Institutional Investment and Cryptocurrency
The perception of cryptocurrency has evolved drastically over the last several years, from awareness among only the most technically sophisticated, to a well-known (yet little-understood) means of “black market” money, a substitute for currency and even a highly disruptive investment vehicle.
As with any new innovation — perception matters, and can make or break the success of its adoption. In crypto’s case, its perception depends heavily on its industry evangelists. This ranges from academia and research groups to developers working on blockchain projects, the investors who are backing these projects, and of course the lawyers and regulators. While we are still in the early days of adoption, this technology has begun to make its mark, not just in the blockchain community, but in the world at large, and especially in the finance industry. What once was seen as an “under-the-radar” currency used in the black market is now making waves in the worldwide capital markets. Even the largest of institutions are beginning to take notice, and governments are beginning to define and deploy rules and regulations to protect the public and investors.
Bitcoin was created in 2009, and since then, its place in the world has evolved dramatically. In more recent years, more and more businesses and governments are looking closely at how this innovation can best be leveraged on a larger scale. By now, we’ve seen most of the major markets and a wide range of companies starting to use or accept crypto as a method of payment. Just as gold was replaced with paper currency, some believe that cryptocurrency could be the next evolution of this, while others fiercely reject this idea.
Nonetheless, with its increased popularity and track record of returns, investment institutions are looking more and more seriously at incorporating cryptocurrencies into their portfolios.
While some high net worth individuals, family offices and mid-size capital providers have incorporated crypto assets in their portfolio. Most larger institutions have not yet entered the market.
This changed in May of this year when Goldman Sachs announced their plans to incorporate Bitcoin into their investment portfolio, making it the first U.S. bank to do so. Through this, they have set the needed precedent for other investment firms, and it is likely only a matter of time before more and more follow suit. In fact, just a few short days after Goldman Sachs’ announcement, ICE which owns the NYSE, announced their plans to develop their own cryptocurrency exchange.
Why crypto?
Generally speaking, investment institutions hold large amounts of capital, and portfolios tend to have a variety of assets with various risk levels. In this mix of investments, cryptocurrencies (e.g such as bitcoin) do indeed have a place. With their total market cap estimated at around $290B (at the time of writing this article), it’s not surprising to see institutions adding crypto to the mix as a new asset class. With that being said, it is highly volatile and consequentially is likely to only occupy a relatively small portion of a total portfolio. Volatility aside, most investment firms are likely to wait for clearer regulation before market entry at all, as finance is a highly regulated industry in most of the world.
To date, we’ve seen very few jurisdictions apply a definitive regulatory framework, Singapore is one country that has been leading the pack. Over the next few years expect to see a drastic evolution in the regulations surrounding the crypto space. But this transition will not be without its hurdles, especially surrounding the mechanism of custodianship. Different assets have different rules and require different mechanisms regarding how they are held. But there is no clear method of custodianship for cryptocurrency that would satisfy institutional requirements.
One available option for holding cryptocurrencies is to hold them in a crypto exchange, which are unfortunately not always reliable, it is estimated that theft from exchanges could reach $1.5 billion this year. Unsurprisingly, there are many companies are seeking to solve this issue with new technologies.
On the regulatory side, it will be up to governments to decide the rules. Most of these regulatory bodies, mainly in Western countries are quite open to feedback and comments offered by experts from private sector. And this kind of research is critical as the regulators require deep insight and understanding of the space which is mainly shaped by the private sector. Here in Canada we can see a healthy and growing interaction between provincial and federal securities commissions as the main regulators and lawyers and companies in this space. These are very promising steps and many people are hopeful that Canada and the U.S. will be amongst the very first countries to introduce a practical regulatory framework in the space.
As I mentioned, perception in this industry matters and heavily depends on ambassadors of the industry — if this is the case, many of the crypto ambassadors have done an excellent job representing the industry.
My prediction is that we can expect in the very near future to see some restructuring of our current investment institutions and a fat capital injection into the space. The hope is that with the backing of strong and solid venture capital firms and also help from governments effectively shaping regulations — we will see the entry of institutional capital into the space relatively quickly, enabling this technology to open to door to even more innovation as the next generation of entrepreneurs build a better future.
