By Anton Chashchin, Managing Partner, Bitfrost.io
Crypto markets have had a bad start to the year and many enthusiasts may have déjà vu of the crypto winter that followed the 2017 boom.
However, we are not in a crypto winter – far from it. The crypto industry is completely different to what it was in 2018. While 2017 was largely driven by more fickle retail investors, the latest boom has been caused by an influx of institutions, and they are in it for the long haul.
Research has found that 80% of institutional investors were now allowed to have exposure to cryptocurrencies, with nearly two-thirds of them already with dedicated staff for the crypto market. Last year, a total of $1.14tn worth of cryptocurrencies were traded by institutional clients in 2021, up from $120bn the year before. Many large companies – and even some governments – are entering the market, with crypto funds seeing billions of inflows as institutions have entered the scene.
The decision-making process behind these is strategic and considered, with risk assessments and board meetings preceding every buy. By buying and creating more scarcity, these institutions are catalysing a positive cycle that will contribute to a healthy growth trajectory despite volatility.
Reasons for adoption
So, why are institutions entering the market? Generally, there are three key reasons.
First, institutions have recognised the potential in crypto and view it as a forward-thinking move. Many institutions have lockup policies or will use Bitcoin as a hedge against growing global inflation. As such, they will look to buy the level of crypto that suits their risk appetite.
Second, it’s affordable. Whether a smaller firm or a trillion-dollar fund, if an institution’s objective is to have 5, 10 or 20 per cent of their portfolio converted to crypto, they have the liquidity to do so.
Third, adoption is self-perpetuating. Institutional trading creates larger volumes, and larger volumes attract new institutions. Simultaneously, any holding behaviour adds to scarcity.
As Bitcoin has reached all-time highs, interest among traditionally conservative entities continues to grow.
The primary incentives of institutions differ depending on what the buyer is looking to achieve. But whereas retail investing is usually speculative, institutions have more responsibility and movement into the space has been carefully considered.
First-time buyers
The majority of this segment is still traversing cryptos for the first time and therefore tend to lean toward Bitcoin given its popularity, status, and liquidity, which means they view the asset as trustworthy.
Their advances into cryptos are not necessarily because they’ve fallen in love with Bitcoin, but rather they’ve fallen out of love with the excessive fees and legacy services of traditional banks. Some approach it with a risk-averse mentality – only working with countries with licenses. Others opt for a higher risk, higher return approach.
In many cases though, the overarching objective of the institution is education. Even though they may not fully trust crypto, it’s often a pilot project as opposed to being core to their strategy or a get-rich-quick scheme. They want to know what benefits they could reap from using cryptocurrencies. To do so, their CFOs, accountants, lawyers, and managers have to learn how to invoice, send, receive, exchange and tax cryptocurrencies.
Asset managers
This category is the most famous buyers of cryptos, with numerous setting up specialist teams to integrate crypto assets into their portfolio. The scarcity of Bitcoin and growth trajectory aligns well with their own growth plans.
Rather than being put off by the hype, buy-side funds utilizing it to attract more investors, typically adopting the most modern top-performing assets into their portfolio. Consequently, their strategy is fairly PR-heavy.
With more investors on board, they can then buy more Bitcoin and thus gain more commission. The most famous example of a fund selling securities as shares of a fund that has crypto assets on its balance is Grayscale Bitcoin Trust in the US, but there are dozens of similar funds operating across Europe.
Trusts and estates
As crypto has gone increasingly mainstream, the older demographic is gradually becoming interested in reaping the benefits, in turn pulling in established investment vehicles.
Some among the older demographic do not know how to invest in crypto and therefore ask their estate planners to bring crypto assets into their trusts on their behalf. Today, more and more trusts are converting parts of their holdings into Bitcoin. This demand means crypto expertise is an increasingly competitive part of many estate planners services.
Trusts also have used for the more experienced crypto investors. For example, a trust can be used for tax efficiency. Transferring Bitcoin to a trust is not taxable. This allows beneficiaries to reduce taxes on their capital gains while also drawing in more traditional investors.
Furthermore, trusts provide anonymity. Many investors are concerned by the lack of anonymity that Bitcoin provides following new KYC/AML regulations. It means anyone could easily find out where an individual is spending their crypto. Living trusts provide an additional level of privacy by attributing asset ownership to the trustee instead of the owner.
Family Offices
With crypto-aware millennials rising through the ranks, institutional style family offices are increasingly exploring Bitcoin.
Whereas trusts have other motivations, family offices simply want to maximise returns. For them, the attraction to Bitcoin is that it is a protective asset, like gold, due to its scarcity. By allocating just 1% to Bitcoin, an office can safely expect 1-5% return without any significant risk, which is similar returns to some assets which account for 30% of the portfolio.
And the better these Bitcoin investments perform compared to the rest of the portfolio, the more family offices will invest. In fact, Bitcoin is increasingly seen as having an edge on gold. Whereas Gold has real-world limitations, Bitcoin is unconstrained and its room for growth theoretically exponential.
These arguments paired with the post-covid investment landscape have led to a rise in family offices holding Bitcoin.
Liquidity providers
This segment of buyers applies to anyone who provides digital asset services. Whether it a fintech, fund or exchange, you need to buy digital assets in order to sell it.
When it comes to trading BTC/USD, both base and quote assets are needed in the exchange. And as operations are scaled, more is required.
Companies like this are very susceptible to market opportunities. While many closed their crypto trading desks in 2019 because of a lack of low trading volumes, 2022 saw many open once again for business.
As more liquidity start-ups emerge, initial liquidity will become increasingly essential, and thus so will liquidity partners. And as liquidity improves in the market, it will tempt more institutions to enter the market.
A growth cycle
The growing amount of institutional adoption acts as a cycle of positivity for the industry. More institutions in the market encourages competitions and sophisticated products, as well as regulatory initiatives, which is evidence of a stable and maturing market.
Ultimately, greater institutional involvement creates stability, which leads to more institutional investment: an ongoing cycle of acceptance, adoption and innovation.
