The crypto industry thus far has been largely populated by scrappy startups rather than by large institutions due to a number of roadblocks that have held the big players back.
But the crypto world will not be able to get to the next level of development without institutional investors and their massive amounts of capital. It’s time to address these barriers and create an infrastructure and climate that will allow the crypto space to go mainstream and live up to its true potential for all investors.
Regulation, or the lack thereof, is a major roadblock to getting traditional institutions involved in the crypto space. Major players simply don’t want to get into the game until the rules are clear. Right now, global regulators are all over the map as they attempt to deal with the rise of blockchain technology while still protecting the financial system and investors.
Some, such as China and India, have taken a firm stance against cryptocurrencies and exchanges. Others are more receptive, including Japan and Switzerland, where bitcoin is legal tender in practical terms and crypto exchanges are allowed if registered with financial supervisory agencies.
The United States still presents a complex environment for crypto, and institutional money will continue to hesitate to enter the crypto market in the absence of a standard definition and regulatory treatment.
The Securities and Exchange Commission (SEC) defines most crypto assets as securities, while the Commodity Futures Trading Commission (CFTC) views them a commodity and the Internal Revenue Service (IRS) sees them as property. Meanwhile, Bitcoin is not officially legal tender in the country, even though many states allow exchanges and trading.
However, the fact that a senior SEC official has said that Bitcoin and Ethereum are not securities has helped removed some uncertainty about the leading cryptocurrencies.
The lack of regulation contributes to one of the biggest challenges facing institutional investors — custody issues. In many jurisdictions, investment funds with more than $150m (£115m) in assets cannot legally custody their own assets, so they must work with trusted third parties to take custody of their assets.
However, regulatory uncertainty has kept many traditional custodians, such as The Bank of New York Mellon, JPMorgan Chase, State Street Bank and Trust Company and Citigroup, on the sidelines, leaving limited custody choices for institutional investors. While large funds may desire to enter the crypto space, custody logistics hold them back.
However, this has created opportunity for upstarts to stake out new territory. For example, Japanese investment bank Nomura Holdings Inc. joined crypto firms Ledger and Global Advisors to create a custody consortium called Komainu. More recently, Coinbase acquired securities dealer Keystone Capital, an SEC-registered broker-dealer, while Circle has applied for a banking license.
Liquidity is another major challenge for crypto. Crypto exchanges are highly fragmented, which leads to liquidity issues in a volatile market. This, in turn, creates a barrier for institutions used to making big investments. This illiquidity makes it difficult for institutional investors to engage in business as usual without distorting markets by creating huge price swings. So, while conventional trades are executed in seconds, the sale of large holdings can take much longer on crypto exchanges. Five minutes of trading on the world’s foreign exchange markets bring higher transaction volume than in a whole day on the crypto markets.
While custody and regulation challenges are slowly being solved, institutions are still held up by the lack of technology to enable trade execution — and they will continue to hesitate to enter the crypto space unless they can execute trades with the speed and ease that they are used to in the traditional trading world.
Certain members of the industry are now endeavouring to develop technological solutions that can help institutional investors get past these roadblocks as well as support them once they enter the crypto world.
Institutional-grade platforms are now becoming available that can check prices across multiple exchanges, manage risk portfolios and support high-frequency trading to meet the needs of sophisticated investors. As the roadblocks to crypto markets come down for institutional investors, these companies are waiting to help them make the most of the crypto world’s potential.