As the cryptocurrency market matures, efforts are underway to supplement its transition into the mainstream of asset classes
Cryptocurrencies have been growing in popularity as retail and institutional investors increasingly turn to digital assets seeking new sources of return and a hedge against inflation and other worrisome economic trends.
Throughout the Covid-19 pandemic, interest in cryptocurrencies spiked, driven higher by a combination of factors, including their potential as an alternative investment to gold and the rising popularity among amateur investors. Cryptocurrencies are poised to become a mainstream financial asset class, bringing new ways to conduct financial transactions and more transparent processes.
Institutional adoption of crypto assets has long been seen by many as a necessary step on the path to going mainstream. There is now evidence that this is beginning to take place, with momentum from traditional financial institutions ramping up their exposure and presence within the sector in recent months.
Digital asset investment manager CoinShares reported that the first quarter of 2021 was a record-setting period for crypto investments, with $4.5bn (£3.19bn) in institutional inflows during the period.
At the same time, major banks have ramped up their infrastructure to facilitate increased exposure to crypto assets. In May, Goldman Sachs revived its cryptocurrency trading desk to meet the growing demand from institutional clients, while other firms on both Wall Street and in the City of London responded to the popularity of the emergent asset class.
All this points towards the incremental, wider growth of cryptocurrencies according to The Crypto Maturity Model, a framework for how traditional financial institutions can build cryptocurrency products.
Produced by Chainalysis, a blockchain data platform known for its role in cyber investigations and compliance for government agencies, financial institutions and cryptocurrency businesses, the roadmap outlines how traditional financial players can embrace cryptocurrency products while adhering to global regulatory measures.
From training staff in the nuances of crypto assets to establishing cryptocurrency exchange-traded funds (ETFs) and building facilities to take custodial ownership of clients’ assets, the pace of adoption within previously reluctant organisations has accelerated.
As traditional banking takes lessons from crypto assets, the inverse is also true. With the greater incursion of mainstream banking into the crypto market, this new asset class is adopting principles from the established assets, with investors rightly expecting a similar degree of regulatory accountability, transparency and reliability.
Transparency and the advantages of blockchain technologies are key to the surging growth of cryptocurrencies, and an imperative driver of its future. When applied to a system still rooted in legacy, the possibilities are set to be bountiful.
“In the longer term, increasing numbers of assets are likely to be digitised,” says Philip Gradwell, chief economist at Chainalysis.
“Already, stablecoins such as USDC are digitising dollars, and crypto exchanges are tokenising stocks. If legacy banks do not get familiar with blockchain technology then they will lose business as assets move to new platforms,” he says.
It is no secret that investors are demanding access to cryptocurrencies. On the retail side, the FCA estimates that 2.3 million adults hold crypto assets in the UK. Likewise, institutionally, hedge fund managers expect to hold 7% of assets in crypto within five years, research from fund administrator Intertrust suggests.
But pairing the opportunities of the asset with forward-looking regulation is a hurdle not yet tackled by many governments.
Nevertheless, a post-Brexit regulatory overhaul, as recommended by the Kalifa review of the UK’s fintech sector, is on the horizon, presenting legislators with an opportunity to cultivate an environment that supports the proper use and regulation of cryptocurrencies, and to turn the UK into a global hub for the industry.
Such regulation that facilitates the transparent use of cryptocurrencies is set to be beneficial for investors, and already the FCA is wielding its power to support crypto-holders, with pressure placed on the industry to step up efforts to meet anti-money-laundering standards. Existing regulation will only go so far in ensuring the longevity of the asset, and if the asset is to further proliferate, more needs to be done.
In India, a nation whose official stance on crypto has been unclear for some time, bitcoin’s anticipated classification as an asset class comes in parallel with new regulations that seek to bolster the positive effect of crypto assets on the nation’s economy.
Recently, India’s imposing regulation on cryptocurrencies may have stifled the opportunities for its citizens to capitalise on the asset.
Chainalysis research found that bitcoin investment gains in India stood at $241m (£173m) in 2020, significantly below the expected gain owing to the nation’s GDP and population.
“Right-sized regulatory oversight and supervision, that which ensures financial integrity without compromising the development and adoption of the ecosystem will encourage economic growth and technological advancement in tandem,” said Jesse Spiro, chief of government affairs at Chainalysis.
Meanwhile, US financial authorities are taking steps to have a more active role in market regulation. It is hoped that better federal oversight will reduce risk exposure to investors.
Fundamentally, crypto assets are primed to embrace the growing need for accountability, both from a regulatory stance, as well as from the practical application of the mainstreaming of the asset class.
Blockchain technologies have already instilled an unprecedented discourse of transparency within the financial sector, and that principle cannot be impeded on by regulation.
“Given the transparency crypto assets provide, regulators should seek to apply additional regulation around activity, not the technology itself,” says Spiro.
Unlocking opportunity is fundamental to cryptocurrencies and the returns available to investors, but furthering the reach of the asset requires a broad spectrum of industry support.
From institutional dollars projecting cryptocurrencies into the mainstream to regulation cementing its longevity, the transition of crypto is dependent on its fundamental tenets - transparency and accountability – and backing those ideas now will go some way in creating more opportunities down the road.
For more information please visit chainalysis.com