Richard Willsher
Richard Willsher

When, not if – we will see more electronic platforms and increasing institutional demand for digital assets

Even allowing for a certain amount of hype, there is plenty of evidence that institutions are showing increasing interest in investing in digital assets. As yet however, the e-infrastructure to support them is fragmented and imperfect. Richard Willsher investigates.

In its “Institutional Investors Digital Asset Survey” published in June, Fidelity Digital Assets (FDA) reported on the views of 774 investors’ preferences and behaviour towards digital assets. Roughly half were European and half in the United States. This cohort was made up of high-net-worth individuals, financial advisors, family offices, crypto hedge and venture funds, traditional hedge funds, endowments and foundations. Of these, 36 per cent currently invest in digital assets, 60 per cent have a neutral or positive perception of them and 80 per cent “find something appealing about digital assets.”

“We started to see a broadening of user profiles through 2018 and into 2019,” explains FDA’s Head of Sales and Marketing, Christine Sandler. “We’ve seen continued adoption across the full spectrum of institutional participants. Even at the most conservative end of that spectrum, we’re seeing activity from pensions and endowments as well. The profile of investors is very diverse and the activity continues to be quite strong.”  

Ms. Sandler notes that the entire market capitalisation of digital assets as yet amounts to around USD350 billion globally. Moreover, Bitcoin is the runaway leader in terms of preferred assets. She adds that both the market cap and the range of available digital assets are expected to increase as the ecosystem matures.

Why digital assets?

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Christine Sandler

“We started to see a broadening of user profiles through 2018 and into 2019. We’ve seen continued adoption across the full spectrum of institutional participants.”

One of the key appeals of such assets is that they’re digital from the outset. They emerge from and live in the digital world. Post-covid, it is pretty clear to anyone who’s worked remotely from their employer’s place of work or used Zoom that the move from analogue to digital is wholesale across business and investment activity.

The FDA survey found that lack of correlation with other assets classes, exposure to innovative technology and “high potential upside” were attractions in a virtually zero per cent interest rate environment. Another appeal to the less regulated, more adventurous investor was the lack of control by central banks and regulatory authorities. This however is a two-edged argument, as we shall see.

Further evidence to support FDA’s optimistic findings is available from several sources. Grayscale Investments describes itself as “the world’s largest digital currency asset manager, with more than $4.0 billion in assets under management as of June 30, 2020.” Its Q2 2020 “Digital Asset Investment Report’s” key numbers were that: “For the first time, inflows into Grayscale products over a 6-month period crossed the $1 billion threshold, demonstrating sustained demand for digital asset exposure despite a backdrop characterized by economic uncertainty.” And “Cumulative investment across the Grayscale family of products since inception has reached $2.6 billion. Grayscale Bitcoin Trust and Grayscale Ethereum Trust both experienced record quarterly inflows of $751.1 million and $135.2 million, respectively.”

Among more conservative voices State Street Corporation’s wide-ranging December 2019 survey of US asset managers and owners concluded that “Digital assets continue to come a long way in gaining credibility among institutions, with only six per cent of survey respondents reporting that they have no digital assets-related investments and no plans to invest in the next year.”

“Our definition of digital assets is pretty much anything that would trade on a distributed ledger,” explains Nadine Chakar, State Streets Boston-based Head of Global Markets. “What we’re seeing is a massive, massive spike of some of the largest global investors coming to us.  But,” she cautions, “it’s still very nascent.  They want to talk about tokenisation.  They want to talk about launching new products, ETPs obviously, whether they’re backed either by Bitcoin or other currencies. 

I can’t tell you how many presentations we’re doing to large sovereign wealth funds and insurance companies. But they’re doing proofs of concepts, and although we’re happy to engage with them, there’s a lot that needs to happen to make it efficient as an institutional investor.  Don’t forget, we all have shared responsibilities as well. So, it’s still nascent, but I think there’s an incredible amount of activity and work that’s happening for institutions like ours, to our clients, to build the right infrastructure.”

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Key highlights from Fidelity Digital Assets (FDA) Institutional Investors Digital Asset Survey

Regulation and infrastructure 

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Hu Liang

“With the underlying technology of blockchain and distributed ledger playing out their course, I’m a firm believer that five years from now crypto and blockchain will be part of our daily investment lexicon.”

Although unregulated digital assets may appeal to some sectors of the market, regulatory approval, discipline or least direction is essential to large, highly regulated, fiduciary institutions. “We’re working with the SEC,” explains Ms. Chakar, “but we haven’t really seen anything to give us guidance on moving forward.”
It’s a developing story for sure. As yet the SEC in the US, the FCA in London nor any other major financial services regulator has pinned clear direction to its mast. Regulation is a key piece of infrastructure without which institutions stand to risk sanction and reputation.

Meanwhile there are a great many exchanges that offer to assist investors to trade digital assets. The market is highly fragmented and some of these may fail and others be consolidated. At the same time investors are at different stages along the learning curve when it comes to understanding distributed ledger, “blockchain” technology that underpins the digital assets trading environment.

