The search for yield is driving institutional investors to boldly go where no investor has gone before, and this is nowhere more evident than in the crypto markets, which swelled to $2tn in 2021, aided by all types of institutions getting into the market. Last year saw higher highs for bitcoin, the world’s best-known cryptocurrency; and despite its January 2022 pullback to an October 2021 low of $41,564, bitcoin remains the best-performing asset class over the past 10 years.
Custodians are leading the institutional digital assets charge, with Fidelity and State Street offering institutional-grade digital custody solutions. They are joined by institutions such as ING, who launched Pyctor, and Standard Chartered, who partnered with Northern Trust to launch Zodia. BNY Mellon has launched a new business unit dedicated to enterprise digital asset services. Custody is the most complex area of digital assets, from a consumer protection perspective, and regulators are often keen to point this out.
A 2021 Fidelity survey of institutional investors found that 70% were already invested in crypto — a healthy indicator of the demand that is driving traditional financial institutions to offer crypto products and services. US pension funds, such as the Houston Firefighters’ Relief and Retirement Fund and Fairfax County, Virginia’s Police Officers’ Retirement System, have taken exposures in cryptocurrency, and US investment management firm Pimco announced in October that several of its fund portfolios are already trading crypto-linked securities.
Institutions are using a range of vehicles to access the cryptocurrency markets, from funds like the Grayscale Bitcoin Trust fund, the pioneering fund launched in 2013, and NYDIG, the crypto fund manager that just completed a $1bn funding round — one of the largest funding venture rounds in history. Coinbase’s 2021 market debut at an $80bn valuation allows investors to take an equity exposure to the sector, or trade through its institutional offering. The launch of the first bitcoin futures exchange traded funds in the autumn also provides low-friction exposure to the asset class.
Crypto cards are also giving consumers bitcoin purchasing power, with payment giants Visa and Mastercard allowing users to quickly and cheaply convert crypto into traditional currencies for spending purposes. Both have developed large crypto-partner networks and are keen to woo banks and institutions with their innovative crypto propositions.
A blockchain world
One of the factors alongside the headline inflation rate driving the January crypto pullback and the decline in tech stocks is the Federal Reserve’s tapering announcement, with many commenting that bitcoin is no longer a hedge against fiat currency. Time will tell, but these market fundamentals are home turf for sophisticated money managers, many of whom are now into crypto.
In addition, regulatory headwinds look to have also taken some of the shine off the market. The US Securities and Exchange Commission chair, Gary Gensler, has the decentralised finance (DeFi) industry in his sights, indicating that unregulated firms may be offering regulated securities. DeFi, algorithmic peer-to-peer platforms focused predominantly on collateralised crypto-lending products, is seen as an important future ‘platform’ for financial institutions. DeFi’s highly networked governance models in the form of decentralised automated organisations, smart contracts and automated market making (AMM) require no humans to execute and are set to further transform financial services.
In November, the Swiss Digital Exchange (SDX) issued its first native digital bond with Credit Suisse and UBS Investment Bank on R3 infrastructure, and has announced that digital security tokens are not far behind. This is in addition to supporting the Swiss National Bank with a wholesale central bank digital currency, Project Helvetica. SDX is positioning itself in the digital financial market infrastructure (dFMI) space with a focus on smart contracts and the greater transparency of data to facilitate AMM and greater liquidity.
Digital securities often raise an eyebrow from managers who buy and sell securities electronically today. Technology that moves private market securities onto smart contracts on the blockchain will open up an estimated $1tn market for primary and secondary funding to all investment segments, and bring the access and transparency of public markets to private markets. FinP2P, a decentralised private market digital securities network, is leading the way here, following a pilot with many of the world’s top financial institutions.
The digital genie is out of the bottle and it is not going back in. January 2022 marks the 13th anniversary of bitcoin, which has driven an avalanche of technological innovation through distributed ledger technologies, networked governance models, smart contracts, and financial assets and tokenisation, in open and transparent platforms that threaten walled gardens and proprietary systems. Many financial institutions recognise that crypto and digital assets — and dFMI — are an important part of the future of financial services and are positioning themselves to compete.
Lawrence Wintermeyer is executive co-chair of Global Digital Finance.
