There have been rumors about institutional money moving into crypto assets for some time now. On November 16th of last year, Coinbase chief Brian Armstrong indicated that there may be up to $10B dollars of institutional money 'waiting on the sidelines' to invest. In late December, Goldman got everyone talking again with the announcement that they would be setting up a cryptocurrency trading desk. For a minute there, the future of institutional money moving into cryptocurrencies seemed like it was right around the corner. So why haven't we seen it happen yet?
'You're telling me to invest in what, exactly?'
The simple explanation here is that the cryptosphere has gotten out over its skis a little bit. Yes, the gains that the market saw in 2017 were eye popping. And with one year upstarts like Binance recording larger profits than Deutsche Bank it's only a matter of time before the institutional money will want to get in on the fun. But global asset managers including sovereign wealth funds, endowments, pensions, foundations, and mutual funds (among others) are used to acting in a certain way. They have a very established method of behaving and investing in the current financial system that they are comfortable with. Additionally, the class of investors mentioned above control roughly $131 trillion of global wealth. Along with that colossal stock pile of money comes a high degree of fiduciary responsibility, one that won't be gambled on assets that are perceived as at best overly risky, and at worst potentially fraudulent. But let's break it down a little more, because there are a host of other reasons that institutional capital is (in the words of Brian Armstrong) waiting on the sidelines.
A Host of Other Reasons
1. Education - So I did just talk about this one, but I think it's the most significant roadblock so I'm going to reiterate here. Fund managers will not invest in an asset that they don't at least have a basic understanding of. And this extends beyond just how blockchain works. They need to understand why this asset is likely to outperform over the next 3, 5, or 10 years (depending on the structure of the investment vehicle they choose to go with). Also, in many cases institutional gatekeepers can't allocate capital like a retail investor. They need an investment thesis, and it'll be up to existing players in the space to help them develop one.
2. Infrastructure - Even if fund managers did understand and want to invest in crypto assets, they would have extremely limited opportunity to do so today. That is because the current market lacks the infrastructure to support an institutional level of capital. Let's examine the topic at the forefront of everyone's mind right now: custody. In the existing financial system, institutional investors rely on trusted custodians (i.e BNY Mellon, State Street, etc...) to physically hold onto their financial instruments. Additionally, traditional financial assets are typically instrument registered as oppose to crypto assets, which are 'bearer.' Crypto assets represent both a technological challenge to safely custody, as well as a significant 'trust barrier' for institutional money. Until there is a well developed and trusted custodial solution, the big money will continue to sit on the sidelines. What will be interesting is whether the Wellington's of the world will trust existing custodians like Coinbase or if they will wait for the BNY Mellon's of the world to move into the space. Time will tell.
3. Regulation - Hard to overstate the importance of this barrier to entry. As of December, the SEC had issued extremely limited guidance as to how token issuances would be treated. Jay Clayton’s recent statement on Ether has given investors the impression that an asset may start out as a security, but somewhere along the line can transition into either a currency, property, or commodity. What we still don’t know is the exact criteria for when that shift happens, or if this direction will hold up in an official ruling. Until investors are absolutely sure how to be compliant, they will hold off on major capital commitments.
4. Liquidity - The proper definition of liquidity is 'the degree to which an asset can be quickly bought or sold in the market without affecting the price of the asset.' Based on that definition, there are currently no liquid crypto assets for institutional investors. This is a pretty ironic (and rarely talked about) point, because one of the primary advantages of crypto assets is supposed to be their liquidity. One promising solution to liquidity (as well as volatility) is stablecoins. I've discussed in other articles how a stablecoin pegged to the US dollar could be an interesting solution to the liquidity issue in the crypto space.
5. Stigma - This reason shouldn't be discounted. In the case of crypto assets, perception truly is reality. And right now, the reality is that many of the venerable names on Wall Street simply do not want to be associated with the 'lambo money' stigma of crypto, even if they recognize opportunity. Now, once the space matures and the bad actors are weeded out this problem will in all likelihood sort itself out. In the short term at least though, the fear of negative public perception will prohibit capital inflows.
Slowly at First, and Then All at Once
It's difficult to put a timeline on when we'll institutional money roll in. Ari Paul, who regularly communicates with pensions and endowments and the like, thinks we'll see institutional investment over the next couple of months. He also has predicted that although no one wants to make the first move, plenty will follow quickly after someone does. Because after all, what institution wouldn't feel comfortable investing after Yale's endowment has?
I think the bigger question is what this will mean for the space. Let's return to our definition of liquidity for a second, and the lack thereof in the current crypto ecosystem. At the time of writing this article, the total market cap for all cryptocurrencies is $273B. Now let's take a look at BlackRock, which has just under $6.3 trillion in AUM. If BlackRock were to allocate just 1% of its portfolio to crypto assets, the total market cap of the space would increase by 23% overnight.
That scenario isn't likely to happen anytime soon. But, that being said, it's not ENTIRELY unlikely to happen, and is a good illustration of how relatively tiny the space still is. I think it'll also be interesting to see some of the hallmarks of more mature financial markets that institutional players bring in with them. You've got players like Genesis Trading and Capital working on two way price discovery by providing borrow. You've got the Winklevii that just secured their second patent for a regulated ETF. Some of the early movers and crypto anarchists might be sad to see the 'wild west' feeling of the space diminish over the coming months, but ultimately it's what's needed for the space to progress.