This article was contributed by Kapil Rathi and Kristin Boggiano, Co-Founders CrossTower
The recent confluence of macroeconomic forces – a global pandemic and unprecedented experiments in monetary policy combined with the rise of stablecoins and central bank digital currencies (“CBDCs”) – is a tipping point for broader acceptance of cryptocurrencies and other digital assets.
Global quarantining has compelled millions of people to move their financial lives online, and embrace commerce without cash, plastic or nonessential intermediaries. It will be fascinating to see whether this unplanned social experiment will open more minds (and crypto wallets) to the use of digital assets in the months and years ahead. But other forces are at play in the rise of digital assets.
Governments around the globe are printing money to mitigate the economic impact of coronavirus while individuals who have experienced hyperinflation are increasingly turning to cryptocurrencies as an alternative to their depreciating government-issued fiat.[1] Many market participants expect heightened inflation given the unprecedented increase in the money supply. The hallmark of cryptocurrencies like Bitcoin is their supply inelasticity and store of value, which make them relatively difficult to seize, freeze or devalue and a natural hedge against inflation.
In May, macro investor Paul Tudor Jones publicized his recent investment in Bitcoin for exactly this purpose, likening it to the choice of gold during the bear markets of the 1970s.[2]
There is ample evidence around the globe that the adoption of digital assets is on the rise. The World Economic Forum established a new consortium to govern digital currencies, including regulated government-issued stablecoins, which central bankers have increasingly embraced.[3] There is widespread discussion in the media about the imminent issuance of China’s DCEP (digital currency / electronic payment), the official name of China’s CBDC.[4] In March, the Indian supreme court opened the Indian market to digital currencies in a landmark supreme court decision, bringing a massive new base of digital asset market participants.
Here in the US, former Chairman of the CFTC, Chris Giancarlo, is heading up the Digital Dollar Project which published its white paper in May on the use cases of digital USD.[5] In April, Libra’s new whitepaper focused on introducing potentially billions of people to the Novi wallet.[6]
Week after week, these and other announcements by industry participants embracing the digital economy continue to emerge. Digital assets, digital wallets and their use are becoming increasingly familiar. Indeed, it will soon be unusual NOT to have a digital wallet, and we will look back to the year 2020 as a pivotal year for digital asset adoption.
Digital Assets – Born Amid Unprecedented Global Pressures
History shows that acute periods of market stress often lead to change, and yet the current pandemic and financial market conditions are not the first to compel investors to consider the merits of digital assets. The 2008 credit crisis led many market participants to lose faith in centralized financial institutions. Boosted by heightened skepticism in the transparency and efficiency of traditional markets, Bitcoin was launched in January 2009 offering the promise of a peer-to-peer, decentralized payment network that sidesteps the opacity and inefficiency of existing trade settlement and clearing processes.
Then, as now, innovation and free market competition continue to reshape global markets with a proliferation of trading platforms and new payment systems and asset classes, some better positioned than others to afford ease of access and protections for participants.
Today’s Crypto Markets
In the 11 years since Bitcoin’s launch, a growing number of platforms have emerged to offer crypto issuance, trading and investment albeit most outside the purview of regulated markets. A lack of regulatory clarity in the crypto markets remains a primary impediment to institutional participation.[7]
Despite the lack of investor safeguards within the 100+ crypto exchanges in existence, the industry has experienced significant growth in size and scope in recent years. According to CoinMarketCap, the market capitalization for digital assets increased 32 times in 2017 reaching a record high of $829 billion in January 2018 before falling by 70% to $250 billion in April 2018. The crypto markets have since experienced extreme volatility and inflows, consolidating at a range of $150-$500B.[8]
In March, Bitcoin and broader crypto markets plunged in the ETH-led Black Thursday selloff[9] as market volatility reached new heights. According to CryptoCompare’s March 2020 Exchange Report, March 13th produced the single greatest volume in the history of crypto assets, with all exchanges and markets producing $75.9 billion in trade activity over 24 hours.[10] This was followed in April by the second highest daily trading volumes of $66.2 billion, and Bitcoin surpassing $9,000.[11] Trading venues have seen the strongest activity in the most widely held crypto assets, including BTC and ETH.
Some conclude that the volatility in cryptocurrencies make it akin to tulip mania and have the shortsightedness to dismiss it as an illegitimate asset class. However, others note that young asset classes often experience volatility. Andreessen Horowitz, the famed Silicon Valley venture capital fund, concedes that the cyclical evolution of crypto markets can appear “chaotic,” but believes there is an underlying order that is indicative of the longer-term growth of the asset class.[12]
Institutions are Coming
The combined forces of the global crisis, macroeconomic risk, unprecedented experiments in monetary policy along with alluring spreads and seismic stock market activity are driving traders and investors to consider the merits of crypto finance seemingly as never before.
