What are the Implications of Institutional Participation in the Cryptospace?

By and large, institutional interest in cryptocurrencies and their related technologies reached new highs in 2023 with all kinds of activity occurring on this end. Consequently, next year could just be the “it” year for crypto, with global adoption rising to unprecedented levels.

Our team of experts has given their thoughts on the implications of this institutional shift.

Here’s the lowdown….

Peter Eberle President at Castle Funds

“Rising institutional participation in the crypto space has led to many wondering what the effects are on the industry. I need an expert who will provide insights on the issue. I need an expert opinion to provide insights into trends and ideas on this issue.

Right now, bitcoin is still very much a retail investor product with only a small percentage of institutions having small percentage allocations. The amount of money these institutions control is enormous, and their investment horizons are extremely long. Once they allocate to a given asset, they are not flipping the asset, instead they may adjust the percentage allocated.

The top six pension funds managed $2.14 Trillion dollars as of January 2022. If they chose to invest just 1%, $21 Billion dollars, the price impact would be huge. Now try to consider if all the US Pension funds wanted to do this. Or all Insurance companies.

This won’t happen overnight, but with easier access to the bitcoin spot market, better custody solutions, and greater regulatory clarity we are certainly moving in the right direction.”

Cuautemoc Weber, CEO and Co-founder of Gateway.fm

“Growing institutional participation in the crypto space presents significant opportunities for growth, but also brings more rigid regulation. The arrival of more investors and capital into the space can spur greater levels of innovation, and the prospect of more institutional involvement can give rise to tailored products that can provide a more comfortable entry point for these investors to explore the crypto space.

For example, innovations like Exchange-traded products (ETPs) are already attracting significant levels of institutional interest. However, greater institutional involvement brings heightened regulatory scrutiny, potentially undermining the decentralized ethos of the industry. I feel that there is finally an avenue for allowing traditional markets to participate in this new asset class by offering these new regulated products from traditional finance.”

 Caspar Sauter, Co-Founder at D8X

“Traditional organizations are building the rails to enter the digital asset ecosystem. From Brazil to Switzerland, we have seen multiple major banks entering the space in the past months.

For example, Brazil’s Itau Unibanco recently announced the launch of crypto trading and custody services, while state-owned banks in Switzerland – for example, PostFinance, Luzerner Kantonalbank and St. Galler Kantonalbank — have partnered with private crypto bank Sygnum to do the same. And Germany’s Deutsche Bank is exploring digital asset custody and tokenization services via a partnership with Switzerland firm Taurus.

The situation in Europe and elsewhere is different from in the U.S., where a lack of regulatory clarity is making traditional entities more cautious in regard to digital assets. So far, major traditional banks don’t appear to be positioning themselves to compete directly with crypto-native Centralized Exchanges but rather are offering additional utility to existing clients and increasing retail exposure to the crypto asset class.

I expect more and more banks to offer crypto-related services to their clients, first focusing on custody and trading solutions, and leveraging white-label products offered by partners rather than developing in-house solutions. Ultimately those banks will also build rails to the DeFi ecosystem, and will be looking to white-label partners such as D8X.”

 

Jeff Owens, Co-Founder of the Haven1 Layer 1 Blockchain

“Over the past 18 months, regulation in the crypto space has ramped up significantly, with even major players like Binance and Coinbase unable to avoid the long arm of the law. This level of regulatory scrutiny has been a long time coming, but contrary to the convictions of the early crypto evangelists, regulation will not be the death knell for the digital asset space. Rather, the developments we have seen since the collapse of the Terra/Luna ecosystem, which kicked off the 2022 crypto downturn, mark crypto’s coming of age as it finally gains a seat at the table with the big boys of the financial industry.

Nothing exemplifies crypto’s falling into line more than Binance’s $4.3 billion settlement with the US Securities and Exchange Commission. However, as the biggest crypto exchange in the world admits wrongdoing during the early days and vows to turn a new chapter, it appears the industry is begrudgingly finding common ground with regulators. Though perhaps painful in the short term, ultimately this will be positive for cryptocurrency and its users. The coming bull market really will be different from the past crypto bull runs, because it will finally facilitate mainstream crypto adoption. And for an asset breaking out into the mainstream, a certain level of regulatory oversight is crucial to ensure appropriate user protections.

Indeed, we have seen what happens when financial services are offered with no guardrails or risk assessments in place. The collapse of Celsius, FTX et al will long remain a painful reminder of the potential perils of the cryptocurrency space. However, we’re now coming out the other end, with the guilty verdict for FTX founder Sam Bankman-Fried after a very public trial likely to become a significant deterrent for any future wrongdoers. With 2022’s bad actors sifted out of the market and regulators in Europe, Hong Kong, Singapore and other nations across the globe dedicating efforts to developing comprehensive crypto legislation, digital assets can finally become a legitimate asset class suitable for both sophisticated and retail investors alike.”

