institutional investmentThere has been much speculation recently about institutional cryptocurrency investment. Much has been written about institutional investors getting ready to enter the cryptocurrency market.

This is not surprising when:

  • Many institutional investors recognise that with the average P/E ratio of US equities now being around 20x, stocks may well have entered bubble territory. This is forcing them to consider risk-taking in different asset classes.
  • The eye watering returns that cryptocurrencies can generate are there for all to see. In 2017 the cryptocurrency market as a whole recorded a staggering 4,500% growth and an increase in market capitalization from $17.7 billion to $800 billion.
  • The large price pull backs from the highs at the end of 2017 could be presenting buying opportunities for institutional cryptocurrency investment.

What Has Held Institutional Cryptocurrency Investment Back?

The main factors that have been causing institutional investors to sit on the sidelines are:

Lack of Custodian Solutions

Institutional buyers such as hedge funds and pension funds have a duty to protect the interests of their clients.

Traditionally they have entrusted global custodians such as JPMorgan, Northern Trust and BNY Mellon to safeguard their assets including cash, precious metals and diamonds. Cryptocurrencies present a different type of challenge however since they are vulnerable to hackers. What’s more, stolen crypto funds are more difficult to track and recover.

Up to now there has been a lack of reliable, reputable and qualified custodians with experience in the cryptocurrency space.

Lack of Regulations

Regulations, and more so the lack of them is a grey area in the cryptocurrency market. Institutional investors need to seek safeguards for their clients and they are therefore some of the biggest proponents of regulations. Without regulations in place there is the fear that regulators could clamp down in the future with unknown consequences.

Gary Goldsholle, senior advisor to the director of the Trading and Markets Division of the US Securities and Exchange Commission recently gave his opinion that regulated cryptocurrency custodians would encourage institutional cryptocurrency investment.

The former US Commodity Futures Trading Commission chief Jim Newsome who now reports on ‘cryptocurrency best practises’ for the Chamber of Digital Commerce is of the opinion that regulations are crucial.

Institutional investors seem to be following these experts’ lead and are awaiting new regulations.

Safety

The vulnerability of digital assets to hackers is of concern to institutional investors who must do everything possible to protect their clients from exposure and to ensure that their holdings are not stolen. Some institutional investors have been exploring the possibilities of cold storage (storage on an offline and personalised wallet).

Uncertainty and Fear of The Unknown

Cryptocurrency is still in its infancy. Bitcoin, the first cryptocurrency only came into being in 2009. Compare that with traditional asset classes such as gold and silver which have been around for thousands of years and it’s not surprising that there is so much uncertainty and fear surrounding the ‘wild west’ of investing in relatively novice cryptocurrencies.

Liquidity Issues

Institutional cryptocurrency investment would come in large volumes – millions, 10’s of millions and 100’s of millions of dollars worth of cryptocurrencies at a time. This is relevant to both purchase and liquidation. Not many dealers have access to those sorts of quantities. There is a lack of institutional cryptocurrency products in the marketplace.

A Wind Of Change – Recent Developments

New US Custodian Solution Launched

In July 2017 Coinbase, the world’s biggest cryptocurrency exchange with over 20 million users launched a cryptocurrency custody service aimed at institutional investors. This could potentially open the doors to institutional cryptocurrency investment and start a surge of billions of dollars of investment capital into the crypto marketplace.

This has huge implications for the cryptocurrency market. With the hurdle of custodianship overcome a wave of new capital from institutional investors could be unlocked.

According to a Coinbase spokesman they anticipate winning approval soon of ‘qualified custodian’ status which complies with stringent US standards for the guarding of assets.

More Custodian Solutions Coming

institutional crypto investmentCoinbase are by no means the only crypto-custody offering in development. There are many more similar services in development, some of which are nearly ready.

Other crypto-custody start-ups at an advanced stage of development include BitGo and Circle, both of whom are already in discussions with regulators.

Nomura Holdings Inc., the investment bank have teamed up with cryptocurrency firms Global Advisors and Ledger to form a custodian consortium named Komainu which is already making plans to commence testing in private.

Three huge Wall Street custodians, Northern Trust Corp, JPMorgan Chase & Co and Bank of New York Mellon Corp are reportedly exploring or are already developing crypto-custody services.

Trustology, the custody technology provider claims to be close to launching a brand new institutional custody service.

Awaiting Regulators

A number of start-ups are reportedly already in discussions with the Financial Industry Regulatory Authority or the Securities and Exchange Commission

BitGo, which took over Kingdom Trust, a qualified custodian, is said to be working towards becoming a qualified custodian itself. According to Bloomberg, BitGo’s CEO Mike Belshe is working in South Dakota to get approved there and they already have hundreds of hedge funds and wealth managers lined up ready for when approval is given.

Some new custody projects are exploring additional ways to give their customers comfort and confidence including insurance, KYC (know your customer) checks and cold storage (offline storage to prevent the possibility of hacking).

Any such services and particularly regulated ones would give comfort to fund managers who have already entered the crypto market. At the moment they face the prospect of cryptocurrency focused funds being in danger of regulators clamping down, especially as investment advisors are normally obliged by the Securities and Exchange Commission to place client funds only with a qualified or certified custodian.

Potential Price Hike

Sam McIngvale, the leader of the Coinbase project estimates that around $20 billion of cryptocurrency assets could potentially pour into regulated custodian services once they are up and running.

Institutional buyers such as hedge and pension funds entering the market in high volumes would most likely give cryptocurrency prices a significant boost. This could have the knock on effect of encouraging smaller investors to enter or re-enter the market particularly as they are given the confidence of big players being prepared to trust cryptocurrency investment. That would then most probably result in a further price uplift. As a consequence of this stimulated demand price hikes could be self perpetuating.

Cost Implications

Regulated crypto-custody comes at a considerable cost. Coinbase requires a minimum investment balance of $10 million. It charges a set up fee of $100,000 then 10 basis points per month. It is anticipated that prices will come down as the number of alternatives expands however and the marketplace becomes more competitive.

The (Relatively) Unknown, Existing Solution for Institutional Cryptocurrency Investment

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There is already a solution that offers institutional investors:

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  • no restriction on investment quantities
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  • many cryptocurrencies offered, not limited to just the main ones
  • insurance with Lloyds of London for 100% market value
  • competitive fees and terms
  • limited time KYC offer of spot -1% on BTC investments of $1million

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Conclusion

The cryptocurrency market is gearing up to service institutional investors and institutional investors who have so far been sitting on the sidelines are getting ready to enter the market. Once the first one does it is anticipated that FOMO (Fear Of Missing Out) could start a stampede. Institutional cryptocurrency investment is imminent.