25 May 2020

The Institutional Adoption of Crypto

For years, there have been dramas regarding the relationship between the institutional world and digital assets. Large institutions have historically been skeptical about cryptocurrency, but recently we see keen institutional interest in this new asset class.

The Surge in Institutional Investment in Crypto Funds

According to Grayscale Investment’s Q1 2020 report, they had $2.2 billion in assets under management (AUM), and 88% of those came from institutional investors and significant hedge funds. Resulting in the most substantial quarterly rise in Grayscale history, raising $503.7 million just in the first quarter of 2020. With the market crash due to COVID-19, the fast recovery of Bitcoin price strengthens the gold narrative of Bitcoin and its ability to become a hedge, which could become a lure to institutional investors looking to include digital assets in their portfolio. From 2018 to 2020, Grayscale’s AUM nearly ten-folded from $248 million to $2.2 billion, while institutional investments went from 56% to 88%. Meaning that within less than one and a half years, there was nearly a $1.8 billion inflow of institutional investment into Grayscale’s digital asset funds.

Led by Michael Novogratz, an ex-hedge fund manager in Fortress Investment Group and ex-partner of Goldman Sachs, Galaxy Digital launched two new Bitcoin funds in November 2019, for institutional and accredited investors. At the end of April 2020, Galaxy Digital reported its preliminary assets under management (AUM) as $370 million.

While a lack of regulation has been one of the obstacles for institutions to embrace crypto fully, now Grayscale and Galaxy Digital, two leading crypto investment companies, are both registered with SEC, U.S. Securities and Exchange Commission. With the regulation and legal enforcement provided by the SEC, more institutional investors may ease up and be comfortable with crypto investment soon. Moreover, on June 3, 2020, the old-school investment management firm VanEck, and cryptocurrency data provider CryptoCompare are launching an hourly Bitcoin benchmark rate. Such a representative reference rate would be significant for professional investors to get a more accurate measure of the Bitcoin performance as well as be more confident to invest in the digital asset class.

Major Bank’s Crypto Paradox

J.P. Morgan, the biggest bank in the US, despite its CEO Jamie Dimon calling Bitcoin a “fraud” in 2017, is an early adopter to the blockchain technology and cryptocurrency. As early as in 2016, J.P. Morgan started to build its Quorum Blockchain platform as part of the Ethereum Enterprise Alliance. On February 14, 2019, it launched its digital coin, JPM Coin, as a stable coin that matched the US fiat dollar. JPM Coin’s goal is to achieve instant payments and is exclusively for institutional clients currently. In April 2020, J.P. Morgan approved banking accounts for Coinbase and Gemini crypto exchanges, officially stepping in to service the crypto exchange market.

On the other hand, Goldman Sachs holds very consistent disapproval regarding Bitcoin from 2017 to 2020, while they have been actively investing in multiple crypto startups. On May 27, 2020, Goldman Sachs held a call with clients entitled “US Economic Outlook & Implications of Current Policies for Inflation, Gold, and Bitcoin.” Before the meeting, the public made plenty of predictions if Goldman will finally consider Bitcoin in their investment portfolio, and many were optimistic. Yet, Goldman Sachs castigated Bitcoin and cryptocurrency, saying that they’re “not an asset class,” and “not a suitable investment for our clients.” With a clear goal to keep its clients away from crypto investment, Goldman Sachs itself invested in many crypto projects, including BitGo (provides institutional-grade custodial and liquidity solutions for digital asset investment), Circle (launched USD Coin), Axoni’s Equity Swap Platform (a blockchain built tool initially designed for Ethereum), among many others.

All evidence implies that major banks may not be fans of Bitcoin, but they are believers in the crypto technology and the market behind it.

Building Infrastructure for Institutional Crypto

As more institutional investors and banks are in the market, more institutional-grade infrastructures are also under development.

In 2018, International Exchange (ICE), who owns the New York Stock Exchange (NYSE), launched Bakkt. It aggregates digital assets to enable instant liquidity and transactions for both institutional and retail clients, which could be a significant infrastructure for future large-scale adoption of daily crypto usage. In September 2019, Bakkt launched Bitcoin Futures. As discussed in Seaquake’s article about Bitcoin Derivatives, adding derivatives would potentially add more volume and drive up the price. That’s when robust infrastructure will be the most needed.

In December 2019, Fidelity Digital Assets Services fully rolled out its custody and trade execution services for institutional clients. In February 2020, Swiss securities giant SIX Group led a $14 million investment into Omniex, a provider of an institutional trading platform for digital assets. Furthermore, BitGo, Coinbase, Gemini, and many more companies launched their crypto custody services. All the preparations are done as crypto is marching towards institutionalization.

Besides basic trade execution and custody service, institutions also heavily rely on competent and consistent market making and liquidity providers in order to facilitate their larger market orders without slippage.

Are We Ready?

Concluding what has been happening in the past years — more institutional investors in crypto funds, crypto asset management firms getting SEC approvals, the biggest bank in the US launched its digital coin, more crypto projects backed by major banks, crypto derivatives becoming the new trend, players busy building infrastructure for institutional crypto, …. All events pointing to the definite path of the institutionalization of crypto.

For an asset class to be bankable and institutionalized, many more infrastructures are needed to support that. Except for custody service, the ability to execute large volume orders without slippage is another key to enable the system flow. The next building block for the institutional adoption of crypto is to fulfill the demand for a smart order routing system to provide liquidity and market-making. Only with reliable crypto market makers and crypto liquidity providers can institutions be confident in executing large orders in high frequency without slippage. Are we ready for the game?

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