Why institutional money is still staying out of crypto

Why hasn’t the herd yet arrived in the land of cryptocurrency? A new assessment has reached some pointed conclusions…

Build it and they will come. Is this strictly true for cryptocurrency? The promise is clear: an entirely new asset class, currencies that are decentralised and trustless in a way that countries do not have to rely on shady central banks that devalue their currency when it suits them or engage in vast quantitative easing to prop up sagging economies.

The reason why institutional money is still keeping clear of investing in cryptocurrencies is that the space is not professional or responsible enough to attract risk-averse investors.

That’s the assessment of LCX, the Liechtenstein Cryptoassets Exchange. In a September 11 Medium post, they detail the main reasons why billionaire Mike Novogratz’s famed axiom – The Herd Is Coming – has not yet come true.

Novagratz made the prediction in November 2017, around the time when the price of Bitcoin went to the moon, sparking riches and Lambos for a few lucky early adopters and a whole lot of FOMO for retail and individual investors.

LCX write: “The Herd will come if we speak its language…Ultimately, institutional investors will make their way in, if responsible, professional companies and advocates within the ecosystem can bridge the gap between the old and the new financial worlds.”

The five main reasons why this hasn’t already happened, according to the report, are:

1) Regulatory uncertainty
2) Lack of options for business-grade custody wallets
3) Exchanges don’t have enough liquidity to fulfill big, regular orders
4) Customer service is poor at best and dedicated account managers are nowhere to be seen
5) Not enough sophisticated data analytics

“The expectations of The Herd are very different than most retail investors,” say LCX, “and they come from an environment that is used to a culture of compliance, tailored custody, liquid markets and institutional-grade customer service.”

Lack of trust is a serious issue. Despite efforts to bring cryptocurrencies into regulatory alignment with the rest of the world, there still exist major pain points for institutional investors that effectively prevent them from joining the crypto party, say LCX: “The institutional infrastructure that old money needs is extremely underdeveloped.”

Exchange group LMAX tried to thread the needle by launching a cryptocurrency trading desk aimed at large institutional investors called LMAX Digital, hinting that it was more secure than other options because the LMAX parent company was regulated by the UK’s Financial Conduct Authority. In truth, LMAX Digital itself is not FCA-regulated.

Instead, it’s registered with the Jersey Financial Services Commission (JFSC). Jersey, a tiny 100,000-population island 12 miles off the coast of France, is a British dependency and sets its own financial laws. The JFSC says that any cryptocurrency exchange with an annual turnover of £150,000 or more is fully supervised by them and has to comply with standard anti money laundering (AML), counter-terrorism financing and know-your-customer (KYC) legislation, such as flagging suspicious accounts, or those tied to known criminals.

Exchanges with less than £150,000 turnover are exempt from these laws and go into a regulatory sandbox situation where they can test out their product without having to worry about these strict laws. As a side-note, any exchange that deals with transactions higher than €15,000 – are called ‘high value dealers’ under the Proceeds of Crime Act 1999 – therefore must be supervised by the JFSC and comply with AML and KYC rules.

And so, crypto-friendly jurisdictions like Jersey or Malta offer some form of authorisation, even if it falls short of the level of protection that would be offered by being regulated by the FCA or the US Securities and Exchange Commission.

In its press releases LMAX Digital Exchange Limited, which runs LMAX Digital, is effectively borrowing permissions from traditional assets to sell the idea of a safe space in dealing cryptocurrencies. Institutional investors see through this kind of thing straight away.

And despite the fact that big, recognisable brand names like Goldman Sachs and the New York Stock Exchange’s Bakkt platform are launching their own products and trading in derivatives, large inflows from “old money”, as LCX puts it, are still something of a pipe dream.

LCX say: “The vast majority of institutional investors continue to operate in traditional markets and asset classes with no interest of move into crypto whatsoever. In reality, most old money is not just ignoring crypto, but is actively disinterested and skeptical.”

Institutional money is, in general, highly risk-averse. Pension funds, for example, as a rule do not invest in precarious assets with high volatility.

The largest in the world include Norway’s Government Pension Fund, with assets of $898bn, three times the entire market cap of the cryptocurrency industry. Norway is a good example as it also refuses to invest in companies that it believes are harmful to the planet, including tobacco, firearms and nuclear weapons producers, companies that breach workers’ rights, or the mining or logging companies that cause significant environmental damage. Using vast warehouses of computers to mine cryptocurrency consumes incredible amounts of electricity and could, in fact, be accused of contributing to climate change.

Potential is not enough to bring the Herd to cryptocurrency. What will, are greater security, the safety of regulation, the familiarity of dealing with household names and a structure that has the sophistication to deal with demanding institutional clients.

The interesting thing to note is that LCX is somewhat behind the curve in their assessment.

Addressing the first point of regulatory uncertainty, it’s clear that high GDP countries like the US and the UK are following their Far Eastern counterparts in bringing forward directives that will tackle the issue. The UK’s powerful Treasury Select Committee has outright stated that the current ‘Wild West’ situation of excessive volatility, minimal consumer protection and hacking vulnerabilities for cryptoexchanges will have to be combated with new laws.

In terms of high-level data and analytics, as LCX say, “While traditional investors have for decades relied on complex analytics and data tools, the crypto markets lack this sophistication. Hedge funds cannot function without their [Bloomberg] Terminal…whereas crypto’s data landscape is fragmented, unreliable and sometimes fraudulent.” US stock exchange Nasdaq is understood to be working on solutions to this problem, bringing with them almost 50 years of institutional trading understanding, and the benefit of a household name.

Business-grade storage and custody options are close, too. BitGo, one of the world’s largest processors of on-chain bitcoin transactions, has recently been accredited by the South Dakota Division of Banking as a place to securely store digital assets like cryptocurrencies. HyperBlock’s insured crypto-custody solution HyperVault is also on the way. So choices for institutions are coming.

The Herd is Coming. Perhaps not in the short-term, but certainly in the medium to long term. Exactly what form that will take is not yet clear. But it’s not as far away as the doom-mongers might have you believe.

Images: BigStock