John Palmer, President at Cboe Digital

“We’ve seen tremendous growth across the crypto ecosystem, but its age is quite young compared to other highly liquid asset classes, payment systems, or global tech networks. We could compare each of these categories and likely many others in the lens of increasing institutional involvement and even defining what an institution is for that category. For Cboe Digital, we can take it as an asset class since we operate an exchange and clearinghouse offering our customers the ability to trade, clear, and settle crypto assets and derivatives on those assets. As an asset class, the ecosystem grew extremely fast without mainstream institutional involvement (outside of VC investments and advisory) and importantly without an institutional-friendly regulatory framework across much of the globe. There are three main trends or areas in focus with respect to the market structure of cryptocurrencies as institutions continue to grow their presence in the space we think about.

First, separation of duties. Institutions have become accustomed to interfacing in markets where the same vertical integration that exists in crypto either is not allowed or if it is, requires significant transparency and regulatory oversight of the firms involved. As institutions continue to increase their presence in crypto assets, their preference is for a market structure that supports the separation of duties among the firms and the venues they choose to do business with. We are already seeing the growth and development of platforms that separate exchange and custody, custodians offering networks to other custodians and venues, and frameworks that mirror other traditional financial markets to supercharge adoption from institutions.

Second, liquidity. As institutional participation grows, so will liquidity. We are seeing more and more traditionally based liquidity providers either enter or grow their footprint in the crypto space. In the US, many of them start with derivatives given its regulatory base under the CFTC, and expand from there. As these firms continue to enter the space in either derivatives or spot markets – they bring technical, operational, and risk management systems and processes that have stood the test of time across potentially many asset classes to the crypto ecosystem and in doing so increase liquidity, especially in volatile markets – something the crypto ecosystem has seen its fair share of.

Finally, regulatory frameworks and oversight. In the last few years, we’ve seen substantial progress in regulatory frameworks and the oversight of firms operating with specific licenses in offering access to crypto markets. This trend is important for both the mitigation of systemic risk, but also for trust and transparency. All three are key aspects institutions consider among others as they perform their due diligence on the asset class and the counterparties they will face when participating in it. While we are seeing quite a bit of development globally in this area – it’s most likely just the start of an iterative process that will continue to be refined as institutional participants enter the space and begin to influence both the firms providing services to it and the regulators overseeing it.”

Akbar Thobhani, CEO at SFOX

“The cryptocurrency industry is at an important juncture, as major financial institutions like BlackRock, Fidelity, Grayscale, and Franklin Templeton await the U.S. Securities and Exchange Commission’s (SEC) approval for their proposed spot bitcoin exchange-traded funds (ETFs). This collective anticipation from leading financial firms signals a potential surge in Bitcoin demand, stirring speculation about its future market impact.

Contrasting the narrative of regulatory clarity, the current environment is uncertain. The SEC’s strategy, leaning towards regulation by enforcement, has left the market navigating a landscape without clear regulatory guidelines. Despite the SEC expanding its cryptocurrency enforcement unit by 40%, this increase is seen as a move towards reactive enforcement rather than establishing proactive, transparent regulatory frameworks. Institutions and investors, therefore, find themselves in a complex scenario, weighing the potential risks and rewards of participating in an ambiguous regulatory space.

The prospect of these ETFs involving key players in the financial sector brings both excitement and caution. Analysts project that the approval of these ETFs could redirect substantial investments from traditional assets to Bitcoin, with potential capital inflows estimated to be between $12 to $24 billion. This influx, despite the backdrop of regulatory uncertainties, suggests a significant elevation in Bitcoin’s price and market capitalization.

In this evolving landscape, institutions aiming to capitalize on the burgeoning crypto market must employ a strategic approach that encompasses not only robust risk management but also a nuanced understanding of the regulatory challenges. The future of Bitcoin and the broader cryptocurrency market, while promising, is intertwined with these complexities. However, this environment starkly contrasts with a proactive regulatory framework, where clear, forward-looking rules could provide a stable foundation for both institutions and investors. Instead, the current reliance on regulation by enforcement creates a reactive, uncertain atmosphere, making strategic planning challenging and often leaving market participants in a state of ambiguity about future regulatory directions.

In short, the cryptocurrency sector is navigating a period of transformative growth and notable institutional interest, juxtaposed against a backdrop of regulatory ambiguity. For institutional investors, adeptly managing these intricacies is crucial to unlocking the potential of this emerging asset class. The road ahead may be fraught with challenges, but for those who navigate it skillfully, the opportunities could be significant.”