A rise in institutional money pouring into digital assets
In recent years, we have seen a significant increase in the involvement of institutions in the cryptocurrency market. From banks and hedge funds to universities and pension funds, institutions of all types are starting to take notice of the potential of digital assets. JPMorgan Chase & Co to Visa, some of the world’s largest and most well-respected companies, have embraced Bitcoin, digital assets, and blockchain technology in diverse and unexpected ways. This trend indicates that the crypto market is maturing and becoming more mainstream. In this blog post, we will discuss why institutions are starting to invest in the cryptocurrency market, the challenges they face, and the impact they are likely to have on the future of this emerging asset class. Whether you are a seasoned crypto investor or new to the market, this post will provide valuable insights into the current state of institutional involvement in the crypto market and what we can expect to see in the future.
In this article, we will outline how digital asset infrastructure improvements have paved the way for institutional adoption in recent years. So, let’s dive in!
“We see the potential of digital assets and blockchain technology to transform the financial industry, and we are actively exploring ways to participate in this space.”
– Morgan Stanley CEO, James Gorman
The Rise and Fall of Crypto Markets
The cryptocurrency market has seen significant fluctuations in recent years, with both highs and lows impacting the involvement of institutions in the space. In January 2018, the total digital asset market capitalization reached $800 billion, but by the end of that year, it had dropped to $125 billion. In November 2021, it surpassed $3 trillion for the first time, but by July 2022, it had dropped to $900 billion. These fluctuations have been caused by a variety of factors, such as the de-pegging of a significant algorithmic stablecoin and issues with risk management and fraud within digital asset investment and trading firms (e.g., Alameda Research, Three Arrows Capital), lending platforms (e.g., Celsius), and exchanges (e.g., FTX). These events have made many institutions cautious about their digital asset strategies in the near term.
An Overview of Digital Asset Markets
When analyzing institutional involvement in the digital asset market, two key points are clear:
- The industry has grown too large for institutions to ignore. With a total market cap of around $850 billion, institutional investors must have a basic understanding of digital assets to fulfill their client obligations.
- Institutionslookingtostayaheadoftechnologicaladvancementsmustpayattention to the experimentation and innovation happening in the digital asset industry.
Layer-1 platforms such as Ethereum are expanding the capabilities of blockchain technology beyond just digital cash and digital gold and driving innovation in various fields. Stablecoins, decentralized finance, and non-fungible tokens are among the top innovations built on layer-1 platforms like Ethereum that have caught institutions’ attention.
- Stablecoins like USDCoin, which are created on public blockchains and maintain a fixed value with traditional currencies such as the US dollar, provide individuals and institutions the ability to conduct transactions on a low-cost, round-the-clock, and worldwide basis.
- DeFi protocols are revolutionizing traditional financial services by utilizing public blockchains to eliminate the need for intermediaries and offer low-cost financial services to anyone, anywhere, at any time.
- NFTs that are issued on public blockchains are transforming the way digital property rights are defined. They give users unchangeable ownership of things like art, collectibles, and even potentially other assets, such as real estate, which are expected to be tokenized in the future.
Altogether, these advancements have broadened the range of opportunities available in the digital asset market and have given institutions multiple options to consider when it comes to adopting them.
Institutional Building Blocks
The building blocks for institutional adoption in the digital asset market are being established through the emergence of firms that offer products and services such as digital asset exchanges, OTC trading firms, lending platforms, custody firms, digital asset-focused banks, regulated digital asset investment product issuers, and digital asset tax & accounting firms. These firms provide institutions with the tools they need to participate in the market.
Exchanges, OTC Trading, and Lending
Exchanges are essential players in the digital asset market, with Coinbase being a notable example of a reliable and professional exchange that has been in operation since 2012. It has helped onboard millions of users to blockchain technology by providing easy conversion between traditional currencies and digital assets. Despite recent issues with other exchanges such as FTX, Coinbase never suffered a major security breach, and its listing on Nasdaq in April 2021 at an estimated $85 billion valuation was a significant moment for the industry. The volume of digital asset exchanges, which support the trading of traditional currencies, has increased from around $200 billion in 2018 to as much as $1.3 trillion in Q2 2021. Over 20 venues now offer trading pairs between fiat and digital assets.
OTC Trading Firms
Institutional investors are turning to OTC trading firms such as Genesis Global Trading for their large-scale purchases and sales of digital assets. Genesis handled $17.2 billion and $9.6 billion of spot OTC trading volume in the second and third quarters of 2022, respectively. Similarly, Coinbase has also established itself as a significant OTC trading venue, processing $4.8 billion and $450 million of spot OTC volume in the second and third quarters of 2022, respectively.
