The digital assets wing of popular Contract For Difference trading platform, Etoro, recently released a report, examining key developments in the crypto space to date. EtoroX, in conjunction with research firm, Aite Group – in addition to the above – looked into hurdles keeping institutional investors on the sidelines, shining a light on how some of those issues could be addressed.
Though still dwarfing the classic markets in market capitalization, digital asset markets have done a great deal of growing in the decade since inception. Cryptographic asset prices, in 2021, suggest that markets have fully thawed from the Crypto Winter of 2018-2019, with the much prophesied entry of institutional investment into the space buoying markets to new highs.
With some of the more daring institutional firms having already dipped sizable toes into cryptocurrency markets, the question has shifted from “will institutions invest in digital assets?” to “when will mass institutional investment become a thing?” Etoro, and Aite’s impact report – titled Institutional Cryptoasset Trading: Looking for the Missing Bits – examines the latter question in detail, identifying what institutional investors will require before they can invest comfortably, in cryptocurrency markets.
Meet The Institutional Investors
The term, institutional investor, is a broad nomer for investors who represent a company, and typically handle investment activity on behalf of somebody else. Banks, Funds, and Asset Managers are some of the financial world’s best known characters, who fall into the Institutional Investor classification.
The study interviewed 25 institutional investors (technology vendors, brokers, exchanges, liquidity providers, digital assets oriented funds, and investment bankers) in the third quarter of 2020, to get their thoughts on what kept crypto assets unattractive to both them, and their counterparts. The group was composed of 14% Custody Providers, 18% Funds & Asset Managers, while Banks/Brokers made up 41% of the group. Liquidity Providers, and Market Maker Services made up the remaining 27%.
Things As They Stand
EtoroX’s report, acknowledges that cryptocurrency markets have come a long way, but notes that the asset class still has some way to go before it reaches an equal maturity level to traditional asset markets. Key bones of contention regarding the asset class still seem to be asset security, liquidity (mostly the lack thereof,) and the fog of war that blankets the regulation front. Some have even come to liken the current state of digital asset markets to the retail Forex market – before regional regulatory frameworks lent the market some legitimacy.
Since the launch of Bitcoin in early 2009, the total market capitalization of the digital assets market has swollen from nothing, to over a $ trillion, to date. The asset class has gone as far as garnering the patronage of investment firms, and global fintech companies such as PayPal. Digital currencies have even gotten a regulatory nod of recognition from some of the world’s most significant – current and future – financial centres, with the US’s Securities and Exchange Commission (SEC) considering the approval of Crypto-pegged Exchange-traded Funds (ETF’s.)
Although the market capitalization of the cryptocurrency market pales in comparison to incumbent markets, the speed at which it grew to reach a trillion (a little over a decade) is still quite a bit to write home about, it appears. This – apparently – is a sign of investor interest in the burgeoning asset class. Bitcoin’s dominant market share, over the wider digital assets market – as the report states – is an indication of investor confidence in the progenitor digital currency. Aite Group, also found that owning some Bitcoin has become a kind of status symbol in some circles (quite a far cry from when it was viewed as a medium for illegal activity.)
So, Institutional Investment?
Well, as things currently stand, some institutional investment activity has been increasingly directed into digital assets in recent months, however the initial wave of institutional investors has been lead by smaller funds with more dynamic, and aggressive investment/trading strategies. As of yet, it is high-net-worth individuals, and small institutions that have shown the most institutional investor interest in the crypto asset arena. With things in classic markets looking, more, and more uncertain, EtoroX, and Aite Group expect the trend to pick up momentum.
Despite the rosy picture, painted above, the report cautions that there is still quite a way to go before institutional money is beating down the door to get into crypto. The disjointed nature of the digital assets ecosystem, is one of the chief gripes institutions may have with digital assets in their current state – suggests the report. The various technologies that make up the digital assets ecosystem make it a cumbersome task to set up crypto trading desks, or trade digital assets directly. Apparently, managing Risk, and Balance Sheets would be a nightmare, due to the difficulties imposed by the fact that cryptocurrency markets lack much of the infrastructure incumbent to formal markets.
Until these issues are sorted out, the ever-impending inflow of institutional money, pretty much abstains from impacting key areas in the digital assets sphere, that could drive unprecedented growth. Market Structure, Regulatory Certainty, Security, and Custody, Credit, Tech Innovation, Pricing, as well as liquidity are areas the interviewees helped Aite Group to identify as areas that would improve institutional confidence, and be bolstered by institutional participation.
Challenges & Opportunities
Informed by interviewee responses, Aite believes the digital assets market is at the cusp of greater institutional adoption. Institutions have watched Crypto markets from a distance, citing the lack of regulatory clarity, and minimal first-mover advantage offered by digital asset markets (as evidenced by the scandals, scams, and yoyo-like market movements of recent years.) Wider regulatory approval seems inevitable at this current point in time, which will likely prompt a stampede of institutional money into the space. The interest – from institutional investors in crypto – is certainly undeniable, according to Aite.
Challenges to Institutional Adoption:
- Global Regulations Surrounding Crypto Still Unclear
- Minuscule Market Capitalization (By Institutional Standards)
- Lack of Participation From Other Traditional Financial Players
- Prime Brokerage, and Custodial Markets Still Underdeveloped
- Fears Regarding Security, and Risk To Reputation
- Complexity of Digital Asset Markets, Making Valuation Difficult
Opportunities For Institutional Adoption
- Lend Impetus to Drive For Regulatory Approval, and Crypto Based Derivatives
- Continued (If Not Accelerated) Development Of Digital Assets Market and Crypto Based Financial Products
- Healthy Development Of Digital Asset Based Derivatives, Lead By Classic Asset Exchanges
- Growth In Setting Up Of Sound Market Infrastructure
- Participation Of Institutional Grade Digital Asset Exchanges, And Other Service Providers
“There’s a dot way out on the horizon that represents a mature institutional market for cryptoasset and digital assets. It’s sort of like we’re not really sure how we’ll get there, how long it’ll take, and what we’ll find when we do—but we’ve pointed the boat at the dot and set sail.” – unnamed interviewee
Although concerns around regulatory clarity, security of assets, and a wisp of a market cap – regarding crypto markets – have historically kept institutional players out of the game, Aite notes a shift in the general institutional attitude towards digital assets. A combination of FOMO (read, looking to obtain first-mover advantage as institutions begin to pour into the asset class,) the Covid-19 pandemic induced global financial crisis, and investors generally seeking greener pastures in times of traditional market uncertainty, seem to be spurring more institutional players to take the plunge into crypto markets.
The digital assets ecosystem has matured a great deal in recent years, however the development has not been uniform. Infrastructure has developed, but has largely been focused on retail and passive users, with the infrastructure required for institutional participation taking the backseat. Though market capitalization, and disparate global regulatory frameworks are still hurdles to institutional participation in digital asset markets, crypto-based service providers have done a lot to reduce many of the barriers that kept classic financial heavyweights out of crypto.
Aite Group sees the next wave in the growth, as well as, maturity of the digital assets market being led by institutions, given impetus by an improved regulatory environment, the introduction of institution-friendly infrastructure, and technology. There seems to be, in 2021, an unspoken agreement that the digital assets market must reach maturity, as such, more classic and crypto market players are taking on more risk in order to see this vision through.