The NYSE's Owner Wants to Bring Bitcoin to Your 401(k). Are Crypto Credit Cards Next?

The NYSE's Owner Wants to Bring Bitcoin to Your 401(k). Are Crypto Credit Cards Next?
Backed by Microsoft and Starbucks, Intercontinental Exchange is launching a startup called Bakkt to make the cryptocurrency safe for your retirement fund, and maybe for retail, too.
By Shawn Tully
8:31 AM EDT
Bitcoin could be on the verge of breaking through as a mainstream currency. At least that’s the goal of a startup that is soon to be launched by one of the most powerful players on Wall Street, with backing from some of America’s leading companies.

This morning the Intercontinental Exchange—the trading colossus that owns the New York Stock Exchange and other global marketplaces—announced that it is forming a new company called Bakkt. The new venture, which is expected to launch in November, will offer a federally regulated market for Bitcoin. With the creation of Bakkt, ICE aims to transform Bitcoin into a trusted global currency with broad usage.

To achieve that vision, ICE is partnering with heavyweights from the worlds of technology, consulting, and retail: Microsoft, Boston Consulting Group, and Starbucks. ICE did not immediately disclose the total investment of the investment partners, a group which also includes Fortress Investment Group, Eagle Seven, and Susquehanna International Group—or the ownership stakes.

The founding imperative for Bakkt will be to make Bitcoin a sound and secure offering for key constituents that now mostly shun it—the world’s big financial institutions. The goal is to clear the way for major money managers to offer Bitcoin mutual funds, pension funds, and ETFs, as highly regulated, mainstream investments.

The next step after that could be using Bitcoin to replace your credit card.

“Bakkt is designed to serve as a scalable on-ramp for institutional, merchant, and consumer participation in digital assets by promoting greater efficiency, security, and utility,” said Kelly Loeffler, ICE’s head of digital assets, who will serve as CEO of Bakkt, in the press release announcing the launch. “We are collaborating to build an open platform that helps unlock the transformative potential of digital assets across global markets and commerce.”

In an exclusive interview, Loeffler (pronounced “Leffler”) told Fortune that ICE and its partners have been “building the factory” that will power Bakkt in the strictest secrecy for the past 14 months. The name of the company was only decided in the past two weeks. Loeffler explains that “Bakkt” is a play on “backed,” as in “asset-backed securities,” and it’s meant to evoke a highly-trusted investment.

If the Bakkt blueprint works as planned, a panoply of new Bitcoin funds would tap the pent-up demand for the cryptocurrency, making it a safe and easy choice for everyday investors—notably millennials getting their first 401(k)s. Wall Street could then tap Bitcoin’s popularity as an alternative to stocks and bonds to generate giant trading volumes. And that flood of institutional buying and selling, in turn, would take the terror out of Bitcoin by smoothing its wild swings in price.

The volatility of the cryptocurrency has both attracted individual speculators and scared off institutional money. In the fall of 2017, the price of Bitcoin spiked from $6,400 to nearly $20,000; it has since fallen back to around $7,700.

Cracking the 401(k) and IRA market for cryptocurrency would be a huge win for Bakkt. But the startup’s plans raise the prospect of an even more ambitious goal: Using Bitcoin to streamline and disrupt the world of retail payments by moving consumers from swiping credit cards to scanning their Bitcoin apps. The market opportunity is gigantic: Consumers worldwide are paying lofty credit card or online-shopping fees on $25 trillion a year in annual purchases.

Bakkt’s founders tell Fortune that the institutional investor campaign is the first of two phases. They’re a little coy about the second phase. But the presence of Starbucks and Microsoft strongly suggests that Bakkt will strive to revolutionize the way consumers pay at the mall and online. The coffee giant is already a leading player in encouraging customers to pay with the their smartphones rather than their credit cards. And Microsoft, through its Azure cloud business, serves a huge base of retailers, handling back-office tasks from invoice processing to e-commerce.

“As the flagship retailer, Starbucks will play a pivotal role in developing practical, trusted, and regulated applications for consumers to convert their digital assets into U.S. dollars for use at Starbucks,” said Maria Smith, vice president, Partnerships and Payments for Starbucks, in the press release.

Bakkt is the brainchild of Jeff Sprecher, the founder, chairman, and CEO of ICE, and a disrupter par excellence. Sprecher (pronounced “Sprecker”) stands alone as the leading force in modernizing the world’s exchanges in recent years from open-outcry pits into super-efficient electronic marketplaces. Along the way, Sprecher built a flailing electricity exchange that he reportedly purchased for $1 into a global trading and data empire now worth $44 billion. “In 25 years he’s gone from nothing to the most powerful exchange entrepreneur in the world,” says Larry Tabb, chief of consultancy the Tabb Group. “He hasn’t failed yet.”

