Cryptocurrencies offer a new paradigm of money that can solve short-term issues of volatility, high transaction fees, and slow settlement. The system is designed to be faster, more secure, and cheaper than existing monetary systems.
Cryptocurrencies are a form of digital money. Like traditional money, cryptocurrencies are units of account, stores of value, and mediums of exchange, including remittances and cross-border transfers. However, because bitcoins and other cryptocurrencies do not possess a central issuer like banks or governments, but rather function autonomously via blockchain technology, they were designed to be much more reliable (and secure) than traditional payment systems.
Crypto Market Inflection Point
The digital asset market is at an inflection point. Institutional interest in the asset class is at an all-time high. In light of the significant downturn in crypto markets, that development may seem strange, but this bear market is unlike any other.
In spite of short-term volatility, institutional players are now focusing on the long-term when it comes to digital assets. A number of leading asset managers have invested in digital assets this summer, including Abrdn, Blackrock, and Charles Schwab.
Investors from a wide range of backgrounds are clamoring for access to this sector, which is representative of a broader trend. Over a third of traditional hedge funds now invest in digital assets, nearly double the figure from last year, according to a PwC report.
Several centralized-finance companies have also collapsed this year. Known as CeFi, they specialize in digital assets and are relatively traditional financial institutions. There is hardly any or no regulation of many of them. Many investors’ go-to-market strategies have also been fundamentally reshaped by prominent failures.
Customers have only limited clarity on what will happen to their assets after Celsius, Voyager, and Vauld declare bankruptcy. Transparency, asset security, and deposit protection are now top priorities for investors.
A new understanding of this asset class’ volatility is driving demand. Institutional investors, however, need to have confidence in the industry and unlock the next phase of growth by addressing a few key concerns.
Our first step should be to learn from the CeFi wipeout. The collapse of a number of CeFi platforms serves as a stark warning to investors. In spite of the fact that these platforms mimicked traditional banks on the blockchain, they were unable to sustain their business model due to a lack of supervision or regulation. It became obvious when the market began to turbulence that some platforms didn’t have enough deposits to support client withdrawals once there was significant market turbulence.
Crypto Assets
For institutional investors to engage with digital assets at scale, there needs to be a clear set of rules of the road. Asset managers won’t invest in markets where basic financial requirements aren’t met, or where supervision is ineffective.
Liquidity and capital requirements must be imposed on such companies in order to encourage them to engage with digital assets. In order to ensure investors’ deposits are protected, financial institutions must impose standardized deposit protections and monitor them closely.
The funds deposited with bankrupt CeFi platforms have not yet been received by many investors. In many jurisdictions, digital assets are subject to fledgling legal and regulatory frameworks, making it unclear when or even how much they will receive. These issues must be addressed by regulation.
Regulation of digital assets has been led by several jurisdictions: Switzerland and Singapore have two of the most well-established frameworks, providing clear rules for operators to engage in the sector with confidence. A growing number of states are now joining these jurisdictions in an effort to unlock the burgeoning growth and innovation in the sector.
A landmark regulatory bill on digital assets was adopted by the EU in June. The “Markets in Crypto Assets” act harmonizes rules on digital assets and infrastructure across the 27 member states and gives the European Securities and Markets Authority the power to ban or restrict crypto platforms that fail to adequately protect investors. In this way, prominent institutional players will be able to invest with confidence in the digital asset sector.
There is a lot of interest in the EU’s plans among other leading financial centers. It is noteworthy that President Biden’s executive order on crypto has prompted U.S. regulatory agencies to develop a comprehensive, overarching framework for the asset class. Likewise, the United Kingdom intends to be a global hub for digital assets, with the Treasury announcing a regulatory framework and a “financial market infrastructure sandbox” to encourage innovation.
As states develop regulations, they would benefit from collaborating. By doing so, we would avoid creating friction in our financial infrastructure. In addition to greater transparency and strict capital requirements, this regulation should take into account the fallout from the CeFi meltdown.
Security is the final piece of the institutional jigsaw. In the crypto industry since January, over $2.4 billion has been hacked or exploited. In order to mitigate the risk of asset compromise, investors need institutional-grade infrastructure.
Institutions have debated the merits of different key-management technologies. When evaluating counterparties, investors should look beyond technology. In the event of a compromise, deposit insurance can also guarantee reimbursement, while regular independent reporting on custody solutions should be considered a security requirement.
Companies should also segregate assets on their balance sheets, as shown by the CeFi collapse. When a financial collapse occurs, investors’ assets are at risk if they use counterparties without segregation.
There is no doubt that institutional engagement with digital assets is entering a new phase of growth. As a result of the development of clear regulation and the availability of mature institutional-grade infrastructure, investors are participating with increased confidence in the sector. The future of financial services will be shaped by digital assets and their associated infrastructure. Now that an institutional adoption blueprint is in place, investors must ensure they don’t get left behind.
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