What’s Driving Institutional Adoption of Cryptocurrencies?
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As the cryptocurrency markets have surged over recent months, many people have harbored suspicions that it's too good to be true. Following the last great bull run of 2017, prices crashed, and the markets entered a prolonged "crypto winter." Therefore, it's understandable to think that the current price spikes, where Bitcoin has hit an all-time high above $58,000, could be similarly unsustainable. 

However, there are many signals that crypto is in a very different bull market this time around. Whereas the 2017 price rally was almost entirely attributable to individual investors, the current upward trend is widely attributed to institutional inflow. 

Over recent months, companies including Tesla and MicroStrategy have invested heavily in cryptocurrencies. Banks are following the money. In early March, JP Morgan announced it was launching a "cryptocurrency exposure basket" tracking companies that are focusing on buying up digital assets. Meanwhile, its competitors, including Goldman Sachs and BNY Mellon, are steadily expanding their services into cryptocurrencies. 

So it's clear that the 2021 investors are a very different group to those that bought in during the 2017 run. With a more sophisticated understanding of the financial markets, they're also less likely to get spooked by temporary volatility, meaning the prospects of a big sell-off are more remote. But what's bringing institutional investors into crypto now? Or, to put it another way, what was keeping them out before? 

Rocks on the Runway

According to a recent report issued by institutional trading platform eToroX, several core blockers have been keeping institutions from stepping into crypto thus far, and many of these challenges are heavily intertwined. Perhaps predictably, regulatory uncertainty features high on the list. Over recent years in the US alone, regulators including the Securities and Exchange Commission, the Commodities and Futures Trading Commission, the Internal Revenue Service, and more have issued statements and guidance relating to the treatment of cryptocurrencies. 

The net result is that banks and other institutions that may have wanted to enter the crypto markets were left with an unquantifiable degree of risk. While the market cap of all cryptocurrency assets was still well below $1 trillion, the trade-offs were often perceived to be too great. 

This lack of regulatory clarity also means that it's taken time for the markets to develop to a point where they can accommodate institutional clients. The eToroX report highlights that institutional participants show an overwhelming preference for participation in regulated markets and exchanges, which of course, can only exist once service providers know which regulations apply to them. eToroX is one of the firms blazing a trail in this regard, providing a regulatory-compliant solution for institutions seeking to enter the cryptocurrency space. 

Similarly, when it comes to security and custody, institutions have a strong desire to work with traditional custodial banks over crypto-native custodians and exchanges or self-custody. When you consider that cryptocurrency exchanges have become honeypots for hackers, it's hardly surprising that professional investors. Therefore, the entry of established financial firms like Goldman Sachs and BNY Mellon is undoubtedly a tipping point that will spur other institutional players to join the cryptocurrency segment. 

Complexity and Fragmentation

The lack of regulations and, therefore, lack of standardization in the cryptocurrency markets has also led to significant complexity for users, whether retail or institutional. Back in 2017, only a handful of exchanges allowed a user to onramp to cryptocurrencies from fiat, meaning they then had to shift funds between exchanges to trade. This also resulted in an extremely busy and competitive exchange market, with the total markets fragmented across many different trading venues. Only now that the market cap is sufficiently high to increase liquidity, and with the entry of secure custody providers and an improving regulatory landscape, institutions are starting to make their move. 

Going beyond the eToroX report's findings, there have been other developments over recent years that are likely to have played a part. For instance, back in 2017, the cryptocurrency derivatives market was in its early infancy. It was only in December of that year that the Chicago Mercantile Exchange started offering regulated Bitcoin futures. Now, open interest in Bitcoin futures is approaching $20 billion, and there are a more comprehensive array of derivatives products, including hedging instruments, available to participants. 

Furthermore, the prospect of a Bitcoin ETF has been discussed since the 2017 bull run, but so far, the US SEC has been steadfast in its refusal to approve one. However, the Chicago Board Options Exchange has recently made yet another filing, which is believed to have a more optimistic chance of getting listed. 

A Snowball Effect

Ultimately, it's taken over twelve years for the cryptocurrency market to mature to a point where traditional finance would be willing to accept it. Now, the incremental improvements that have taken place over the last decade, but particularly in the years since the last bull run, are finally starting to pay off. The net result is a kind of snowball effect, where more and more institutional participants are getting in on the ground, at least from their perspective. Therefore, the prospects of digital assets entering into the deep freeze of another crypto winter currently look to be fairly remote.

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