People walk outside the Microsoft store on Fifth Avenue in New York City on April 26, 2018 in New York.
People walk outside the Microsoft store on Fifth Avenue in New York City on April 26, 2018 in New York. Kena Betancur—VIEWpress/Corbis/Getty Images
Today ICE is the world’s second largest owner of financial exchanges by revenue behind the CME, and one of the largest purveyors of market data. ICE’s 2017 revenues of $4.6 billion divide pretty evenly between those two main franchises. ICE owns twelve exchanges, served by six clearing houses. And to the delight of shareholders, Sprecher has delivered profitability as much as growth. Since going public in 2006, ICE has delivered annual total returns of 24.1%. The company’s towering 54% margin of net profits ranked fourth in the S&P 500 last year.

Even in the heavily-fragmented galaxy of stock and bond trading, ICE has established a Brobdingnagian footprint. The NYSE is by far world’s largest stock market, trading 1.5 billion shares a day—or nearly one-in-four of all equity transactions. ICE also owns NYSE American, the leading platform for mid-cap companies, as well as Arca, the world’s largest marketplace for ETFs. ICE is the world leader in almost all categories of futures for “soft” agricultural commodities such as sugar, coffee, and cotton, chiefly through its 2007 acquisition of the New York Board of Trade. And ICE Futures Europe is the dominant global marketplace for the Brent crude, the global oil price benchmark.

Now Sprecher, the visionary who assembled this empire, is crusading to make Wall Street asset managers and Main Street consumers love Bitcoin.

Sprecher and his investment partners are putting this one-of-a-kind mission in the hands of a first-time CEO who’s Sprecher’s soulmate in both business and in life: Kelly Loeffler. The ICE executive has ridden shotgun alongside Sprecher since the company’s fledgling days in 2002. In 2004, they married. Loeffler long ran marketing, investor relations, and communications for ICE. Now she’s giving up her ICE roles to run Bakkt.

Over the past two months, Sprecher and Loeffler sat for several hours of exclusive interviews with Fortune. Above all, they emphasized how Bakkt, in part by exploiting ICE’s trading infrastructure, could provide precisely the tools Bitcoin needs to achieve broad acceptance.

At a recent meeting with the couple in the plush Bond Room at the NYSE, Sprecher stressed that Loeffler has been a collaborator in charting ICE’s next big move. “Kelly and I brainstormed for five years to find a strategy for digital currencies,” says Sprecher.

At first glance, the pair present an unusual twosome: At over six-feet in her high heels, Loeffler, 47, stands much taller than her 63-year old husband. But their bond is quickly apparent—a passion for gig ideas that need lots of tinkering to succeed. “I’m an engineer who likes to fix things that are broken,” says Sprecher, who repairs his vintage Porsche racecars on weekends. “And Bitcoin was the epitome of a broken model that if fixed, could change the world.”

Adds Loeffler, “Jeff and I get excited about big things that for most people, seem to have no answer.”

If they succeed with Bakkt, it could be the biggest development in the churning, hazardous frontier of cryptocurrencies since a mysterious programmer (or programmers) under the pseudonym Satoshi Nakamoto unveiled Bitcoin in 2009.

---

Sprecher’s plan for bringing crypto to the masses runs contrary to what Bitcoin supporters typically champion. The purists favor Bitcoin’s “distributed” architecture, and adamantly oppose putting a big exchange at the center of the both the Bitcoin investment and payments systems. “A regulated exchange with a custodian in the middle contradicts the basic idea of Bitcoin,” says Abhishek Punia, a crypto-currency analyst with venture capital firm Draper Associates. “Bitcoin was designed to be decentralized, without intermediaries taking fees. A regulated exchange may be popular for a short period of time, but it’s not the future. The future will be the original idea of a peer-to-peer network.”

Sprecher and Loeffler disagree, arguing that a strong central infrastructure is precisely what’s needed, and that ICE and its partners are the ones to supply it. The challenge is getting the banks, asset managers, and endowments to embrace Bitcoin. “Being from the exchange world, we looked at the problem differently,” says Loeffler.

The big institutions are ICE’s main customers, and Sprecher and Loeffler understood their thinking about crypto-currencies. They reckoned that Bitcoin could thrive as a mainstream investment because the big money managers recognize that ten of millions of their current and future investors want to own it––if it can be packaged as mutual funds and ETFs. “The institutions saw that Bitcoin had lots of appeal as a store of value like gold or silver,” says Loeffler.

