationally mobile crypto businesses,” says Garvey. The market players are actively establishing a locally regulated presence in the markets where they expect to gain larger customers, such as the USA, parts of Europe and Japan. “We expect this trend to continue with more and more locally regulated entities being established,” he adds.

The risk factor

New money is pouring into crypto and blockchain deals from traditional and crypto-focused venture capitalists and funds, which combined became the largest source (38%) of M&A activity in 2021, according to PwC.

Kubli warned that there could be a problem of overvaluations as venture capital and funds have to use large amounts of cash. Last year, the average size of the top 10 M&A deals in the crypto industry was $3.3 billion, over nine times larger than Binance’s $400 million. the acquisition of CoinMarketCap in 2020, according to PwC. “The reason there is so much chaos and so much risk in finance is because the cash flows of these financial instruments are not properly defined and standardized,” said Kubli, a board member of the Casper Association, which oversees the Casper Network, a modular blockchain designed for to issue and manage crypto-based financial solutions.

Kubli believes that the digitization of traditional finance requires standardized, digital, algorithmic financial contracts that define the cash flows between the parties. Without such contracts, it will not work: “We are building capital markets the right way, from the ground up again.”