Crypto Lending Platforms
To meet the needs of institutional investors, lending platforms have been created to allow them to deploy capital and execute complex trading strategies. Genesis Global Capital, the lending arm of Genesis, has originated $244 billion worth of digital asset-related loans by Q3 2022. However, poor risk management and allegations of fraud have become major challenges for these firms and their customers. Despite this, institutional investors have demonstrated a strong demand for these lending firms, as evidenced by Genesis’ nearly $15 billion outstanding loans in Q1 2022.
Custodians secure digital assets on behalf of their customers. They are typically regulated at the state level in the United States (e.g., Coinbase Custody is supervised by The New York Department of Financial Services). At the same time, technology providers (e.g., Fireblocks) provide software that enables customers to secure their digital assets and implement bespoke governance processes.
While institutional custody firms have been in operation for ten years, the industry has matured significantly in the last three to five years, with more than 25 professional custody firms now offering differentiated solutions for securing digital assets across a variety of regulatory jurisdictions.
Companies in the digital asset industry use traditional banking services to pay employee salaries, cover operating expenses, and conduct day-to-day operations. Due to the relatively small revenue opportunity provided by digital asset firms and the increased regulatory scrutiny following the 2007-2008 financial crisis, Wall Street banks have traditionally avoided taking them on as clients. JPMorgan Chase began providing banking services to leading digital asset exchanges Coinbase and Gemini in 2020. Nonetheless, to meet the needs of digital asset intermediaries, several digital asset-focused financial institutions have emerged over the years.
Silvergate and other digital asset-focused banks have fine-tuned their service offerings with 24/7 fiat money transfer services to meet customer demand. One such service is Silvergate’s Silvergate Exchange Network (SEN). It has processed over $1.4 trillion in aggregate transfers and seen demand pick up significantly over the last two years – through Q3 2022, SEN has processed over $100 billion in quarterly transfers for seven consecutive quarters.
Banking Services and Stablecoin Issuance
In addition to meeting the everyday needs of digital asset firms, these banks have played a crucial role in fostering the growth of the stablecoin ecosystem. Stablecoin issuers rely on traditional banking relationships to secure the US dollars against which they issue stablecoins.
While Tether (USDT), which has relatively low levels of transparency and questionable reserve management policies, has historically dominated the stablecoin market, alternatives with higher levels of transparency, such as Circle’s USDC, have been gaining popularity.
Regulated Investment Products
Asset management firms began offering access to digital assets in early 2013 through regulated investment products that trade on secondary markets and are available to retail investors through traditional brokerage accounts.
ProShares’ futures-based Bitcoin Strategy ETF debuted on the New York Stock Exchange on October 19th, 2021, marking a significant milestone in the evolution of Bitcoin investment products. BITO surpassed $1 billion in AUM in just two days, breaking a 17-year-old record set by SPDR’s gold ETF in 2004. Following the approval of BITO, Global X, Valkyrie, and VanEck have all approved futures-based Bitcoin ETFs.
Grayscale officially began its efforts to convert GBTC into a spot Bitcoin ETF in 2021 with an SEC filing.
Tax and Accounting
The Internal Revenue Service (IRS) in the United States issued a notice in 2014 clarifying that digital assets (“virtual currencies”) are to be treated as property for tax purposes. As a result, regardless of their size, all digital asset transactions, including trades of one digital asset for another, are subject to capital gains tax, posing a significant challenge for institutional operators.
The need for regulatory clarity around digital assets and the businesses built around them continues to challenge institutional adoption. However, some progress has been made in the US, with the CFTC stating in 2015 that it views Bitcoin as a commodity and the SEC not classifying ETH as a security in 2018. Despite the rise of alternative layer-1 networks, Bitcoin and Ethereum still account for over 50% of the total digital asset market cap, and their historical classifications as commodities have reduced the risk that institutional firms could face.
In 2021, the OCC also stated that banks could transact stablecoin payments on behalf of their customers, and in 2022, the New York State Department of Financial Services issued formal guidance for stablecoin issuers. The guidance sets clear requirements for the full-backing and redeemability of stablecoins, outlines qualifying reserve asset categories, and mandates monthly and yearly audits of issuers’ management assertions for firms under its supervision. This is considered a step in the right direction regarding regulatory clarity and has spurred increased institutional interest and engagement from regulatory agencies.
Current State of Institutional Adoption
Corporate Treasury Allocations
Corporations are beginning to include Bitcoin on their balance sheets as part of a treasury management strategy. In August 2020, US-based business intelligence company MicroStrategy converted $250 million of its treasury reserve into Bitcoin. As of November 15th, 2022, it held 130,000 BTC (worth ~$2.2 billion), which accounts for 0.7% of all BTC in circulation. Tesla also followed in MicroStrategy’s footsteps in February 2021 and purchased 48,000 BTC (worth ~$1.5 billion at the time of the investment) to diversify and maximize returns on cash.
