CEO of IPC, a technology and service leader powering the global financial markets.
Investor interest in digital assets — a novel asset class that covers a broad spectrum ranging from cryptocurrencies through to “stablecoins” and a vast array of other types of digital “tokens” — has skyrocketed in recent months, as has their price action. The cumulative value of all cryptocurrencies grew 300% in 2020, currently totaling over $2 trillion. Bitcoin, the first and flagship digital asset, reached a record high in April 2021 and exceeded $60,000 each — a marked contrast to its trading range in 2010 of sub-$0.10.
What is fueling this growth, and what is the path forward for institutional investors? Many firms are aggressively expanding their presence and capabilities in digital assets of various forms. From Goldman Sachs re-opening its cryptocurrency trading desk to JPMorgan creating its own digital coin, market participants are moving quickly to meet increasing demand.
As is typically the case with the exponential adoption of any new trend, several factors have converged simultaneously to propel the value of digital assets. These factors fall into three categories: technological, structural and geopolitical.
The strengthening of core transactional technologies, such as the use of qualified custodial services, has reassured many investors that their investments are safe. The potential for misappropriation of digital assets — intentionally or otherwise — has been a major concern and a blocker to adoption for many institutional investors. The emergence of institutional-grade custodians, as well as the connectivity required for investors to access and trade digital assets easily and securely, have been primary drivers of price growth.
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Furthermore, just as the digital asset ecosystem is evolving to meet the modern markets, so too are the markets adapting to encompass digital assets. Due to their varied and novel qualities, digital assets have often flummoxed regulators globally. Are they commodities? Currencies? Securities? Depending on their structure and usage, digital assets may display attributes of multiple asset classes. To date, this lack of clarity has led to gaps in regulatory coverage and guidance, which stayed investor appetite.
In order to allay investor concerns, the market has responded with smart structural solutions such as the creation of trusts of cryptocurrency derivatives. These vehicles offer investors the same exposure as the underlying assets but via a well-understood, legally sound mechanism. The first cryptocurrency ETF, which provides access to cryptocurrencies without direct ownership, has been a runaway success for the same reason. Meanwhile, the regulators themselves have adapted by further clarifying the rules surrounding digital assets and taking steps to establish their place within the regulatory environment. For example, the U.S. Office of the Comptroller of the Currency recently approved the use of stablecoins for the settlement of financial transactions by federally chartered banks and thrifts.
Significant geopolitical developments have also accelerated the take-up of digital assets. The current low-interest-rate environment has investors exploring any and all investment opportunities to generate alpha. Concurrently, as barriers to retail investing have been loosened, the collective flood of capital has lifted cryptocurrencies in particular to price targets that are appealing for professional investors as well.
So what does the path forward for digital assets look like from here? Though the future appears to be encouraging, it’s important to remember that some assets, such as cryptocurrencies, still display extreme volatility at times. Many trends within digital assets are still too new to provide a clear road map for future developments. Non-fungible tokens (NFTs), which are cryptographically secured assets certified on the blockchain, are one such example. Recently, high-end artwork became one of the first uses for NFTs, with a piece sold by Christie’s for an astounding $69.3 million. Will NFTs create a market for high-end digital art, analogous to physical works of art? Only time will tell.
As digital assets become more established and as the understanding of their various characteristics and regulatory treatment develops, we will likely see a maturation of the market. Cryptocurrencies, stablecoins and NFTs represent but a small (although perhaps disproportionately publicized) proportion of the digital asset landscape. Other variants include security tokens — tokenized representations of traditional equities, bonds and other securities. Their usage could well represent an evolutionary step forward for traditional financial markets, allowing massive gains in operational efficiency, reduced costs and friction associated with trading, and real-time settlement.
Facebook’s Diem (formerly Libra) is yet another flavor of digital currency and may soon be in our (digital) wallets. We have also recently seen a significant and timely expansion of central bank digital currency (CBDC) projects. These represent a means for central banks and governments to start leveraging some of the benefits of digital assets while retaining control over issuance and usage of their own sovereign currency. They are also of interest to institutional investors given their critical importance in closing the settlement gap — making payment for transactions on a blockchain — when it comes to trading digital assets.
All in all, it is increasingly apparent that digital assets are here to stay, and institutional investors are taking notice of developments in this space and taking steps to understand where alpha can be found in this dynamic new landscape. As with any new asset class, it is one that will require some adaptation and change. Market structures are still evolving, and infrastructure providers are often new to the game themselves and still developing an understanding of institutional needs and requirements.
As with any new asset class, this is a landscape filled with both potential opportunities and pitfalls. Greater institutional adoption of digital assets will, therefore, also require greater collaboration between firms, investors, regulators and market infrastructure providers to ensure that the future and promise of digital assets can be fully realized.
The writer’s views are for information purposes and should not be construed as providing investment advice or predicting the movement of markets.