“The financial industry is in a constant state of transformation,” explains Hu Liang, Co-Founder and CEO of Omniex, a San Francisco based digital asset trading platform. “What we knew as brick-and-mortar finance before the Internet is nearly non-existent today. I believe the impact of digital assets is on a similar scale. Whether we’re talking about the underlying blockchain and distributed ledger technology or the actual investable tokens themselves such as Bitcoin or Ethereum, the possibilities are ample.”

“At Omniex,” he continues, “Our approach is to build a platform that looks and feels familiar to institutional investors so they don’t have to climb a steep learning curve. At the same time, we want the platform to be resting on the latest technologies so it can scale and perform well into the future. This is what we have done for crypto with the Omniex Edge platform. We have PMS, OMS and EMS functionalities that users are familiar with, layered on a familiar GUI and the dependable FIX API. We also connected it to dozens of crypto exchanges and OTC venues to provide access to deep liquidity and an assortment of assets.”

Hu Liang concedes that regarding digital assets as mainstream is, as yet “premature.” And for institutional investors to step out of line with their peers and place significant amounts of their clients’ money into digital assets is a big ask. However, blockchain adoption as a secure means to transparently record transactions between counterparties looks like being the important first step towards the development of a market that exists purely within the blockchain environment. “If I had the chance to leave the reader with only one thought,” says Hu Liang, “it’s that digital assets are here to stay. Despite the unrealized hype of 2015 and the crypto bubble of 2017, it’s not going away. So don’t treat it as a fad. Learn the underlying values and understand how it’s different from today’s model and how it compliments financial transformation.”

This view is echoed by State Street’s Nadine Chaker. “It’s a matter of when and not if, but a lot needs to happen before we can get there,” she says. “From an infrastructure perspective, you still need to open accounts everywhere.  So, I think there is work that we need to do as an industry. But it’s the chicken and egg.  Do you make the investments now, or do you wait to get more legal and regulatory clarity?  We would want to see a much, much reduced number of exchanges that are out there. 

In my opinion, I’d like to see more instant settlement-type of activities, because there’s no reason why you couldn’t settle in real time.  And I think that would then help investors to be able to get in there with efficiency.  You allow them to spend less of their capital, and you create liquidity.  

These are some of the pre-conditions that need to emerge before you could see really robust players like ourselves and others provide e-trading platforms for our clients.  It will happen, there’s no doubt about it. I think in meantime the central banks need to get their heads around this. You need a regulatory and legal framework to operate in.”  

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Data taken from FDA Institutional Investors Digital Asset Survey

Build it and they’ll come

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Nadine Chakar

I’d like to see more instant settlement-type of activities, because there’s no reason why you couldn’t settle in real time.

As if to take up the challenge suggested by Ms. Chakar, Fidelity has established itself as a committed, institutional digital asset trading venue, as Christine Sandler explains. 

“There’s the concept of counter-party risk. When we designed our system, we considered some of the frictions that institutions face with adopting or transacting in digital assets. We’ve created a network of liquidity providers and exchanges and our clients transact through us as a single, trusted counter-party.  Clients put in orders, we attempt to match them against other orders that are in the system, and if there is no match available, we leverage smart order routing technology and access a fully vetted network of liquidity providers.  This gives our clients access to multiple pools of liquidity through us acting as the central counter-party. As our platform grows, we expect to see more natural matching and we will  continue to expand on the functionality of our platform, including, for example, algorithms, so that clients can begin to time-slice across a period of time.” 

As more institutions begin to adopt digital asset strategies, there will be the demand for transparency and for more robust data tools, both in terms of analytics and in terms of trading interfaces. Christine Sandler says that the demand for an ecosystem is beginning to pick up and those players that are coming are likely familiar both foreign exchange and equities, and so they’ll demand infrastructural standards.

Another key piece of infrastructure is also being provided by exchange group CME. Its Bitcoin futures and options on futures offers scope to hedge Bitcoin exposure. At the same time its CME CF cryptocurrency reference rates and real time indices also add a base of data to support trading and investment. 

Piece by piece the infrastructure elements familiar to investors in other asset classes are beginning to underpin digital assets. This seems to support the now widely held view among those we spoke to for this article that digital asset investment will happen on much larger scale in due course. How long it will take is anyone’s guess. 

Hu Liang sees the pace gathering. “Due to the pandemic, global quantitative easing efforts are further accelerating the recognition that an inflation-protected asset class has a place on the global stage next to gold. Furthermore, regulatory regimes around the world are looking at digital currency initiatives backed by central banks. With the underlying technology of blockchain and distributed ledger playing out their course, I’m a firm believer that five years from now crypto and blockchain will be part of our daily investment lexicon.”

“I think five years is probably right,” says State Street Nadine Chakar. “It may be before that.  My guess is that it’s going to be a slow churn until we get something [in the way regulatory guidance] and then once we get it, it will float.  The good thing about the technology we have today, is that it will allow us to build systems that are much faster than we’ve done with the previous generations of trading platforms.”

Slowly, steps are being taken to ramp up the security, trade execution, workflow capabilities and other key features and functionality that e-trading platforms need to provide in order to cater for the needs of institutional clients. Research suggests that these clients are finding the prospect appealing. However, for some, like eyeing a Ferrari in the showroom, fancying a spin is still a rather different thing than paying the money and driving it away.

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Obstacles to investment - Data taken from FDA Institutional Investors Digital Asset Survey