However, it is still being determined how committed these firms are to their investments over the long term. Tesla sold 75% of its BTC in Q2 2022 to boost liquidity amidst uncertainty stemming from extended lockdowns in China. It is still being determined whether these investments will be accretive to shareholder value over the long term. As of September 30th, 2022, MicroStrategy’s BTC holdings had a cost basis of $4.0 billion, while their market value stood at $2.5 billion, representing a $1.5 billion unrealized loss.
Wall Street Weighs in
Wall Street firms generally have diverse opinions on Bitcoin (BTC) and digital assets. Some have published research reports detailing their investment theses for Bitcoin and even put price targets on it. Others have remained firm in their distrust of Bitcoin and digital assets and are unlikely to change their stance. Despite this diversity of opinions, many top financial institutions have provided their customers with avenues for investing in digital assets. Some have gone as far as entering strategic partnerships with or taking ownership stakes in digital asset startups.
Fidelity is one of the early adopters of Bitcoin; as early as 2014, they began mining BTC. In October 2018, the company launched Fidelity Digital Assets, a standalone subsidiary providing BTC custody and trade execution for institutional investors. In October 2022, the company announced that it would launch support for ETH custody and trade execution. In November 2022, the company began rolling out access to Fidelity Crypto, which allows retail users to buy and sell BTC and ETH directly from the Fidelity Investments App and leverages Fidelity Digital Assets’ trading and custody platform.
“We are open to the idea of digital assets and the opportunities they offer, and we’re actively exploring ways to participate in this space.”
-Wells Fargo CEO, Charles Scharf
Massachusetts Mutual Life Insurance Company also acquired a minority stake in NYDIG, a full-stack bitcoin platform focused on making Bitcoin accessible. At the time of its initial investment, the company also made a $100 million BTC purchase facilitated by NYDIG for its general investment account. In August 2021, the company announced that its broker-dealer, MML Investors Services, would grant qualified clients access to BTC via a fund issued by NYDIG.
Morgan Stanley, Goldman Sachs, Citigroup, and JPMorgan Chase have also begun offering their clients digital assets via funds, partnerships, and platforms. In March 2021, Morgan Stanley started offering digital assets to its wealthy clients via three funds, two from Galaxy Digital and the third via a joint effort of FS Investments and NYDIG. In May 2021, Goldman Sachs began offering exposure to BTC via derivatives trading for its clients and later announced it would add support for ETH derivatives in June 2021.
In conclusion, despite Wall Street firms’ diverse opinions, many have begun to offer digital assets to their clients via funds, partnerships, and platforms. The entry of these financial institutions into the digital asset market is a sign of increasing mainstream acceptance and adoption of Bitcoin and other digital assets. It is still to be determined whether these investments will be accretive to shareholder value over the long term.
Card Networks and Fintech Integrations
Card networks such as Visa and Mastercard are integrating digital assets into their business models. Both networks have gone live with credit card partnerships, where customers can either spend their digital assets or receive digital asset rewards in place of cash-back or loyalty points. Visa, in collaboration with digital asset platform Crypto.com, piloted settlements using USDC directly within its network in March 2021. Visa also purchased a CryptoPunk, an NFT, in support of the emergence of NFT commerce and released a whitepaper on NFTs indicating how it intends to use its network to provide increased access and interoperability to marketplaces. Mastercard announced that it would support digital assets directly within its network by the end of 2021. In September 2021, the company acquired CipherTrace, a crypto analytics firm providing AML services, and in October 2021, announced a partnership with Bakkt to enable customers to buy, sell, and hold digital assets via Bakkt’s custodial wallet and partners to offer digital assets in lieu of traditional loyalty reward points.
Block (formerly knownas Square) has been active in the digital asset space for sometime. It launched BTC trading on Cash App in 2018 and sold over $20 billion BTC through the service. In November 2021, the company announced that it is developing a Bitcoin hardware wallet and published a whitepaper detailing plan to launch a decentralized Bitcoin exchange, tbDEX. In December 2021, the company rebranded from “Square” to “Block” focusing on Bitcoin and blockchain as an increasingly important means to achieving its goal of economic empowerment.
PayPal granted its customers the ability to buy, sell, and hold digital assets in November 2020, later extended this capability to Venmo users in April 2021, and recently granted users the ability to withdraw assets to non-custodial wallets in June 2022.
Robinhood added support for digital assets in February 2018 and, through Q3 2022, generated 26% of its total transaction-based revenue from digital asset trading.
Stripe, the payments software company, had supported Bitcoin payments as early as 2014 but terminated support in 2018, but announced in October 2021 that it would be forming a team dedicated to digital assets tasked with building out the “future of Web3 payments”..
