Institutional structures drive crypto adoption

August 08, 2023 | 08:30
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The cryptocurrency industry has turned convention on its head. Damian Bunce, chief customer officer at Exness, explains how the institutional community is taking note – and so are the regulators.
Institutional structures drive crypto adoption
Damian Bunce, chief customer officer at Exness

A younger generation of non-professional traders and technologists have defined a product, market structure, and a need for cryptocurrency, and it has caught the world’s attention.

Much like the evolution of equity market structures over the last 20 years, crypto needs to undergo a radical restructuring. That asset class can certainly teach crypto a lesson or two in how to navigate the choppy waters ahead, to become a mainstream investment product.

Crypto faces many hurdles on its journey to universal adoption, but two major criticisms faced today are its inherent lack of a genuine “store of value” and that the currency is used to circumvent regulation, to pay for illegal or immoral activities.

The store of value argument is very subjective: whilst a bitcoin is not backed by any physical collateral like gold or even a fiat currency, its inherent value is linked to the strength of its holders.

If the majority of holders are the young, technical generation that created it, many of whom have limited financial resources, then in a downturn there is a high probability those holders will sell the asset as soon as possible, causing the price to plummet further.

On the other hand, institutional asset managers and pension funds managing trillions of US dollars for clients whose managers hold a small percentage of bitcoin for diversification purposes (as they do with gold, private equity, and real estate) are not going to sell at the first sign of problems.

These holders can afford to hold the asset at the buying price, which in itself creates a store of value, a natural floor in the product that can weather a downturn. As more long-term institutional money enters the asset, its foundations strengthen along with its store of value. Institutional adoption of the product enables this. Bitcoin store of value is also enhanced by its finite nature, the lack of supply plays a major role in its valuation.

That crypto is used to conduct illegal activities is of course a real concern, and one that will remain while regulation continues to be weak, disjointed, and confused. New industries are often battle-tested by bad actors in ways that ultimately improve their offering, and help regulators and law enforcement define corrective measures.

Ease of trade

Crypto is at this stage of its evolution. Indeed, fiat currencies continue to see their fair share of illegal activities, but the safeguards are far higher, with strong regulation and cooperation across the global banking sector.

Unlike crypto, developed with the interests of retail traders and investors at its heart – and only recently gaining approval from institutional markets – equity markets were the opposite: built by institutions for institutions, and only made accessible to retail investors in later years.

In the early days of equity markets, trading was very much a closed shop of operators, first between open outcry market makers, later evolving to exchanges, then trading between institutions.

Further rapid evolution saw institutions establish phone-based stockbroking firms, where retail investors could now trade equities via an authorised broker. Then fast-forward through the late 90s, to electronic equity trading companies like Instinet (now owned by Nomura).

Through Microsoft Windows-based platforms, individuals could trade stocks from the comfort of a home computer, and by the turn of the century the process was made even simpler and much broader, with trading in equities and most asset classes possible from a phone or Apple Watch – anywhere in the world and often for free.

Foreign exchange trading followed a similar path to equities: once a phone-based, bank-to-bank business, it evolved into electronic trading solely between banks until eventually a version with much wider spreads was offered directly to retail traders.

Today, the global FX market trades around $7.5 trillion a day: retail trades make up roughly $1 trillion of this, and spreads are exceptionally tight.

The strength of FX trading’s success and widespread adoption lies in its origins: born within institutions and then evolved out to retail. This meant that regulations were baked into the system from the start, and that most problems were ironed out between institutions, long before the market was let loose on retail traders.

Conversely, crypto’s starting point being in retail is why it consistently faces questions around weak regulation. With no institutional scaffolding before being unleashed on the general public, it was simply anchored to the products and services it saw at the front-ends and trading screens of other asset classes. All with no grasp of the infrastructure’s critical needs.

Institutional structures drive crypto adoption
Crypto is held by many equity funds for their investment portfolio diversification

Major catalyst

The labyrinth-like structure of the now bankrupt cryptocurrency exchange FTX, where a single entity controlled all aspects of the client journey – the platform, custody, the coin currency, lending services and the liquidity – would have never been allowed to flourish in today’s equities markets.

While seemingly an attractive end-to-end business proposition for the exchange, it was never a safe structure for clients, being unable to be monitored and deemed free of conflicts of interest.

FTX’s collapse played out to great effect at the end of last year, and is no doubt linked to the US Securities and Equities Commission’s current legal pursuit of Coinbase and Binance.

Crypto trading’s market structure needs to start mimicking institutional market structures if it is to thrive. This will encourage the institutional community to enter the market and allocate tangible capital to its assets. EDX Markets, a brand new non-custodial digital exchange backed by some of the largest institutional market makers like Citadel and Virtu, is a major catalyst in the right direction.

Blackrock’s application for a Bitcoin Spot exchange-traded fund is precisely the sort of news that can propel the asset: with an estimated 20 per cent of Americans holding crypto, such a move could help trigger mass adoption.

Laser Digital, Nomura’s crypto investment arm, recently conducted a poll of 300 institutions representing $4.9 trillion worth of assets. An overwhelming 96 per cent believed crypto was a good diversification measure, and 82 per cent were optimistic about the asset over the next 12 months.

Today, regulators, particularly in the US, are on the back foot in dealing with crypto’s structural fallout. Their focus would be better served by listening to and acting, quickly, on behalf of the institutional community. The impact would be immediate. With institutional backing, enjoyed by the likes of equities and FX, trust and interest in cryptocurrency would also soar.

We are already starting to see a few key crypto companies taking the institutional route. Such firms are generally led by executives with backgrounds in traditional finance who understand institutional market structure.

Crypto trading venues and infrastructure providers like finery markets and crossover markets understand that unbundling services like trading and matching, from services like custody of assets are key to institutional adoption.

Meanwhile, companies such as London-based and Komainu focus on crypto storage and custody, avoiding trading services altogether. Domain-specific expertise is the path to strengthening the crypto industry and driving institutional adoption.

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By Damian Bunce

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