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Dominos of Institutional Capital in the Crypto Market

News that Yale University invested in cryptocurrencies came out in early October. This created a buzz among financial observers talking about a potential “Dominos Effect”, believing that the vote of confidence in crypto from Yale’s CIO will convince other investment officers to take a look at the emerging asset class.

Within a week, the news seems to have already attracted five other major educational institutions into investing in cryptocurrencies — including Harvard University, which controls the world’s largest endowment with $35.6 billion in assets.

These institutions are among the first entrants from mainstream finance to invest in cryptocurrency hedge funds — the first institutional dominos to be placed in the crypto asset market.

After the university endowments, who exactly would be “the second domino” from mainstream finance to invest in crypto assets? And who will facilitate the herd with the right infrastructure?

No one can really tell. But perhaps we can learn from how the dominos fell in place for other markets.

The Wall Street of Crypto

Although unarguably of a different time and era, parallels can be drawn to the way other asset types have developed. The equity market has always been an enterprise-level venture with institutional players from the very beginning. Vast wealth in new lands are being discovered by the Old World, but putting up expeditions to claim them proved to be cost-prohibitive for any single non-state group. Thus, a then unique cost- and profit-sharing, limited liability organization was put up in the form of the first corporation. Partial ownership of the corporation can then be traded as shares.

Stock trading has not always enjoyed the same regulatory acceptance it sees today. The establishment of formal exchanges can be traced back to the 1500s, but during its early days, the stock market can be described like how the crypto market is oftentimes described now — a financial Wild West. It experienced a bubble and a crash, and authorities became wary of the market as a whole to the point where England actually severely restricted the issuance of shares until 1825.

Despite the restrictions, forward-thinking private enterprises still found ways to do business on (the precursors of) the London Stock Exchange, and, despite trading and investment practices still being in relative disarray, the Subscription Room was created in 1801 to become one of the first regulated exchanges. This development soon paved the way for codified rule sets meant to move the market from being Wild West to being more regulatory-compliant. Press and public opinion, however, still continued to be generally against what was then still a very young stock market. This may very well be the period of development the crypto asset market is in right now.

The global center of stock market activity shifted from London to the United States when the stockbrokers of New York formally reorganized in 1817 to become what is now known as the New York Stock Exchange (NYSE). The exchange thrived and prospered through a series of self-initiated market reforms (further curbing manipulative trading, for example), favorable regulatory and banking conditions, and its location at the hub of regional trade and commerce. While stock regulations continue to be prohibitive in London, a more flexible New York embraced the market, and Wall Street was born. The Wall Street of crypto will be a similarly vibrant, flexible jurisdiction with the foresight to grab the opportunity to nurse and nurture the fledgling crypto asset market.

This is no longer a question of ‘whether’ or ‘if’ this will happen. It is now only about ‘when’ and ‘where.’

From High-Yield Bonds to Cryptocurrencies

Bond issuances have been around for millenia, and can be traced back to the earliest human civilizations. Initially, it was for guarantees of grain, but statecraft and war soon found a way to take advantage of this as a mechanism to raise funds.

The London Stock Exchange was even used by the British government as the platform for issuing and trading war bonds to support the military effort against Napoleon. This greatly legitimized the Exchange in the eyes of the government.

In the same way, the crypto market and all the mechanisms and infrastructure being developed to support and sustain it will see greater legal recognition when governments find a way to directly benefit from them. Even now, a few countries are already exploring the possibility of issuing a state cryptocurrency.

Over time, even corporations began guaranteeing debt. For most of the twentieth century, only investment-grade corporate bonds were allowed to be publicly issued. These are riskier than government bonds with almost just as low a yield. Institutions may invest in them for diversification, but they were not really that attractive then. This was until the arrival of High-Yield debt, which is a kind of bond issued by non-investment-grade companies. A High-Yield debt, also called speculative-grade or pejoratively as junk bond, is a higher-risk, higher-reward financial instrument which may appeal to less risk-averse investors. Junk bonds are also generally cheaper. These factors, together with the economic conditions of that time, made holding speculative-grade bonds a viable, even desirable, investment strategy. This caused an explosive growth in the bond market, especially since the competition made investment-grade debt securities also adjust to give more favorable yield rates.

Cryptocurrency now occupies the role junk bonds had before as a high-risk, high-reward investment. However, speculative-grade bonds are usually engaged through limited and indirect exposure from mutual funds and exchange-traded funds (ETFs). Neither is currently an option for investors. At present, there are only dedicated crypto funds. Mutual funds usually invest in a diversified pool of securities, which do not typically include crypto assets. Several crypto ETF applications have already been turned down by the U.S. Securities and Exchange Commission.

Mutual funds may well become the second domino from mainstream finance to get into the crypto market. Now that the largest university endowments have taken positions in cryptocurrencies, mutual funds would see the demand, and may consider including a basket of crypto into its asset pool. This would give traditional investors limited exposure to a high-risk, high-reward investment that most diversified portfolio allot a certain portion to.