To study how digital currencies work, ICE in early 2015 took a minority stake in the largest U.S.-based marketplace for digital currencies, Coinbase. “Coinbase has twice as many customers as Charles Schwab,” says Loeffler. “Many of the people who have opened accounts on Coinbase are millennials who use it to make small investments in crypto-currencies.”

Adds Sprecher: “Millennials don’t trust traditional financial institutions. To gain their trust, banks, brokerages, and asset managers can use a currency that millennials believe in, like Bitcoin. Using digital currencies brings a lot of sizzle.”

So far, cryptocurrencies have gained little traction with asset managers like Fidelity and Vanguard. The reason, says Sprecher, is that “Bitcoin does not have a good market structure.” For consumers, it’s expensive to exchange dollars for Bitcoin, in part because trading is spread thinly across too many venues that individually do too little trading. He notes that more than 200 marketplaces trade over a dozen major digital currencies, from ether to Ripple to Litecoin. “Even for Bitcoin, different markets are posting lots of different prices,” says Sprecher. “And you can pay an up to 6% spread to exchange dollars for Bitcoin, meaning Bitcoin needs to rise by as much 6% before you break even.”

Cryptocurrencies today serve primarily as a vehicle for speculation by daredevil traders, and by the hedge funds that own 80% of the roughly $300 billion in digital currencies worldwide. (Bitcoin is by far the biggest cryptocurrency for now, with a recent total value of around $134 billion.) The combination of rampant betting and relatively arid liquidity sent Bitcoin careening through four bear markets in the decade since its creation. “The result is a crisis of confidence,” says Loeffler.

In addition, the freewheeling Bitcoin ethos clashes with the ultra-cautious, post-financial crisis mindset on Wall Street that emphasizes safeguarding the investor at all costs. “People at the big institutions have the view that cryptocurrencies can be unsavory actors procured by elicit means,” says Loeffler.

Not to mention that some on Wall Street still view cryptocurrencies as being run by “kids” whose motivation can be summarized as, “Let’s screw the banks and do it all ourselves.”

But Sprecher and Loeffler concluded that fragmented marketplaces and alien culture weren’t the real reasons the institutions avoided Bitcoin. In their view, a broad universe of fans wanted to invest in Bitcoin or other digital tokens, but couldn’t find the right products. The solution: A new ecosystem that provided Bitcoin the same protections afforded the stocks, bonds, and commodities futures traded on ICE’s exchanges. That would open an investor universe far beyond a relatively small group of retail customers and adventurous hedge funds.

So why aren’t the Vanguards and Blackrocks taking a “serve them and they shall come” approach? For Sprecher and Loeffler, the reason is fundamental—and fixable. “Two things are missing,” says Sprecher. “Trading on an official exchange, and safe storage for digital currencies on an institutional scale.”

Put simply, Sprecher says, the big money managers won’t create digital currency funds unless they can first buy the tokens on a federally regulated exchange, and, second, store the tokens for their investors in accounts rendered super-secure by the safeguards provided by those exchanges.

Today, the tokens for cryptocurrencies such as Bitcoin and Ether aren’t traded at all on the major futures or securities exchanges. Official exchanges are overseen by the Commodities Futures Trading Commission (CFTC) for futures, and the Securities and Exchange Commission (SEC) for securities. The venues where folks exchange dollars or Euros for digital currencies—including the biggest ones such as Coinbase and Gemini—are often called “exchanges,” but they’re actually marketplaces that are licensed under state laws.

These platforms fall under three main regulatory regimes: First, Coinbase and many other marketplaces are licensed in the individual states as “money transmitters.” Second, Gemini, the platform founded by Cameron and Tyler Winklevoss, is licensed in its home state of New York as trust company, and that designation is its passport to operate in a number of other states. The third category are markets called SEFs; more on them in a bit.

Jeffrey Sprecher, chairman and CEO of Intercontinental Exchange, with his wife Kelly Loeffler, the chief communications and marketing officer of ICE, at the company's headquarters in Atlanta on July 27, 2018.
Jeffrey Sprecher, chairman and CEO of Intercontinental Exchange, with his wife Kelly Loeffler, the chief communications and marketing officer of ICE, at the company's headquarters in Atlanta on July 27, 2018. Gillian Laub for Fortune
The reason why these trading platforms aren’t governed by either of the two federal watchdogs—the SEC or the CFTC—relates to how the two bodies classify cryptocurrencies. The SEC, which oversees stocks, bonds, and other securities, has said that the two biggest cryptocurrencies, Bitcoin and Ether, are not securities. The SEC is taking a wait-and-see approach to the others. So far, none of the current marketplaces have secured the SEC imprimatur as regulated securities exchanges for digital tokens.

