Are the institutions really coming this time?
Recent events may have created the perfect cocktail for institutions to get involved and alter the crypto market structure for good.
Consider the following statement:
“Crypto markets are undergoing a significant transformation. What began as a fragmented, speculative ecosystem is now maturing into a robust financial sector, increasingly intertwined with traditional finance (TradFi). Regulatory shifts, the emergence of new products and institutional interest are driving this change, with tokenized assets taking centre stage.”
If you’ve been following the crypto markets for several years, you will have undoubtedly heard this statement before, and we wouldn’t blame you for taking it with a big grain of salt. In the wake of the US election, crypto seems to have become the talk of the town again, with Bitcoin making new highs and the sector overall enjoying capital flows similar to the last bull cycle. The questions on everyone’s mind now are: how sustainable is this new uptrend and what, if anything, is different from last cycle? And what role will institutional investors play in all this?
Presumably, if the adoption of blockchain technology and applications is obvious, the institutional money will follow. However, when looking at previous technology cycles, it appears that creating the financial conditions for people to speculate on a certain technology, is equally important as its real-world utility in determining the odds of its success. In the case of crypto, its mostly unregulated nature over the past few years has meant that it was very easy for retail investors to invest in the asset class. Contrary to popular belief, this is actually a good thing (!). The flip side, however, is that large TradFi institutions have had valid reasons to stay on the sidelines as they didn’t know if they could “legally” interact with the technology.
Retail capital isn’t sticky. It ebbs and flows with hype cycles and tends to amplify the volatile boom-bust cycles that have characterized the asset class since its inception. This has been painfully evident over and over again, the latest example being August 5th after the BOJ increased interest rates which led to a market-wide sell-off; equity markets globally saw a mid- to high-single digit correction while crypto gapped down 20-25% in a single day. This is because, today, there aren’t enough long-term holders of fundamentally-sound assets in the space. A few factors we see responsible for this:
Crypto is considered a risk asset, and it happens to be much more liquid compared to other risk assets for which there only exists a private market. So, when a risk-off event occurs, people “throw out the baby with the bath water” and sell all they can without regard for quality.
The lack of liquidity is, but for the top 10 assets in the space, a big driver of volatility. A third of crypto’s market cap is made up of long-tail assets (read start-ups), most of which are in their relative infancy and therefore struggle to find efficient price discovery for their token. Imagine if your average venture fund portfolio was publicly listed, it would be quite chaotic.
The holder base of the average crypto asset skews towards crypto-native institutions. These two groups have shown a great appetite to trade momentum using leverage vs. more fundamentally driven spot buying. Combined with a lack of liquidity this adds insult to injury and only serves to exacerbate volatility.
TradFi institutions are slow-moving behemoths. So once they are pointing in a certain direction, it takes a lot of effort to change course. Thus, it feels relevant to ask whether the institutions are coming (and staying) this time, as their long-term capital should in theory bring more stability to valuations and liquidity, in turn making crypto a more investable asset class.
Past crypto cycles have created numerous crypto-native institutions, most of which were started from scratch as existing TradFi institutions, with a few exceptions, remained on the sidelines. We believe this time will be different, however:
The ETFs have opened the flood gates
Long before the recent “Trump pump”, the introduction of the BTC and ETH spot ETFs earlier this year irreversibly cemented crypto’s place in traditional investment portfolios. Crucially, they offer a compliant gateway for institutions and are responsible for a large chunk of capital flows into the space over the last several months. The BTC ETF is the most successful ETF in history, reaching a combined $110bn of AuM and counting in less than a year. Even though this pool of capital is segregated from the on-chain world, we believe it will act as a beachhead for investors to explore more sophisticated opportunities further along the risk curve.
Favourable regulatory winds
Now that the US is expected to come in line with the rest of the world on crypto regulation, large institutions no longer have a foot to stand on when declining to offer crypto-related products and services to their clients. Two important pieces of legislation, one for stablecoins and one for decentralized applications, are expected to make their way through a Republican-controlled US house and Senate early next year. In addition, the new head of the SEC is known to be pro-crypto and for his involvement in several crypto projects. If previously engaging with crypto entailed career risk, the situation has now flipped, and you may be taking career risk by NOT engaging with the technology.
“Operation Chokepoint 2.0” is no longer
A purported coordinated effort by US government agencies to stifle the growth of the crypto industry by debanking crypto firms without formal legal proceedings and threatening financial institutions wanting to expand in the space, is now a thing of the past, thankfully. An ever growing number of TradFi onramps will remove the cap on the growth of the industry. Furthermore, the political pushback from lawmakers hanging their hat on misguided armchair research claiming that crypto has a bad ESG record, is an “unproductive asset” and is predominantly used for criminal activity, is also a thing of the past. Mainstream adoption is finally forcing them to do their homework and face the facts.
The honeypot of fees is too big to ignore
The increasing sophistication and growth of the crypto markets is evident in the proliferation of leveraged instruments. Open interest in perpetual swaps has reached all-time highs, reflecting both increased trading activity and higher asset valuations. As crypto markets mature, tokenized assets are likely to play a big role. The focus will shift from speculative growth to yield generation and risk management. Tokenized products like covered call strategies, structured yield products, and collateralized loans are expected to gain traction as investors seek to maximize returns while managing volatility.
All in all, we see the rise of tokenized assets as a pivotal moment for the industry, acting as a bridge between TradFi and crypto, and thoroughly entrenching institutions’ appetite for the technology. Not in the least because banks and other financial institutions will find themselves in a situation whereby they are pushing investment products to their clients for which they are the primary adopters of the underlying technology.
About Florin Digital
www.florindigital.io
General Disclaimer
This presentation is not an offer to sell securities of any investment fund or a solicitation of offers to buy any such securities. An investment in any fund, including the digital asset strategies described herein, involves a high degree of risk. There is no guarantee that the investment objective will be achieved. There is the possibility of loss, and all investment involves risk including the loss of principal. Florin Digital makes no representation as to the accuracy or completeness of such information. Opinions, estimates and projections in this presentation constitute the current judgment of Florin Digital and are subject to change without notice. Any projections, forecasts and estimates contained in this presentation are necessarily speculative in nature and are based upon certain assumptions.
It can be expected that some or all of such assumptions will not materialize or will vary significantly from actual results. Accordingly, any projections are only estimates and actual results will differ and may vary substantially from the projections or estimates shown. This presentation is not intended as a recommendation to purchase or sell any commodity, security, or asset. Florin Digital has no obligation to update, modify or amend this presentation or to otherwise notify a reader thereof in the event that any matter stated herein, or any opinion, project on, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.