A new US administration initially brought a flurry of optimism for crypto but as that enthusiasm wanes the industry should refocus its efforts on building the trad-fi foundation that has rehabilitated crypto, says Michele Curtoni, head of strategy, SIX Digital Exchange
A wave of crypto fervour swept the market over the past few months as a new US administration signalled a regulatory environment more friendly to digital assets. That optimism is fading in the face of a number of ‘memecoin’ scandals and slower rollout of new policies.
Crypto is no stranger to waves of hype. It’s almost three years ago, when the market entered the doldrums after the last hype wave ended. The so-called crypto winter culminated with the collapse of FTX, which we now know was caused by a misuse of client funds due to lack of segregation and lax controls in custody.
Between then and now, the crypto industry has been quietly rehabilitating digital assets, rebuilding its image and its very foundation. Many digital assets firms hired from traditional finance, and they brought with them the institutional knowledge of a highly regulated business.
Even through the crypto winter, investors wanted exposure to digital assets but demanded it get the same treatment as real-world assets. One of the fundamental pieces that has given crypto a second life for institutional investors is building the business of holding crypto on someone else’s behalf – custody. Custody is nestled deep in the bowels of post-trade but the market for crypto custody is incredibly vibrant, ranging from completely digitally native custodians to digital-first firms backed by investment banks and traditional exchanges. It may soon include the incumbent custodian banks who are currently building out their digital asset teams and services.
Custody has made crypto investable for institutions, not only by making it safer but allowing for more efficient use of capital. Holding crypto with a custodian can lower margin but through collateral management those savings are multiplied, freeing up more balance sheet for investment. For hedge funds and asset managers who trade using a prime broker or on leverage, centralising collateral is especially important. Having crypto collateralised in the same way or place as traditional securities will further lower the barriers of entry. What will drive institutional investment is making crypto look, feel and behave exactly as any other asset class.
The successful launch of several spot bitcoin ETFs last year demonstrates there is strong demand from investors, but that lack of regulation is holding the industry back. Investors want rules and guidance.
Certainty for crypto
The industry continues to build traditional guardrails around crypto but the most important factor in making it a mature asset class is certainty. Jurisdictions that have passed regulation specifically outlining the rules around crypto have seen the most success in attracting crypto-firms and institutional adoption.
Switzerland has been one of the first countries to allow for digital assets operations to be ‘normalised’ within the certainty of a regulatory framework, leading many Swiss firms to be at the forefront of the industry. The EU followed suit with the DLT Pilot Regime and later with MiCAR. The regulatory certainty around digital assets has given firms confidence to experiment with innovative ways to tie digital assets with the traditional ones, such as through tokenisation of real-world assets.
These rules have created an environment where Europe leads the world for digitally native bonds. According to a report by the Association for Financial Markets in Europe, the EU and Switzerland made up €1.8bn of the €3bn digital bonds issued globally. The US is playing catch-up but is making strides. Within the past month the Securities and Exchange Commission established a crypto task force and repealed SAB 121, which placed crypto on bank balance sheets, clearing the way for more institutional adoption.
Certainty combined with the work the industry is already doing by bringing the safeguards learned from decades of experience in trad-fi markets will underpin institutional adoption in crypto. Its maturity and long-term prospects require a set of rules and regulation to ensure it success isn’t tied to changes in government, whose political or regulatory priorities may fluctuate. Hype comes and goes as these past few months have demonstrated. For crypto to thrive, it must stand on the firm foundation of regulation and institutional-grade infrastructure.
