Arguably one of the most important problems of the young cryptocurrency space has been the relative absence of major institutional investors from the crypto investment scene. As recent research conducted by Binance Research indicates, only 7% of crypto assets are held by institutional investors compared to 90% of publicly traded stocks. This reality deprives many cryptocurrency markets of the necessary liquidity and probably substantially reduces the quality of investors (adjusted by size) participating in those markets.

This probably tends to produce three major consequences. First, markets with low liquidity tend to overreact to news perceived as good or bad, which leads to excessive upward and downward fluctuations in crypto asset prices. Secondly, in the absence of major reputable and well-moneyed investors, it becomes easier for nefarious traders or exchanges to engage in various illicit practices such as wash trading. As has recently been aptly documented by Bitwise, perhaps 95% of the Bitcoin trading volume reported by Coinmarketcap is fake. Finally, low average sophistication of crypto investors probably significantly boosts the fortunes of blockchain projects that rely more on hype than sound innovative tech compared to their less marketing-savvy counterparts.


The standard narrative


The standard narrative about institutional investors and crypto assets is that the former are generally sceptical about the latter because of the supposed unique riskiness of the blockchain space. That riskiness ultimately arises from the fact that, unlike in the traditional industry context, blockchain projects are usually not pursued or at least not pursued just by identifiable companies that can be held accountable. Even where companies play important roles in the blockchain projects (like BlackOne in the case of EOS or Golem in the case of its namesake project), they are not directly associated with the crypto assets associated with those projects. Stated differently, it is the not-clearly-defined communities around those projects that determine what happens to them and their ultimate behavior cannot be predicted with certainty even in general terms.

In addition to this, it is often claimed that it is unclear what an investor owns with regard to a blockchain-related project should this project fail to deliver. For instance, even if the management of a major automaker screws up and steers the company into bankruptcy, the investors can at least hope to recover some of their investment from the sale of the company’s capital assets. But what can a holder of, for example, ETH count on if the project goes under one day?


The standard narrative is unpersuasive: Uber and endowments


This narrative is not as persuasive as it seems, however, at least on the second count. Consider sharing economy mastodons like Uber. They regularly receive enormous volumes of institutional investment compared to crypto projects, however, it is clear that in the case a company like Uber becomes insolvent, there are few capital assets to fall back on. Except for the self-driving car fleet, Uber does not own cars, nor does it have industrial facilities and equipment that could be reoriented to other uses. It only has its trusted intermediary status and proprietary software with a narrow use case.

A recent survey conducted by Global Custodian undermines the conventional wisdom about institutional investors in crypto from another angle and perhaps even more persuasively. The survey featured 150 major endowments and found that 94% of them have exposure to crypto assets either directly (54%) or through crypto investment funds (46%).

Endowment funds are vehicles that allow major non-profit organizations like private U.S. universities to smooth out their spending capacity over time and potentially increase it. The endowments of major U.S. universities like Harvard or MIT have tens of billions of dollars of assets under management. There is, thus, no reason not to consider them to be institutional investors, and it is obvious that their exposure to crypto assets is much more significant than that of investment banks, pension funds, other funds, etc.


Why endowments and not other major institutions?


One could object that perhaps endowments are somehow uniquely prone to risk compared to other institutional investors but this is undermined by the fact that the successful ones do not seem to have very high rates of return. According to the latest annual survey of endowments conducted by the National Association of College and University Business Officers and the financial services company TIAA, the average one-year return stood at 8.2%, and the ten-year return at 5.8%. Even the best-performing endowments, which are the largest ones, had an average annual return of 9.7%.

If it is not the recklessness of endowments that allows them to embrace crypto assets, then what does? The answer seems to at least partly lie in the fact that endowments are not subject to regulatory requirements with regard to financial asset custody.

In the U.S., the regulations supplementary to the Dodd-Frank Act require institutional investors with more than $150 million of assets under management to use qualified custodians. Similar regulations are on the books in many other countries. Until recently, there have been no qualified custodians for crypto assets in the U.S. and most other countries.

At the same time, it appears that endowments are not within the scope of the Dodd-Frank Act, which also means that they are not obliged to rely on qualified asset custodians. This may at least partly explain why they have invested into crypto assets in contrast to other institutional investors of their size.  

A possible retort is that since late 2018, there have been at least two qualified custodians in the U. S. but this has not resulted in a surge in institutional investment. In September last year, Bitgo received approval to create such a service from the state of South Dakota. A month later, Coinbase was given green light to do the same by the state of New York.

However, the habits of large institutional investors probably cannot change dramatically in a matter of several months, thus it is too early to tell whether regulatory requirements regarding custody have been a serious hurdle.


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