Optionality: The key to institutional adoption of digital assets
In this article, Yves Longchamp, head of research at SEBA Bank, explains the rise of digital assets and highlights an important component to unlocking greater institutional adoption.
The digital asset industry is coming of age. Last year’s scepticism has morphed into intense inquisitiveness. In the past nine months, demand for digital asset services has exploded, from family offices to trillion dollar asset managers, firms are exploring digital assets, more often than not due to reverse solicitation from clients. Last month marked 13 years since the publication of the landmark Bitcoin white paper: a period in which the technology of cryptocurrencies has grown and matured and now stands ripe for adoption.
There has never been more momentum behind the adoption of digital assets, with institutional players, in particular, becoming the latest beneficiaries of the asset class. A July report by Fidelity Digital Assets showed that seven in 10 institutional investors expect to buy or invest in digital assets in the future, and more than 90% of those interested in digital assets expect to have an allocation in their institution's or clients' portfolios within the next five years.
This upsurge in interest is evident in other areas, too. Compare, for instance, the hesitant discussions last year among banks considering the value of Bitcoin and weighing up how it fits into asset allocation, with what is happening today: institutions are doing their homework and want tailor-made investment products and pluggable access to trading and custody built on regulated infrastructure.
Fear of missing out on digital assets is beginning to permeate among institutions, with many of the largest financial institutions offering investors at least some exposure to the asset class. BlackRock, the world’s largest asset manager with $9.5 trillion assets under management, is one such notable example. It allows clients to invest in Bitcoin futures via its Global Allocation and Strategic Income Opportunities funds--with further services reportedly to follow in the near future.
Indeed, many of the barriers which once held back the institutional adoption of digital assets have fallen. As the digital asset market has matured, a raft of secure and robust technical infrastructure has grown around it. Regulated and trustworthy partners are in place to securely guide traditional financial institutions into navigating the sector. Coinbase has grown to become a publicly listed company in the US.
Cypto defies doomsayers
When crypto markets tumbled in May, many commentators, perturbed by the volatility of the sector, speculated that it would spell the demise of institutional interest in digital assets. This, however, has absolutely not been the case. In fact, capital inflows to the sector appear to have accelerated, with a record $17 billion in funding flowing to crypto companies to June 2021-- already outpacing funding levels for the entire previous year.
Many of the barriers which once held back the institutional adoption of digital assets have fallen. As the digital asset market has matured, a raft of secure and robust technical infrastructure has grown around it.
Regulation, another major factor in institutional involvement in the space, is also moving in a positive direction. Certain jurisdictions in Europe and Southeast Asia have led the way in offering legal clarity on digital assets to date, most notably Singapore and Switzerland. The latter implemented a comprehensive law on distributed ledger technologies earlier this year.
It is promising to see signs of a number of other jurisdictions following suit. In Europe, The European Commission has been developing a comprehensive framework for digital assets in the form of the Market in Crypto-assets (MiCA) framework. Digital assets, like any other asset class, need clear regulatory frameworks in order to flourish.
Whatever specific legislation entails, the movement towards regulating crypto can only be a positive one for the adoption of digital assets. As clear regulatory frameworks are finalised by governments globally, we can expect a significant acceleration in digital asset adoption by institutions. Already, monetary authorities are looking to trustworthy regulated entities in the digital assets industry who can engage and consult with stakeholders on how best to manage this transition.
Optionality: the flexible solution
That said, what does this all mean for institutional involvement in the industry? Firstly, it is clear that the calculus among many institutions has shifted from: why should we incorporate digital assets into operations, to how can we best incorporate digital assets into operations? Accomplishing the latter is no small feat.
Innovation in the digital asset industry is evolving at a breakneck speed. Keeping pace with the latest technological developments and financial products is daunting for even the largest of institutions. For example, decentralized finance (DeFi), the industry of peer-to-peer financial infrastructure that enables complex financial services without the need for centralised intermediaries, has already accrued $85 billion in assets locked on platforms – despite only existing as a formal concept for little over a year.
This speed of innovation poses significant challenges for traditional financial institutions, which often require ample time to adapt to new financial products and technologies. The solution lies in optionality. Predicting the next major technological breakthrough in digital assets is a fool’s game, even for the deepest of experts, and building infrastructure which may or may not be relevant in five years is not a productive long term strategy.
To mitigate risk, firms need to look to trustworthy providers that offer the full suite of services, including the necessary optionality to integrate new digital asset services as they emerge and adapt services in response to the fast-paced digital asset environment. The freedom to build bespoke products, create APIs and interoperate with multiple specialist third party service providers is the golden ticket institutions are searching for.
Seek out agility in providers
Such providers can absorb the risk for financial institutions of building use-case specific infrastructure and enable institutions to get on with what they do best: managing client assets. The case of asset tokenization provides a telling example for why specialist full suite digital asset providers will be key to financial institutions' entry into the industry.
Currently a nascent market, it is predicted to grow to a multi-billion dollar industry by 2025. For institutions looking to get involved in the space, the size of the market may not make immediate sense for them to build a service offering in the area.
However, by choosing to work with an agile provider who delivers optionality in terms of their digital asset services, they can initially start with services in the highly liquid crypto and DeFi markets, with the capacity to integrate access to asset tokenization markets whenever best fits their needs.
Navigating the complex digital assets industry will be challenging for institutions of all sizes. Optionality is the cornerstone upon which they can make their transition to the industry a success.