Indeed, cryptocurrencies are seeing historic institutional interest and inflows as a means of portfolio diversification, hedge against inflation and arbitrage trading. In 2019, one of the largest investment managers of digital assets, Grayscale, achieved more than $600 million of inflows into their funds, surpassing all investment from 2013 to 2018 combined. In Q1 2020, Grayscale raised a total of $503.7 million, nearly doubling its previous quarterly record high of $254.8 million in Q3 2019.[13] In May 2020, Andreessen Horowitz was reportedly targeting $450 million for its Crypto Fund II, which was significantly oversubscribed and raised a staggering $515 million.[14]
This momentum is consistent with State Street’s most recent industry outlook survey, which showed sizable gains in the credibility of digital assets among institutions. According to the survey, ninety four percent (94%) of the bank’s clients that responded to the survey already have or plan to have digital asset-related investments within the coming year. Additionally, more than two-thirds (69%) of the largest firms are now planning to increase their allocations to this asset class.[15]
Further underscoring growing institutional interest in cryptocurrencies, one of the most widely respected and profitable hedge funds in the history of hedge funds, Renaissance’s Medallion Fund, with some $10 billion in assets under management,[16] plans to include BTC futures in its portfolio.[17]
Furthermore, according to the 2020 Crypto Hedge Fund Report from PwC and digital asset investment specialist, Elwood, hedge fund investment in digital assets is notably growing. The total AUM of crypto hedge funds doubled globally to over US$2 billion in 2019 from US$1 billion the previous year.[18] Unlike in the broader hedge fund markets, crypto hedge funds are able to command 2/20, indicating there is opportunity and demand to get paid to manage digital assets.
This contrasts with activity in the traditional markets where, for example, BlackRock, the world’s largest asset manager, revealed net outflows of $19 billion for Q1 2020.[19] BlackRock saw net outflows from its long-term investment products for the first time in five years during the first quarter.
Why Institutions Have Only Inched Into Crypto
The emergence of numerous new prime brokers in recent weeks is evidence of the maturation of the crypto asset class and a means of addressing market structure fragmentation and a lack of consistent liquidity. Nevertheless, the vast majority of investors are entering the asset class cautiously.
For one thing, there continues to be skepticism regarding valuation metrics for cryptocurrencies, and therefore traditional asset managers that rely on fundamental valuation have not embraced the asset class. This may change as more data and correlations related to cryptocurrencies are published and more research is done. Institutional clients are keeping their eye closely on this issue.
There are a host of other issues holding institutions at bay. Among these, most crypto exchanges face exorbitant fees, fragmented or stale liquidity, poor technology as well as limited customer service.
Also impeding adoption is the significant uncertainty regarding the regulatory framework for cryptocurrencies. Anti-money laundering (AML) and know-your customer (KYC) standards are inconsistent, for example, [20] although there is a global push for standardization of KYC through the Financial Action Task Force. [21] As well, there is a widely discussed lack of regulatory clarity regarding crypto custody. Additionally, the rules and regulations for trading and investing across globally dispersed crypto exchanges vary widely among states and countries, exacerbating the challenge of participating safely in digital markets that trade both around the clock and around the world.
Conclusion: A Unified Marketplace is on the Horizon
In the crypto industry, regulatory clarity, price discovery, custody and payment standards will take time to emerge. For instance, measures to maintain price and transaction transparency, long established in traditional markets, are now being developed. Eventually, we foresee the creation of a consolidated crypto market data feed that supports National Best Bid and Offer (NBBO) visibility and a global marketplace in which cryptocurrencies and traditional assets trade with the same level of protections.
If any good can come of it, the current global crisis could for the first time establish crypto and decentralized finance as a more prevalent means of availing more efficient financial services to more people, including those who lack the reach and resources to transact.
We look forward to playing an active role in the evolution of financial markets as innovation paves a path to a next generation digital economy.
[1] https://inflationdata.com/articles/2019/07/15/high-inflation-drives-countries-crypto/
[2] https://www.scribd.com/document/460382154/May-2020-BVI-Letter-Macro-Outlook
[3] https://www.ft.com/content/b8fa16c6-6d11-11ea-89df-41bea055720b
[4] https://www.forbes.com/sites/biserdimitrov/2020/04/16/these-chinese-blockchain-platforms-are-launching-soon-here-is-why/#14c37d73207e
[5]https://static1.squarespace.com/static/5e16627eb901b656f2c174ca/t/5ecfc542da96fb2d2d5b5f15/1590674759958/Digital-Dollar-Project-Whitepaper_vF.pdf
[6] https://libra.org/en-US/white-paper/#cover-letter
[7] https://www.finextra.com/blogposting/18398/we-need-more-clarity-to-regulate-digital-assets-on-a-global-scale
[8] https://coinmarketcap.com/
[9] https://www.theblockcrypto.com/post/61797/maker-foundation-class-action-lawsuit-black-thursday?utm_source=newsletter&utm_medium=email&utm_campaign=2020-04-14
[10] https://data.cryptocompare.com/reports/exchange-review-march-2020
[11] https://www.cryptocompare.com/media/36935188/cryptocompare_exchange_review_2020_04.pdf
[12] https://a16z.com/2020/05/15/the-crypto-price-innovation-cycle/
[13] https://grayscale.co/wp-content/uploads/2020/04/Q1_REPORT_2020.pdf
[14] https://www.coindesk.com/vc-firm-andreessen-horowitz-targets-450m-for-second-crypto-fund-report
[15] https://newsroom.statestreet.com/press-release/corporate/state-street-survey-reveals-bright-future-both-digital-assets-and-semi-trans
[16] https://www.wsj.com/articles/renaissance-s-10-billion-medallion-fund-gains-24-year-to-datein-tumultuous-market-11587152401
[17] https://files.adviserinfo.sec.gov/IAPD/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=636807
[18] https://www.pwc.com/gx/en/financial-services/pdf/pwc-elwood-annual-crypto-hedge-fund-report-may-2020.pdf
[19] https://s24.q4cdn.com/856567660/files/doc_financials/2020/Q1/BLK-1Q20-Earnings-Release.pdf
[20] https://ciphertrace.com/q3-2019-cryptocurrency-anti-money-laundering-report/
[21] https://www.wsj.com/articles/crypto-firms-assess-how-to-comply-with-anti-money-laundering-standards-11568626200
