By Oliver Linch, CEO of Bittrex Global
The most recent events within the crypto landscape have shaken the ecosystem and the landscape of crypto exchanges we once knew. Despite the usual suspects using the fall of FTX, which came amid what was already an ongoing ‘crypto winter,’ to proclaim – for the umpteenth time – the death of crypto, all the evidence is that institutional investment is as strong now as it ever was.
But those of us in the crypto industry must not take this for granted.
With more than 3.3% of professional investors putting money into crypto, and almost all the major banks now populating a substantive crypto desk, it is fair to say that digital assets are now not only of interest to speculative investors but are a must-have for any forward-thinking financial institution. Institutions realize that the time to engage is now, lest they run the risk of being left behind. Although the digital assets landscape of today is considerably different from that of 2021, institutional interest in crypto as an alternative investment model is still very much a feature, especially amongst the nimblest funds and asset managers, who were, and remain, ahead of the curve.
Big banks, so often the lumbering beasts of the financial industry these days, were slow to wake up to the potential of crypto and spent much of 2021 and early 2022 scrambling to make up lost ground. The arrival of the bear market in mid-2022 and subsequent scandals may have spared the short-term blushes of those traditional bankers who failed to capitalize on the opportunities of getting involved in crypto earlier or who, with perhaps some justification, were wary of the threat posed to their cosy traditional methods of investment and antiquated banking systems. However, the underlying analysis and the mid-to-long-term potential of crypto remains firm, and all the evidence suggests that banks continue to invest heavily in crypto products and services.
While it is clearly not true that institutions have slammed on the brakes, a glance at trading volumes across the board shows that they have eased off the gas. A good amount of work is still being done behind the scenes, as institutions and market participants work ever more closely together to figure out how to engage with crypto in a meaningful way. The question, therefore, is how crypto market participants can entice these institutions back into the sector.
There is no deep mystery here. In fact, the institutions are being very clear that they are looking for three key things: regulation, security, and innovation.
On the regulatory front, institutions are quickly reassessing their relationships with counterparties. Quality is now much more important than quantity, as big players revisit previous assumptions and, in particular, reprioritize the weight ascribed to a counterparty being properly and robustly regulated. Whether through ignorance or naivety, institutions had seemingly fallen into a trap of assuming that all crypto exchanges were essentially alike, and so focused their assessments predominantly on price. Even for those institutions that did engage in (at least the language of) regulation – and FTX was certainly one of them – too little scrutiny was given as to where an entity was regulated.
Perhaps this was because the traditional financial sector has, over many years of concerted effort, effectively eliminated significant regulatory arbitrage in major jurisdictions. Differences certainly exist but the core regulatory obligations are generally pretty similar, especially as global standards have been established. Whereas in crypto, institutions have failed to investigate where entities are regulated, to what standards, and how those standards are enforced. Too little additional credit has been given to entities that subjected themselves to robust standards in jurisdictions with meaningful regulatory regimes. Moreover, exchanges and other participants made use of complex legal structures, so that it was often unclear whether it was actually the regulated entity that was entering into transactions. Too often it was not, and the regulated entity sat in a trophy cabinet gathering headlines and dust, while the real business was done by unregulated affiliates.
If there is any good to come out of the scandals of 2022, it is the consensus on the importance of proper regulation of the sector by both policymakers and, perhaps still too reluctantly, industry participants. Whether this is new regulation such as the EU’s MiCA proposal or the UK’s renewed commitment to a crypto future, doing so will have a positive effect and further drive the industry forward.
Security is the second major ask by institutions as a pre-condition to re-engaging with crypto. The “not your keys, not your coins” brigade will always be there in the corner, but even among the mainstream crypto participants, the relationship between centralized and decentralized crypto is being reassessed. Exchanges and other participants that lack seriously robust technology and security procedures will simply be discarded by the institutions. As with regulation, banks expect their counterparties to invest as heavily in security and infrastructure as they do themselves. Of course, no system is completely impenetrable, but those exchanges and tokens that sprung up in the frenzy of the bull market and never quite got around to implementing a robust security program must either very quickly adapt or die.
All of this is a precursor to allowing the institutions to do what they actually want to do with crypto, and that is innovate. Traders, in particular, come with decades of analysis and strategies in traditional markets and are chomping at the bit to adapt and apply them to crypto. For too long, crypto exchanges have arrogantly ignored the needs of traders and other investors, preferring to focus on headline-grabbing, but ultimately pointless, features. Or worse, eye-wateringly expensive sponsorship packages. In the depths of this crypto winter, however, minds are a lot more focused. Both sides realize that the potential opportunities are significant, and the relationship between these traders and the exchanges on which they will trade will ultimately be what drives crypto innovation forward.
These key items – regulation, security, and innovation – are what will jump-start renewed institutional investment in crypto.
Institutions tell us that they still want to be involved in crypto, but we must not be complacent. These are not easy things to do, and it will take time, effort, and commitment to implement them properly. However, it is what is necessary if we are to allow crypto to continue its journey to achieving mainstream adoption. In the wake of the FTX scandal, these things are no longer a “nice to have.” They are essential, and without them, crypto faces an existential crisis as risk committees and boards across the financial sector will simply refuse to allow institutions to touch anything to do with crypto.
During this turbulent time, we must use increased institutional investment and outside interest as a launchpad to regulate, secure, and innovate within our ecosystem, as we continue to create opportunities for digital assets to thrive within the financial industry.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.