Roadblocks for Institutional Adoption of Crypto
We spend a lot of time talking to current and prospective institutional users of cryptocurrencies at Everbloom. While there is great interest in digital assets, we also hear about the roadblocks preventing institutions from adopting crypto in a big way. The rest of this post is an overview of the biggest roadblocks.
Some context first. Last November, I gave a talk on this topic titled “Roadblocks for Institutional Adoption of Crypto”. The video of the talk is on Youtube and the slides are on SlideShare. They are also embedded at the end of this post. This post is essentially a recap of that talk. I want to say thank you to Ivan Burazin and the rest of the organizers of Shift Money 2018 for inviting me to speak and running a great event (check out their upcoming conferences).
When I talk about “institutions”, I’m referring to corporations, hedge funds, venture capital funds, banks, brokers, exchanges, and so on — basically any organization and especially organizations of substantial size.
Institutions face many obstacles on the road to using cryptocurrencies and digital assets. The following slide highlights what I’ve found to be reoccurring themes in my many conversations:
Let’s take a look at each one.
Custody is an impediment for many organizations. A typical cryptocurrency fund interacts with many different exchanges and OTC providers to manage their funds and trade cryptocurrencies. Connectivity to traditional banking infrastructure is also necessary to pay expenses in fiat or invest from fiat reserves.
In today’s landscape, companies and funds are usually self-managing many of these connections. This creates a complicated web that looks something like this:
For some institutions, this is merely clunky, but for others, they might be barred from self-managing custody due to internal policies or external laws. For these reasons, custody will likely consolidate into major custody providers. Institutions will interact directly with one custody provider instead of directly interfacing with many exchanges, creating a world more like this:
At first glance this might look like more centralization, countering the ethos of cryptocurrencies. However, this picture does not mean one custody provider will take over the whole market. There will be a plethora of custody providers providing different solutions for different customer segments. It does mean that a single customer will prefer to work with a single custody provider. It is not tenable for every fund and company to manage many private keys and wallets.
This is why we believe in separating custody from exchanges at Everbloom, and why we built a non-custodial exchange. Institutional custody providers will sit between digital asset users and exchanges in the future, making exchange level custody redundant.
Compliance and Regulation
Complying with regulations are tough when digital assets break the mold of many existing assets and regulations. Some jurisdictions are doing their best to fit old laws to new things, while others are legislating. Some regulate through enforcement while others create regulatory sandboxes to encourage innovation. Regardless, uncertainty exists in many corners, and uncertainty is tough for large organizations.
While they might not have full clarity, at least certain things are clear. Digital assets are a way to transfer value, and so anti-money laundering policies are necessary for certain types of institutions. Another example of a clear need is accounting solutions. Thankfully, vendors are emerging to meet these needs.
Markets are still extremely early. The market cap of the NASDAQ stock exchange is roughly $10 trillion. The market cap of digital assets is roughly one hundred times smaller. This does not move the needle for large institutions. We still have some time before digital assets become interesting to many players.
On top of the market size, the industry still needs to develop mature financial instruments. In many markets, derivatives trade more than their underlying assets. Digital assets will most likely be no different. However, in its present state, most crypto trading happens on the spot market, not on derivatives.
Security is challenging when protecting hot and cold wallets against corporate theft, malicious actors, and accidents. Many institutions are still figuring this out and waiting for the right vendors to solve these issues.
We also have to consider the security and finality of the underlying blockchains themselves in terms of things like replay attacks. To dig deeper on replay attacks and the kind of problems they can cause, I recommend reading about the Bitcoin Gold replay attack.
Another adoption problem for digital assets is the plethora of competing protocols and blockchains. This is Betamax vs VHS amplified a thousand times. The Internet was such a powerful force for the economy because it created a global, connected system. In contrast, businesses will have a hard time transacting in digital assets and deciding on protocols when there are many disparate networks in the world of blockchains.
That said, things like atomic swaps and projects such as Cosmos have the potential to bridge chains together and remove friction between the networks.
Performance is often cited as a limiting factor for blockchains. The development of layer two technologies will be key for the adoption of public blockchains, but the technology still needs time to develop further. Until then, it will be hard to scale trading and payment platforms without resorting to highly centralized solutions.
When building an exchange, we have to touch many different providers in the space (e.g., wallets, KYC and AML providers, dapp browsers, other exchanges, and market makers). Collectively, we all have a long way to go to improve user experience to an acceptable level for mainstream adoption.
I like this quote: “A successful UX in a blockchain application makes it seamless for someone to start using the application regardless of the technology behind it.” Most people do not think about HTTP or HTML when browsing the web, but when you use any crypto application, you’re still keenly aware of wallets and keys and the risks involved.
Why do I care about these roadblocks? Why should anyone care?
Existing financial systems are closed, cumbersome systems that do not promote open financial networks. The mere fact that it still costs me $30+ at major banks to send a wire is egregious. The emergence of Bitcoin and public blockchains is finally causing people to ask, “Can we do better?” A whole industry is attempting to build a new financial system which is accessible to anyone with a computer and a connection to the Internet. With fewer gatekeepers, we can increase access to capital and lower the cost of participating in the global economy. That is worth caring about.
Full Slides and Video Below
Thanks again to everyone at Shift Money 2018!