Twitter rolled out NFT profile pictures to its iOS users in January 2022 and currently supports static image (JPEG, PNG) NFTs minted on the Ethereum blockchain.
Betting Big on “The Metaverse” and NFTs
The metaverse is a term used to describe a virtual world becoming increasingly immersive and interactive. While it’s difficult to predict how it will evolve, many institutions are investing heavily in building their versions of it.
However, it is still a distant reality in another sense, as virtual worlds such as Minecraft and Fortnite are far from the immersive digital worlds imagined in popular culture. It is unclear what role blockchain and digital assets will play in metaverse development. Still, given their ability to grant absolute ownership of digital goods and facilitate low-friction value transfer, they will likely play a significant role. Many institutions are investing billions in building their own versions of the metaverse, with some even re-focusing their entire businesses around this concept. It is challenging to predict how the metaverse will evolve, but it is clear that institutions aim to play a significant role in its construction.
Meta: One big company betting on the metaverse is Meta, which has been active in the digital asset space since 2019. In April 2022, the company made headlines when the fee structure for its Horizon Worlds virtual platform was revealed, with transaction fees for virtual asset sales being around 47.5%. This announcement highlights the wide range of how “open” and user-centric different metaverse experiences will be.
Facebook: is another company that is closely watched in the metaverse space. With over 3 billion monthly active users, any metaverse-related product launch from Facebook will have a significant impact not just on its user base but also on other institutions. Through Q3 2022, Reality Labs, the unit that oversees the company’s virtual and augmented reality projects, recorded a year-to-date loss from operations of $9.4 billion.
Instagram also recently announced plans to allow creators to make their own digital collectibles and sell them to fans. The service will be launched via integration with Polygon, allowing users to mint and sell NFTs on the platform. Additionally, Solana users can showcase their NFTs on both Facebook and Instagram.
Venture capital firms: also recognize the potential for NFTs to represent a form of ownership in the metaverse and are placing their bets accordingly. In November 2021, NFT and metaverse investment firm EveryRealm completed the largest metaverse land acquisition, buying 10,000 parcels of land in Somnium Space, a virtual world built on the Ethereum blockchain.
Epic Games and GameStop are investing in the development of the metaverse, a digital world where users can participate in immersive experiences. Epic Games launched a $1 billion fund in April 2021 to expand Fortnite into a platform for socialization events and virtual concerts, while GameStop entered a partnership with Immutable X, an organization that is building an Ethereum layer-2 network for NFTs, to create a $100 million fund for grants to creators of NFT content. Additionally, Immutable X announced a $500 million venture fund for gaming and NFTs. Leading figures from the traditional gaming industry, such as Ryan Watt and Will Wright, have also entered the blockchain-based gaming space, with startups like Gallum Studios raising funds for blockchain-based games.
NFTs and Multi-National Brands
Leading brands are exploring the use of NFTs to stay current and relevant in the fashion and branding industry and for in-game ownership. According to data from Dune Analytics user @kingJames23, top brands have generated approximately $270 million in revenue from NFTs.
Nike is one of the most active blue-chip brands in the NFT space, with $185 million in total revenue generated from NFTs. In November 2021, the company launched an online game zone in Roblox called “Nikeland,” which quickly attracted over 21 million visitors. In December 2021, the company acquired RTFKT Studios, a developer of custom sneakers designed for video game enthusiasts, to further its goal of digital transformation and to serve athletes and creators at the intersection of sports, gaming, and culture. Following the acquisition, Nike released its first collection of virtual sneakers, CryptoKicks, in collaboration with RTFKT in April 2022. Additionally, in November 2022, the company announced the launch of .SWOOSH, a platform for launching virtual apparel such as t-shirts and sneakers, is set to go live via an NFT drop in January 2023. Notably, all NFT mints related to the.SWOOSH platform will be conducted on Polygon at launch.
For several years, the core infrastructure that has enabled institutions to launch digital asset products has been in place. In 2021, institutional adoption of digital assets reached unprecedented levels. Despite recent market volatility, institutional product launches and partnerships with digital-asset-focused startups are expected to continue until 2022.
While enterprise (i.e., private) blockchain deployments (e.g., Hyperledger, Onyx) were touted as the key pathways to institutional involvement in early 2017 and 2018, leading companies have since embraced public blockchains (e.g., Bitcoin, Ethereum, Solana) in novel and unexpected ways. While some have already incorporated the technology into their business models, all indications are that this is only the beginning of their involvement, which will go far beyond simply investing in Bitcoin.
Despite recent fluctuations in digital asset prices and overall sentiment, activity on layer-1 platforms shows no signs of slowing. The long-term trend of tens of trillions of dollars’ worth of value residing on public blockchains is unaffected in the coming years. The institutions have arrived. While their involvement will fluctuate with market cycles and regulatory developments, most are here to stay. Many more are on the way.
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