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There are multiple other reasons outside of custody institutional investors have held back from trading cryptocurrencies so far. Trading of the digital assets remains unregulated, while questions remain over liquidity, transparency and valuation. Links to criminal activity and money laundering also do cryptocurrencies no favours when attracting the most heavily scrutinised parts of the financial sector either. Perhaps crypto’ s most notorious personality trait in the past 12 months has been its volatility, which has attracted many new funds to the space, but few established ones.
Custody not the only issue“ There is little participation from institutional investors, but it is liquid enough to trade,” said Peter Kambolin, chief executive officer at Systematic Alpha Management.“ If you look at the incredible volatility that all cryptocurrencies are having, it is telling you that investors don’ t know how to value them.”“ Putting a value on where bitcoin is supposed to trade is difficult, some people think it is zero and others think it is worth one million in the future.” Despite the lingering worries, the lure of this volatile new product could be too much for the buy-side to resist for much longer. One hedge fund trader who preferred to remain anonymous commented that“ at this point, we’ d rather be involved and stay small rather than not be involved at all”. Another source explains that members of major buy-side firms are instead using their expertise on the side, by trading the unregulated markets on personal accounts outside of their day jobs. In a chicken and egg scenario, institutional investors are waiting for volatility to steady, but it is the arrival of institutional investors which could steady the price swings. Perhaps the arrival of custodians on the scene could open the gates for them despite the volatility.
Regulatory domino effect Earlier this year, Richard Turnill, Black- Rock’ s global chief investment strategist, said in a note that trading“ should only be considered by those who can stomach potentially complete losses”. He added that their volatility made market turbulence during the financial crisis almost look placid.
“ We don’ t want to get this wrong, if one thing goes wrong then the confidence will be dented.”
TEANA BAKER-TAYLOR, CMO, COINFLOOR
“ Institutional money brings greater volume, for institutions to be able to invest more regularly – if you are a non-regulated entity like a hedge fund or family office, you may already be in the space – regulated institutions like trading desks at major banks need a regulatory framework and you need to understand how those assets are held from a custody side and how they are going to hold it on a balance sheet.” Regulation is possibly the other issue that matches security as holding the key to more institutional investment.“ Why isn’ t institutional investor money flying into this space? It’ s regulatory issues,” said Achim Illner, CEO at Global Crypto One. Again, this comes back to a lack of custodians providing services for cryptocurrencies, which was one of the main reasons behind US regulators quashing applications to launch Bitcoin ETFs in January this year. The Securities and Exchange Commission( SEC) issued a letter asking for firms to withdraw requests to launch the products until multiple issues had been resolved. The SEC’ s concerns focused largely on investor protection issues.“ To the extent a fund plans to hold cryptocurrency directly, how would it satisfy the custody requirements of the 1940 Act and relevant rules?” the SEC asked in a letter to the Investment Company Institute and Securities Industry and Financial Markets Association, back in January this year. Each country’ s national regulator has a stance; most are supportive with caution, though few have official legislation in place. Some of those most welcoming thus far have been Switzerland, Japan and the UK, while China has outright banned crypto exchanges. In the UK, though no official regulations have been passed, the Financial Conduct Authority( FCA) has been lauded by market participants for its openness and willingness to speak to the industry about regulating cryptocurrencies. The big domino effect could come from the US though. According to multiple experts, many institutional investors are waiting for regulatory approval from the SEC before stepping into the cryptocurrency trading world.“ Until there is clarity from the SEC nobody can make moves,” added Illner.“ When they make a statement all the other guys in Europe will look at what the SEC decides and this will give them direction.”
“ Wall Street is hungry” In June, the SEC appointed an associate director to work on the application of US securities laws to Initial Coin Offerings and cryptocurrencies, one of its biggest moves yet in support of the growth of the asset class. In the SEC’ s appointment of its new crypto director, the regulator described cryptocurrencies as a“ dynamic area that has both promise and risk”. The SEC’ s regulatory peer in the US, the Commodity Futures Trading Commission( CFTC), has also been proactive, claiming earlier this year it is leading an international working group to build consensus and common ground with foreign authorities on cryptocurrency.“ I cannot imagine that they will let it die
“ Why isn’ t institutional investor money flying into this space? It’ s regulatory issues.”
ACHIM ILLNER, CEO, GLOBAL CRYPTO ONE
out because Wall Street is hungry for new things and it is not American to stop new things, so I am optimistic there will be a framework,” says Illner. Of the two major issues – regulation and safeguarding of assets – there’ s clearly only one which custodians can solve. Many are playing the waiting game, with their clients doing the same. Ultimately, when it comes to institutional investment, dominos are likely to fall soon enough, and with regulations will come peaked interest, and that demand should prompt more custodians to enter the space. In what capacity, and with what partners and conditions remains to be seen.
32 Global Custodian Summer 2018