In financial markets, regulation is the key driver of institutional adoption. Regulation most directly impacts banks that play the key intermediary role between, on the one side, issuers and manufacturers of investment products – who are also closely regulated – and on the other investors and end-buyers that are less constrained, but that regulation is meant to protect.
Participants in the fast-growing field of decentralized finance (DeFi) talk about institutional money flooding into this new asset class in search of capital gains and income.
They are getting ahead of themselves.
The most recent annual study from PwC and the Alternative Investment Management Association (Aima), released in May, is a reminder that the median assets under management (AuM) at the dedicated crypto hedge funds leading this flow is just $15 million and the median ticket size from their high net-worth (HNW) and family-office clients is only $400,000.
Even beyond hacks and pump-and-dump scams, worrying questions remain
The most successful strategy has been the simplest. In 2020, discretionary long-only in crypto gave a 294% return.
DeFi is not a mainstream strategic allocation yet, but that return is why it could be, with many larger traditional hedge funds now eager to share in the spoils.
Aima surveyed traditional hedge funds with $180 billion of AuM between them. One-fifth already invest in digital assets, which account for an average 3% of their assets, and the vast majority expect to dedicate more capital to them.
Among the 80% of traditional hedge funds not yet in crypto, one-third are either looking to invest and still researching the asset class or are already in late-stage planning to start investing this year.
The main obstacle is regulatory uncertainty. The search is also on for secure ways to invest and ensure safe custody, but the hunger to invest is growing.
In the second quarter, Intertrust Group published a survey of 100 hedge funds with an average of $7.3 billion in AuM, 98 of which expect to be invested in crypto within five years, at a likely average allocation of 7.2% of assets.
Why?
ConsenSys points out in a recent insight report on DeFi for institutions that Compound and Aave are big non-custodial, decentralized peer-to-peer lending platforms that let users lend their cryptocurrency for interest rates far higher than those offered in traditional finance.
In July, Aave launched Aave Pro, which uses know-your-customer’d (KYC) pools to provide institutional investors with direct access to decentralized lending markets.
ConsenSys also notes that decentralized exchanges such as Uniswap, SushiSwap, 0x, ParaSwap and others saw their highest quarterly volume in the three months to the end of June, at $343 billion.
Uniswap is a computer programme hosted on a shared server – Ethereum – which, thanks to a great customer interface, has attracted the highest number of users and largest liquidity pools, and so can transact in digital tokens at the lowest cost.
Even beyond hacks and pump-and-dump scams, worrying questions remain, though, over the Ethereum blockchain at the centre of DeFi and its capacity to process much greater numbers of transactions, potentially in the millions per second.
While the DeFi crowd dreams of that rising tide of traditional money, it is even more focused on Ethereum’s transition next year from proof of work to proof of stake.