While Bitcoin isn’t considered a security, it is deemed to be a commodity. It’s the job of the CFTC to regulate commodity futures and options on those futures—a vast portfolio comprising contracts for everything from crude oil to soybeans to gold. As it is a commodity, Bitcoin futures could only trade on a CFTC-regulated futures exchange, called a Designated Contract Market. (Similar to other currency trading marketplaces, a venue that simply exchanges dollars or Euros for Bitcoin on a “spot” basis do not need to be regulated by the CFTC.)

Today, the Chicago Board Options Exchange and Chicago Mercantile Exchange both trade futures contracts on Bitcoin. The contracts aren’t settled by delivering the actual coins. They’re settled in cash based on the movement of the price of Bitcoin. So in effect, they’re a vehicle for betting on the future price of the cryptocurrency.

Bitcoin’s designation as a commodity opens a rich opportunity for ICE: It now operates the two of the largest commodities futures exchanges on the planet—ICE Futures U.S., and ICE Futures Europe. For Sprecher and Loeffler, these venues provide exactly the type of protections needed to, as Loeffler puts it, “get the institutional engine running.”

It’s important to understand that the major exchanges regulated by the SEC or CFTC provide a broad package of three heavily-regulated services: trading, clearing, and either safe storage in the form of custody (for securities), or “warehouses” (for futures). On trades, the exchange ensures that the posted price the money manager clicks on is what they pay for a stock or futures contract. But the exchanges also set exacting rules for clearing and custody or warehousing. And those rules must be approved, and are overseen, by the SEC or CFTC

The federally-regulated exchanges require clearing services that effectively remove credit risk for both the buyer and seller. The clearing house guarantees that the seller will deliver the sugar, coffee, or gold as agreed under a futures contract, and that the buyer will make the full payment. If either fails to perform, it’s the clearing house––which is jointly funded by the trading firms that are members of the exchange and its owner, in this case ICE––that makes good on the delivery or the cash. As for safe storage, it comes in two flavors: custody for stocks and bonds, and warehousing for futures. SEC-regulated exchanges like the NYSE require that a mutual fund or pension fund hold their stock or bond certificates in super-safe accounts at such independent custody houses as State Street or BNY Mellon.

For futures, ICE and the other CFTC-regulated exchanges mandate that the coffee, gold, or silver that a party has agreed to purchase be stored in a licensed warehouse or other storage facility when the contract expires and the commodity is due for delivery. In effect, the buyer, whether a money manager like Vanguard or a user such as Cargill, can “pick up” the gold bars or bales of cotton at the warehouse. If the items aren’t there for pickup, or if the seller doesn’t pay, once again, it’s the clearing house that covers the losses.

Bakkt would provide the first fully-integrated package combining a major federally-regulated exchange, as well as the clearing and storage overseen by the exchange. ICE owns six clearing houses that are vertically-integrated with ICE Futures U.S. and its other exchanges. By utilizing a CFTC regulated futures exchange for cryptocurrencies, Bakkt would provide two main layers of security that money managers regard as absolutely essential. The first is purchasing a security or commodity—in this case a digital token—through a regulated broker-dealer that’s a member of the ICE futures exchange.

The exchanges stipulate that depositors submit passports, articles of incorporation, and identify the source of funds used to purchase the assets. They also search for patterns of illegal activity. If one investor is, say, repeatedly losing money on oil trades to the same counter-party, those trades would raise a red flag, because the “loser” could be laundering money and getting kickbacks from the buyer.

Only broker-dealers and futures commission merchants (FCMs) that are fully vetted by the regulated exchanges are allowed to trade on those venues as “members” of the ICE Futures U.S. On SEC and CFTC regulated exchanges, the exchange-approved members are trading with one another, on behalf of money managers that they, in turn, have fully vetted. Granted the same protections, investors could be absolutely sure they’re not buying Bitcoin from warlords who hacked a hedge fund to pilfer the tokens.

The second essential is furnishing regulated storage for digital currencies. “A qualified warehouse is the difference between institutional investors’ getting in or staying out,” says Loeffler.

Bakkt’s approach is furnishing what amounts to super-safe lockboxes resembling the vaults that hold gold bars for investors. The warehouses serving futures exchanges provide two main services. First, they ensure that assets can’t be stolen. In Bitcoin’s case, that would mean safeguarding the tokens in digital lock-boxes protected by multiple layers of cyber-security. Second, the policies and procedures followed by the exchanges verify the identities of the investors whose assets are held in the warehouses, guaranteeing that that the gold or oil stored for delivery wasn’t obtained illegally.

