For an industry with roots in online games and virtual goods--and whose most passionate advocates believe that the Internet should exist decentralized and without authority--it might be ironic that large, institutional investors hold the key to market growth. But they do.
With a current overall market capitalization of $250 billion, cryptocurrencies peaked at $800 billion in early January. The run-up in prices was largely driven by a rush of self-directed retail investors, and a slew of small hedge funds, into the market. With Bitcoin dominating headlines and tales of 10,000 percent returns, the fear of missing out was too strong for many to pass up.
Now, with cryptocurrencies taking a huge nosedive in the first quarter, and recent investors left licking their wounds, the market is in need of new money--big money--to sustain prices. More than likely, a capital infusion from institutional investors such as banks, pensions, or endowments is needed for cryptocurrencies to have any real shot at crossing the $1 trillion market capitalization threshold this year.
Although today's prices might seem like a bargain, institutional investors have been sitting on the sidelines. Concerns around volatility, lack of liquidity, and regulatory uncertainty were more than enough to prevent the smart money from entering the arena.
Irwin Stein, a San Francisco attorney who structures offers for institutional investors, thinks sophisticated investors have better options. "If an institution wants to invest in a company that will likely deploy and profit from blockchain, they can buy IBM or Oracle. So the question is, what does the cryptocurrency market have that is of interest to institutions? Right now, not much."
Robin Sosnow, Esq., founder of law firm Robin Sosnow, PLLC, and owner of the CrowdCrypto Newsletter, has a different perspective. "The tide is rising for institutional participation in cryptocurrency in the United States. Last week, the Securities and Exchange Commission announced that formal proceedings will begin to evaluate a rule change that would permit the listing of two Bitcoin exchange-traded funds (ETFs) on the New York Stock Exchange.
"The Bitcoin ETFs could be the beginning of a wave of cryptocurrency-backed ETFs that would enable widespread access these alternative investments without jumping through the hoops of opening wallets and creating accounts on various platforms to buy, trade and cash out," Sosnow said.
While the news of Bitcoin ETFs may provide some hope to the industry, institutional investors will need to buy the underlying assets--the actual tokens--in order to move the needle for the market, and usher in a new paradigm.
According to Stein, "A few institutions might take a chance when Initial Coin Offerings are registered with the Securities and Exchange Commission and prepared to make financial information available thereafter. But there will still be a need for a liquid, regulated secondary market for the tokens so the institutions can sell quickly if things start to go wrong."
Currently, the liquidity providers for cryptocurrency tokens are hundreds of relatively small, unregulated exchanges. In addition to being highly fragmented, these exchanges have a reputation for being prone to hacking, theft and insider trading. The negative headlines have been hard to ignore for asset managers who as fiduciaries, are legally required to act in the best interest of their clients.
While firms like tZERO and CoinList are underway developing compliant secondary exchanges for the trading of security tokens--programmable equity-- institutional investors see too much risk investing directly into so-called utility tokens trading on current exchanges.
According to Dara Albright, Founder of Dara Albright Media, they may be looking at other strategies to enter the market. "Regulations have nothing to do with it. It's all about the hedge. Institutions need to find some way to guarantee profits and hedge against loses for them to play. For example, institutions were not concerned about the lack of regulations in online (peer-to-peer) lending, an industry formed by retail investors."
Can institutional concerns be mitigated? Albright remains optimistic. "If institutions find that magical formula to lock in their crypto returns, they will flood the marketplace."
The temptation for retail investors to participate is still strong. If you're thinking about investing into cryptocurrencies, it's important to do your homework first. Look at the team, their track record, and then at the traction of the business.
Investing into a token with nothing but a White Paper is risky business. A smarter approach is to invest into tokens with existing technology and verifiable growth. No matter what, never invest more money than you are willing to lose. The industry is young, and investments in cryptocurrencies are highly speculative and not suitable for all investors.
And it's ok to take a "wait and see" approach, too. It never hurts to follow the (smart) money.