Defining Trends for Institutional Involvement with Crypto
By Christopher May, Co-Founder and Co-CEO, Finoa
Looking at the different types of institutional investors involved in the current crypto scene, one could broadly identify two different types.
The first are the alternative institutional investors, who mostly started acquiring cryptocurrencies around 2016 or 2017. These early institutional adopters had a risk profile that made them open to this new type of asset and included a full portfolio of funds, such as hedge funds, venture capital funds and dedicated crypto funds. The alternative institutional investors were unintimidated by the lack of infrastructure as well as the minimal regulation surrounding the buying, selling and storing of digital assets.
The traditional institutional investors have been much slower to approach cryptocurrencies and digital assets. Family offices in particular have mostly considered the market too risky and too volatile. Additionally, the lack of infrastructure when compared to the traditional financial world scared away many of these investors, who had no prior knowledge of how to gain access to this market. Whereas the alternative investors wanted to directly own the tokens, such as Bitcoin (BTC) and Ethereum (ETH), the traditional investors were more interested in gaining access to the return opportunities those tokens represented, enabled through structured products such as Exchange-Traded Products (ETPs). Here, investors do not directly own the tokens but rather a share or claim on the underlying asset bundled within the product.
Although uncertainty still prevents many traditional investors from seriously considering the diversification of their portfolio through digital assets, current trends in institutional involvement revolve around the elimination of this uncertainty, particularly in the areas of regulation, security and maturity.
Trend 1: Crafting regulations that are more suited to the crypto ecosystem
More traditional institutional investors are starting to dip their toes into digital assets because they see that regulators and lawmakers are working on measures regarding the crypto ecosystem. As legislatures in many countries lay out regulations for buying, selling and storing digital assets, this helps traditional investors gain more trust in the system.
In Germany, for example, the Federal Financial Supervisory Authority (known as BaFin) has introduced preliminary licenses for crypto custodians. When a crypto custodian can say it is licensed, this gives traditional investors more peace of mind and paves the way to a more open perspective.
Because the crypto ecosystem differs from the traditional financial system in its nature as well as its underlying technology, it requires a new approach and alternative ways of thinking from regulators and lawmakers. While there have been some very progressive and important steps taken around the globe, some questions still must be tackled to ensure a compliant and regulatory environment, while simultaneously doing no harm to the crypto ecosystem.
For instance, anti-money-laundering laws regarding crypto transfers are currently designed similarly to the standards known from the traditional financial ecosystem. These do not entirely reflect the special case of a decentralized and pseudonymous network. Moving forward, it will be interesting to see how, eventually, both ecosystems converge and find common ground in terms of regulatory frameworks.
Trend 2: Improving security through advancements in the crypto infrastructure
Three years ago, there was hardly any infrastructure in place for institutional investors who wanted to get involved with crypto, but that has started to change. While alternative institutional investors have been more open to managing their tokens themselves, traditional investors have been waiting for an infrastructure that’s more similar to what they are familiar with.
The key trend in infrastructure development has been to make the front-end interfaces, such as wallets, as streamlined as possible, removing complexity for the users. It’s not necessary for institutional investors in crypto to see that behind the interface is a completely different technology. The improvements that have been made to the infrastructure are focused on making the user experience similar to online banking activities.
In the custody area, the infrastructure has made vast leaps forward in terms of protection of digital assets, which is another ongoing trend. Early on, traditional institutional investors were put off by stories of hacked accounts and lost cryptocurrencies. News about crypto owners losing their private keys and being unable to access millions of dollars worth of currency also scared traditional investors away from the space.
However, with advances in security and the growth in third-party custodial options over the past few years, more and more institutional investors are considering digital assets as a way to diversify their portfolios.
Trend 3: Stabilizing values to remove uncertainty
Value is an important part of investing in cryptocurrencies, but the market is infamous for its volatility. However, the volatility of Bitcoin has somewhat lessened as the crypto ecosystem has matured, and Bitcoin’s leveling-out will continue to have a trickle-down effect on other cryptocurrencies.
Digital assets have gained validation through the support of crypto by PayPal, along with announcements of major token purchases by Tesla and MicroStrategy, and other big institutional investors. Additionally, a recent survey by the Financial Planning Association reported the number of financial planners using or recommending cryptocurrency has risen from 1% to 14% just since 2020.
Parallels are being drawn between gold and Bitcoin as stores of value, which is attracting the interest of traditional investors, who are becoming more willing to invest via the growing number of funds that include cryptocurrencies among their offerings.
Institutional investment and technological advancement are joined in a virtuous cycle
Most institutional investors are wading into the crypto waters via Bitcoin and Ethereum, which are seen as the most common tokens when talking about digital currencies. As these investors grow more comfortable with these well-known digital assets, they then begin to diversify their crypto portfolios by expanding into more exotic tokens and smaller projects.
The current trends serve to eliminate much of the uncertainty that presents an obstacle to institutional investment in digital assets. As the uncertainty decreases, investment swells and supports the growth and stabilization of the market. It’s a virtuous cycle. The increased amount of capital entering this space fosters new business models, attracting more minds that start building new products to nurture the entire ecosystem and bring it further toward maturity.
While the “fear of missing out” is a big driver for many traditional institutional investors’ interest in digital currencies, recent infrastructure advances are also playing a major role in getting these investors on board. Cryptocurrencies are creeping out of their niche as a means of storing value. The elimination of the remaining uncertainties is imperative for the continued trajectory of digital assets into the mainstream.
About Christopher May:
Christopher May is the Co-Founder and Co-CEO of Finoa, a leading European digital asset custody and financial services platform for institutional investors and corporations. Prior to founding Finoa, Chris was with McKinsey & Company, serving banks and insurance companies on strategy, corporate finance and digital transformation, and previously at BHF-BANK in their asset management department. He earned a degree in Business Administration from WHU – Otto Beisheim School of Management (Vallendar, Germany) and University of Southern California (Los Angeles, USA) and received his MBA from IE Business School (Madrid, Spain). Chris is a guest lecturer at the Kellogg School of Management as well as at the Wolfgang Goethe University in Frankfurt/Main.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.