It may also be possible that a crypto ETF may be approved. Futures-backed ETF applications had been consistently rejected so far, but the commodities-backed VanEck-SolidX Bitcoin ETF should stand a better chance. The SEC decided that they will need more time to decide on that application. An ETF would offer investors and traders access to a crypto position via a traditional exchange(s).

The Quaternary Pioneers

Probably the most useful, and most obvious, comparison that can be made for the distributed ledger technology (DLT) and crypto market is with the early days of internet stocks.

New Economy was supposed to have dawned with the arrival of the World Wide Web. Many dot-com ventures were under the impression that the old economic paradigm no longer applies to them. The “fundamentals” of a tech company shifted from being based on P/E ratios and other hard data points, to vague valuations of its technological innovation. Some companies were allowed to hold an IPO with just an idea, enough backing, and zero revenue. Retail investing and trading rose to unprecedented levels.

The parallels cannot be missed. The DLT market growth is driven by retail investors, largely through a new, almost unregulated, fundraising type called an Initial Coin Offering (ICO) that was made possible by the technology DLT itself has introduced. Most ICOs are just ‘white paper’ ideas, and even to this time, only a handful of projects have actual working products.

The internet bubble ended in a bad crash, and though it may still be too early to consider the current bear market as the bursting of the crypto bubble, it can feel like that to many people.

It is worth noting that the companies that survived the dot-com crash went on to become tech giants the likes of Amazon, Qualcomm, Cisco, and eBay. It is possible for today’s blockchain projects to be global tech leaders as well in the future.

NASDAQ provided the fintech infrastructure for both earlier high growth tech companies like Microsoft and Apple, and the internet startups that followed. In return, in just less than two decades since its founding, the stock exchange had already emerged to become a credible rival to the NYSE. The infrastructure providers for crypto finance, on the other hand, include fiat gateways and crypto exchanges. This space is continuing to expand and evolve, and major players like Coinbase, Binance, and those who will join their ranks, will surely likewise be amply rewarded.

Those behind the dot-com funds became celebrities in the investment world before the crash similar to how the financial managers of crypto funds also were, prior to the bear market. The main difference is that stocks of internet companies are securities while cryptocurrencies are considered commodities at the moment and are traded in derivatives. This prevents most traditional mutual funds from bringing in crypto assets into the fund’s investment pool. As discussed earlier, a growing demand — as has recently been shown by the investment decisions of university endowments — would help convince mutual funds of the value of crypto as an investment instrument, but it won’t be until there is regulatory clarity — in particular, with regards to token topology, i.e. different classification for cryptocurrencies, utility tokens, and security tokens — that they can truly be allowed to hold and invest in crypto assets.

Summary and Conclusion

A common financial disclaimer goes by: ‘Past performance may not be indicative of future outcomes.’ Even so, if the market development for other asset types can reveal a pattern that the crypto market will likely follow, then the institutional Domino effect may have already started with the university endowments. Crypto’s allure (especially for pure cryptocurrencies) right now, as an investment, is on its historically high risk, high reward nature, competing with High-Yield bonds for that niche.

A visionary territory with a suitable business environment, strong banking sector and appropriate fintech infrastructure would soon take the lead in rationalizing the market and passing clear and favorable regulations. It will be to crypto what 1817 New York and the NYSE were to equities. Both the jurisdiction and the infrastructure provider(s) would benefit tremendously from this in the long-term.

The regulatory clarity that this brings, in particular on token classification, will allow mutual funds to include crypto assets in their holdings. After mutual funds, with the nod from both the government and their peers in the financial system, and with the support extended by trustworthy service providers, there would no longer be much barrier to entry for more domino pieces to come in play — pension funds, insurance funds, conservative family offices, banks.

Another important evolution that more accepting regulation will bring about is the issuance and trading of Security Tokens, a crypto asset representing a real world item of value. This opens up its own world of possibilities for the finance of the future.

Alongside these developments, DLT technology itself will also mature, and with it would come adoption. The consumer adoption rate of blockchain is hard to determine, but based on the number of BTC wallets (an admittedly very poor metric), worldwide Bitcoin adoption right now is only at 0.2%. This strengthens the comparison made by many that crypto currently is like the World Wide Web circa 1995. Internet adoption at the end of 1995 was only at 0.4%, but is growing exponentially since to become as ubiquitous as it is now.

When crypto that are purely currencies achieve that level of adoption, they can then be used for their intended purpose of being a medium of exchange. No longer just a speculative store of value, cryptocurrencies will trade more like fiat currencies do now in the FX market.

It would take several moving domino parts — regulation, private ventures building related infrastructure, end user adoption, etc. — aligning, in the process of developing crypto assets as a viable investment market, but if the histories of other earlier asset classes are any indication, this will get a lot bigger than it is now.

The first institutional domino pieces are just now being set. It is still very early days for the crypto asset market.



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