Most market practitioners agree that institutional investors, in general, have still not yet warmed up to cryptocurrencies due in part to the lack of regulation governing the new class and volatility in the asset class. Yet, change could be on the horizon. “There are a whole series of specialist investment possibilities that investors could consider, and those opportunities have to compete for the very limited bandwidth investors have—in general, crypto has not won that fight yet,” said Ian Toner, CIO at Verus. “With unclear regulatory structures, unclear valuation mechanisms and complex underlying technology infrastructure, it’ll likely be some time before we see widespread adoption of cryptocurrencies in most institutional portfolios,” he added.
News on August 24, that the Securities and Exchange Commission (SEC) would review nine proposed bitcoin ETFs that it had rejected two days before brought even more uncertainty around potential regulations on cryptocurrency. The SEC’s reversal on the reviews came just a month after BlackRock CEO Larry Fink declared to the media that there is no investor demand for cryptocurrencies, though the asset manager had assembled a group to examine blockchain technology and Bitcoin.
“Governments can intervene at any time to outlaw or regulate certain aspects of cryptocurrencies, which in turn could lead to a fall in value should the changes be considerable, ” according to Kishen Ganatra, European strategic research director at consultant Mercer. “While it is difficult to eradicate ownership of cryptocurrency, it would be a major setback for investors holding this asset if a cryptocurrency were outlawed, or if significant limits were placed on it in a major territory.”
Mike Leon, a managing director at Athena Investor Services, argued that more regulation will encourage institutional investors to enter the space. “The biggest issue is creating a roadmap for launching initial coin offering (ICOs) and utility tokens within a regulatory framework,” he said.
The more heavily-regulated markets are those that end up flourishing and becoming much bigger, agreed Milston. “A clear sense from the government as to whether cryptocurrencies would fall under the category of currency or commodities would also help,” he added.
Cryptocurrencies have, heretofore, been viewed as a fledgling, unregulated sector. But now, with improvements to infrastructure, the development of crypto exchanges and the beginnings of interest among institutional investors, the market is headed toward a more professional structure, said Gaspard Coudurier, product manager at BSO, a global network provider that enables low-latency trading infrastructure at rapid speeds. BSO declined to name its specific institutional clients.
Institutional investors’ interest in holding cryptocurrency stems from the desire to hold an asset uncorrelated with financial markets, noted Myles Milston, CEO and founder of Globacap, a blockchain capital-raising platform and custodian based in the U.K.
More than 1,000 different cryptocurrencies are in circulation, and the field is widening with further initial coin offerings all the time, Ganatra said. “There are so many cryptocurrencies out there that it is hard to know how to diversify across the space [within an institutional portfolio],” a West Coast fund CIO added.
Top 10 cryptocurrencies and their market caps:
- Bitcoin: $116.5 billion
- Ethereum: $28.3 billion
- XRP: $12.9 billion
- Bitcoin Cash: $9.2 billion
- EOS: $4.7 billion
- Stellar: $4.1 billion
- Litecoin: $3.3 billion
- Tether: $2.8 billion
- Cardano: $2.5 billion
- IOTA: $1.7 billion
A few entities have attempted to create a new version of the cryptocurrency Ethereum that can be used to create new types of tokens, in turn increasing the value of investors’ holdings, Miltson told IA. Examples include Stellar, Cardano, Hedera-Hashgraph and Quorum, created by JP Morgan investment bank. Cryptocurrency is a type of token; other types include utility and security tokens, Milston added.
In June of this year, the Securities and Exchange Commission (SEC) said that the two major cryptocurrencies, Ethereum and Bitcoin, are not designated as securities, Milston pointed out. Most other initial coin offerings (ICOs) are designated as securities because they are linked to the success of one particular company, whereas Ethereum and Bitcoin are not. “Anyone can come along and participate in Ethereum and Bitcoin—the future value of each is not directly a result of any one company’s performance,” added Milston. In contrast, ICOs are linked back to the company that created them; for example, while one type of utility token might provide a discount on a company’s services, another might be used as a medium of exchange on a company’s own platform and/or marketplace that it created with its ICO.
More regulation will encourage institutional investors to enter the space.