Bakkt plans to offer a full package combining a major CFTC-regulated exchange with CFTC-regulated clearing and custody, pending the approval from the commission and other regulators. Bakkt will provide access to a new Bitcoin trading platform on the ICE Futures U.S. exchange. And it will also offer full warehousing services, a business that ICE doesn’t have. “Bakkt’s revenue will come from two sources,” says Loeffler, “the trading fees on the ICE Futures U.S. exchange, and warehouse fees paid by the customers that buy Bitcoin and store with Bakkt.”

Bakkt will provide the biggest marketplace to date. But it won’t be the first or only CFTC-regulated platform trading Bitcoin tokens. The Dodd-Frank legislation created marketplaces called Swap Execution Facilities, or SEFs, that are overseen by the CFTC. (This is the third category of markets we mentioned earlier.) LedgerX, for example, owns a SEF that uses swap contracts to trade fiat currencies for Bitcoin called “Next Day Bitcoin”; it also provides custody services regulated by the CFTC. (Gemini and Coinbase also provide custody services.) The SEFs are far less established, and have far smaller base of institutional customers than the big exchanges such as ICE Futures U.S., but they are potential competitors in the years ahead.

Here’s how Bakkt’s exchange for trading Bitcoin tokens, if approved, would operate. It would trade Bitcoin using what are known as “one-day futures,” contracts that would take the same amount of time to settle as trades in the current cash market, meaning in a single day. The broker-dealer would click on a posted price at anytime during the trading day on behalf of a money manager client. By the market close, the ICE clearinghouse would have arranged to route the cash from the buyer’s to the seller’s bank account, and the Bitcoin tokens would be en route the to the Bakkt digital warehouse.

The clients entrusting their Bitcoin to Bakkt could be either institutions managing Bitcoin mutual funds, or companies making cross-border payments in Bitcoin. So how do those clients spend their Bitcoin? Control of “private keys” allow Bitcoin to be spent. Those keys are a randomly generated string of numbers and letters that resemble digital signatures. Most Bitcoin owners store their keys on PCs or servers, or in accounts at unregulated marketplaces. But private keys on those devices are vulnerable to hacking, and if the hacker steals the key, the hacker keeps the pilfered Bitcoin. Cyber-thieves have stolen more than $1.6 billion in cryptocurrencies by hacking investors’ accounts since 2011, according to Autonomous Research.

Bakkt would solve that problem by storing the private keys “offline” in its heavily-guarded digital warehouse. When a fund manager or company wants take Bitcoin out of the warehouse, Bakkt would confirm the client’s identity and release the Bitcoin using the private key. The warehouse will also hold a second key, called the public key, that opens the recipient’s account to receive Bitcoin. The double-key security resembles how it takes a bank rep and the customer, both with their own keys, to open a safety deposit box.

How about trades that occur all inside the warehouse? Bakkt would be connected to the ICE Futures U.S. exchange, so that customers could seamlessly trade Bitcoin for dollars or Euros. Then, the Bitcoin would simply shift from the seller’s lockbox in the ICE warehouse to the buyer’s lockbox, as if a forklift were transferring gold bars from one storage locker to another.

To make Bitcoin mainstream, Bakkt must overcome the cryptocurrency’s chief drawback: its extremely slow speed. Bitcoin runs on a system known as blockchain, operated by a network of millions of individual members who compete to package and verify transactions. Essentially, every time a Bitcoin owner on the network buys anything using his or her digital wallet, the transaction is “broadcast” to all the “nodes,” or computers in the network. The nodes battle to prove the transactions are legitimate, and the winner is rewarded with free Bitcoin. The rub is that since all transactions—from purchasing a $1.50 cup of coffee to a $60,000 SUV—must be individually broadcast to all the nodes.

As a result, the existing system can manage only around seven transactions per second. That’s much too slow to ever work on the institutional scale that Sprecher and Loeffler envision.

Bakkt, however, would transform Bitcoin’s architecture to run at high speed. Imagine that dozens of mutual funds, pension funds, and endowments hold Bitcoin in the Bakkt warehouse. If Asset Manager A buys $200 million in Bitcoin from Asset Manager B, the Bitcoin tokens simply move from B’s account at Bakkt to A’s account at Bakkt, via a trade on the ICE exchange. The total number of Bitcoins held at Bakkt doesn’t change. Let’s assume that millions of those transactions happen every day, all inside the Bakkt ecosystem. Bakkt simply keeps a ledger of those offsetting Bitcoin debit and credits. The individual purchases and sales don’t need to be broadcast to the blockchain. What does need to be broadcast are any payments coming into or exiting Bakkt’s warehouse.