The Role of Institutional Investors in Cryptocurrency Markets

The cryptocurrency battlefield is getting increasingly crowded. This space is witnessing an increasing amount of attention being cast from multiple facets: governments, banks and other institutional investors alike. Historically a very precarious endeavour, organisations have now set out to explore and reign over this unchartered regime of digital currencies. Ecuador was the first country to launch its own digital currency, the Dinero Electronico (DE) in 2014. Soon to follow were Senegal, Singapore, Tunisia and China, to name a few. China is prepping to take a step further and altogether replace its paper tender with a virtual currency. Only a couple of days ago, the Supreme Court of India has repudiated the ban on trading of cryptocurrency in the country. All these substantiate the claim that cryptocurrency is on the verge of becoming a mainstream subject for governments.

As to the banks, top players across the globe are betting heavily on blockchain and cryptocurrency. Investments are being made in that direction, almost assigning the title of an asset class to cryptocurrency. There is also a speculation brewing that the advent of cryptocurrency, with its decentralized ledger model, could potentially pronounce the death of central banks. What is equally intriguing is the growing participation of other institutional investing options like hedge funds, private equity funds, insurance companies, pension funds and the like, in cryptocurrency markets.

According to Statista, the magnitude of global blockchain would balloon to around $23 billion by 2023, with the financial sector responsible for around 60% of that valuation. Morgan Creek Digital was the first pension fund to make an investment in crypto assets. PwC, in its 2019 report on crypto hedge funds claims that there are 150 active crypto hedge funds managing around USD1 billion (excluding crypto index funds and VC funds). A myriad of new platforms, like Fidelity Investments’ Fidelity Digital Assets offering cryptocurrency trading-related services specifically to institutional investors, are cropping up.

Intercontinental Exchange (ICE), the parent company of NYSE, launched a Bitcoin futures exchange called Bakkt, joining the forex giant, CME Group and the exchange-holding firm, Cboe Global Markets, that first offered future trading options in cryptocurrency in 2017. Ivy League university endowments have also started to consider investments in cryptocurrency. Bloomberg reported in 2018 that hedge funds and endowment funds have been making gigantic purchases of digital coins, in the tune of $100,000,000, through private transactions. Institutional investors are leveraging over-the-counter currency sales that have been thriving specially since 2017-18. Banks like the Goldman Sachs Group has a bitcoin trading product on its portfolio. JP Morgan has rolled out its own cryptocurrency, JPM Coin. Biggies like HSBC, Barclays, UBS, etc. are working together to develop a Universal Settlement Coin, with the ultimate aim of laying the foundation for a cashless world.

Having laid down the magnitude of institutional involvement in cryptocurrency markets, it is now imperative to assess its implications, positive and negative. Proponents of active institutional participation in the cryptocurrency argue that such organized and large investments bring about some stability in this highly volatile space. It is believed that presence of large investors in this market would make it an attractive investment option which would in turn attract a diverse pool of investors, ultimately ensuring more stability. With increasing demand of stablecoins, institutional investors are also likely to come up with their own currencies, adding to the overall supply of digital currency and lessening potential volatility. Also, with increased demand from pooled funds comes the promise of increasing returns to investors, especially the earliest of them, as prices rise substantially. Hence, the implication for early investors is highly positive, with them getting a major share of the pie.According to Statista, the value of bitcoin (BTC) was $968 in Jan 2017 and was almost 9 times that in Jan 2020 at $9,389. This could be attributed to intensified institutional involvement since 2017.

It is also believed that with the presence of institutional investors comes stricter standards of accountability and due diligence. The cryptocurrency markets have witnessed poor custodianship with exchanges getting hacked or turning out to be fraudulent. Hackers stole around $4 billion worth of cryptocurrency in 2019, according to Forbes. In this context, there has been a call for transparency (transparency of trading volume, a recent controversy) and it is believed that institutions with their reputation to uphold, catalyse this process.

Institutional investment also ensures greater access for individuals to crypto markets. Cryptocurrency will no longer be restricted to tech-savvy traders but will be in the reach of anyone who is looking to explore new arenas and diversifying their portfolios. With their platforms, cryptocurrency products and investment options in crypto markets, institutional involvement is spreading awareness and, in a way, developing a level playing field. Summing this side of the argument, institutional investment can potentially ensure tighter spreads, increased transparency, better security and accelerated innovation, and is definitely a trend worth watching.

However, there are also a plethora of downsides to institutional investment in crypto. One of the most primary of those is that it contradicts the very ideology of cryptocurrency- absolute decentralization and absence of one single custodian. This is linked to the fear of recuperation. Internet today is censored, controlled, tracked, and spied upon by governments and big tech companies. There is a rising fear that blockchain technology and cryptocurrency will be absorbed and manipulated by institutional investors, dramatically altering its intended purpose. Institutional involvement, then, is an insult to the basic tenets of cryptocurrency. It is also asserted by researchers that institutional investors, with their big appetites, could topple the market. In other words, there is a problem of limited liquidity and sudden heavy investment or divestment could send the fiat currency balances for a toss.

Also, essential to note here is that the ecosystem is still not completely conducive enough for the growing institutional role in these markets. Lack of a suitable and well established regulatory framework is an impediment to institutional investments like hedge funds. Also, financial institutions with their status quo infrastructure would be underequipped to function in this field that is the one of the most lucrative focus areas for hackers. Institutional investors are trying to address issues like consumer confidence, investor protection, transparency, and the related sort of issues to carve out and secure their share in these markets.A 2020 Fidelity Investments’ research conclusively says that institutional investment in cryptocurrency markets is going to increase exponentially in the next five years, with 47% of those surveyed seeing digital assets as part of their investment portfolio. All in all, there is no denying that institutional investors are warming up to the idea of crypto investments and growing their tech muscle to accommodate more crypto-trades. How it is going to pan out to be and the implications it is going to bear for all stakeholders, are yet to be ascertained in full-scale.

Important analytics from the sources:

PwC Crypto Hedge Fund Report, 2019

Morgan Stanley, 2018

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About the author:
Deeksha Reddy is currently pursuing an MBA (2019-21) at IIM Lucknow.She is humanities graduate with two years of work experience as an HR Analyst in Deloitte. She has an undying love for reading and from it stems her passion for writing.

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