There are very few custodians that are actually SEC-qualified for digital assets, and this limitation is the reason many institutions haven’t been comfortable yet investing in crypto, Austin Trombley, v.p. and data scientist at Franklin Templeton’s Fixed Income Group told IA. “Storing digital assets requires hardware security modules (HSM), a ton of penetration testing, and a full understanding of multisignature and cryptography, very few institutions to date have this in depth knowledge in house,” he added.
The volatility of bitcoin and the lack of custody providers for digital assets are two major reasons that institutional investors have concerns about cryptocurrency and digital assets as an investable asset, Leon noted. “The value of bitcoin in January 2018 was around $20,000—today that value is about $6,400, which is down almost 70%,” he said. “If investors purchased in January of 2017, its price was les
s than $1,000, which is up over 600% from the January 2017 price.” Leon added that this demonstrably high level of volatility has caused family offices to make smaller allocations to digital assets: “These allocations are between one percent to three percent of their portfolio because the volatility is so large.”
When an investor is working with an international portfolio with no hedging strategy, the assets within that portfolio are exposed to currency fluctuations from the normal currency markets, noted Toner. “While some investors use hedging and/or currency strategies to try to offset or minimize that exposure, most still don’t,” he continued. “The impact of spending time understanding and addressing this mainstream type of currency exposure is likely to be much more directly relevant than if that time was spent learning about cryptocurrencies.”
A lot of institutions cannot invest in cryptocurrencies because storage is too risky, noted Toby Allen, head of digital assets at Akuna Capital LLC. “Institutions need trustworthy custodians to manage this—it’s a developing space, and we hope that some qualified and regulated custodians enter the space and can fill this void, potentially allowing larger institutions to take positions in cryptocurrencies,” he added. “The asset class has very low correlations to other asset classes and this is potentially very interesting to large scale investment boards. That said, these institutions could get exposure via futures or forwards, where they wouldn’t need to hold the physical currency—this is readily available already.”
Cryptocurrency has very low correlations to other asset classes, making it potentially very interesting to large-scale investment boards.
How investors store their cryptocurrencies is a major issue, and as larger custodian banks enter the space, there is the potential for SEC-qualified custodians to become the new reality, Leon said. Though custodians will be major asset managers, the distinction must be made that the custodial duties will be performed by the investment banking side of these businesses—the legal structure requires segregated business units under the umbrella of the same company, noted Milston. Potential companies ready to become custodians could include Fidelity, Nomura, Northern Trust, State Street Advisors and BNY Mellon, several consultants said.
When contacted for comment, a spokesperson for Fidelity said: “Fidelity sees the future of financial services taking place on open and permissionless ledgers, with technologies like digital assets, currencies and Blockchains—we are very actively exploring this. However, our mutual funds do not hold Bitcoin or any other digital assets/currencies, and cryptocurrencies are not offered through the company’s broker-dealers.”
Similarly, a spokesperson for Nomura said, “Like any other financial institution, we are studying the cryptocurrency market, but don’t provide any advice to our clients in this field.” And a spokesperson for State Street said, “In alignment with market demand, we are considering all appropriate service offerings that may be developed around the emerging crypto-asset class.”
There is still a tremendous amount of skepticism about cryptocurrency as an investable asset by institutions.
According to a spokesperson for Northern Trust: “Northern Trust currently does not provide custody services for cryptocurrency assets. As part of our market advocacy and technology innovation process, we are actively exploring the potential for safe, secure custody of cryptocurrencies and digital assets. While not imminent, the market is moving fast, and we seek to help shape a solution that works for our clients, shareholders and regulators.”
BNY Mellon declined to comment for this story.
Athena is becoming a registered broker-dealer to provide consulting services to firms looking to launch tokenized assets. It also owns 75 bitcoin ATMs in the U.S. and Latin America as well as an OTC trading platform for investors looking to purchase digital assets. “I believe that institutional investors are really under-invested in the space,” said Leon. “Sixty percent of our clients are high net worth families, with the rest being smaller hedge funds. We are currently seeing some venture capital and private equity firms buy small exposures to crypto,” Leon continued. “There is still a tremendous amount of skepticism about cryptocurrency as an investable asset by institutions, but they have a lot of interest in the investment potential of blockchain.”