Here’s Your Ultimate Guide To Institutional Crypto Investing

The cryptocurrency sector has been very much a retail phenomenon up until this point. Institutions are no doubt making moves, but full adoption is still underway. Once it is clear that the industry is at a tipping point, we will likely see the institutional floodgates fully opened.

In 2017, professional investors such as niche crypto funds cracked the institutional valve by following retail investors into the sector. The industry is still waiting on the entry of pension funds, mutual funds, hedge funds, investment banks, sovereign wealth funds and insurance companies. When you consider that institutions account for over 85% of the trading volume of US stocks, these opened floodgates will take cryptocurrency market capitalization to the next level.

How current institutional investment differs from its retail equivalent

There are several points of differentiation between retail and institutional investing.

Investment size 

Investment size is the primary and obvious differentiator. Institutional investment managers allocate sums that have a real impact on crypto spot prices and liquidity. Comparatively, the institutions are in a different class entirely, with billions under management.

Trading and investing strategies

Whereas the average retail investor employs simple trading strategies, the institutional equivalent uses advanced analytics-driven trading and investment strategies. They have access to a higher quality of financial data, utilize automated trading tools, and can tap into the best trading research to make better-informed trading and investing decisions.

Risk 

The institutions pay a lot more attention to risk and are far more cautious in their approach relative to retail. Most likely, this is because they’re managing someone else’s money rather than their own.

Both retail and institutional investors take on some level of risk, but on average, institutional risk appetites are much lower.

Asset custody, governance and compliance

Institutions have rigid corporate rules to follow that retail investors don’t have to consider. They’re under far more scrutiny to adhere to governance and compliance rules, with oversight being applied by various state agencies.

When it comes to custody and ownership where digital assets are concerned, things are likely to be more straightforward for the individual investor, who owns the asset directly. Institutional investors may not hold the asset — ultimately, their clients are the owners of the assets.

Factors holding institutional investment back

All points of differentiation explain why there has been very little institutional investment in crypto up until now. Institutions have a specific set of fundamental requirements that must be satisfied before considering entering the nascent crypto market.

Institutions need to know there is sufficient liquidity in the markets they participate in to execute trades in short order. The scale of their typical investment allocations has simply been too big relative to the overall market capitalization of the crypto sector. Bitcoin reached a $1 trillion market cap in 2021. Yet that’s just a drop in the ocean when you consider that the global equities market cap stands at $125 trillion, with the bond market on a similar scale.

Relative to trading strategies and risk, there have been concerns regarding market manipulation and other questionable practices in crypto, such as wash trading, which would have implications for institutional involvement.

Institutions have been reluctant to get involved in crypto due to a lack of regulatory clarity. To satisfy know your customer (KYC) and anti-money laundering (AML) regulations and remain compliant with rules built for TradFi, institutions need to know who is on the other side of the trade. The pseudonymous nature of most blockchains makes this problematic.

Despite these difficulties, the institutional investment landscape relative to digital assets is changing rapidly. All the factors holding back institutional involvement are getting resolved as the space grows and matures. Regulation is also catching up, and the ecosystem required to support institutional-grade investment is forming.

The advent of indexing in crypto

In the traditional markets, index funds are an easy way for individuals to invest passively with lower fees. While institutions actively manage funds, there is a case where exposure to an index-like vehicle in the crypto space would be beneficial to them at this stage.

Although institutions tend to have a more conservative appetite for risk, they are increasingly interested in gaining exposure to a high-yielding crypto market. With high risk within individual crypto projects, given their nascent stage of development, a product that tracks the entire crypto market will appeal to them.

Cryptex Finance has launched a total crypto market cap (TCAP) token to capitalize on this market need. TCAP is an Ethereum smart contract that relies upon trusted crypto data oracles for real-time price information. TCAP is a crypto-derivative asset that tightly tracks pricing relative to thousands of cryptoassets. Through it, individual and institutional investors can gain price exposure to the entire crypto market in real time.

Although the US doesn’t have any form of a crypto exchange-traded fund to date, investment trusts such as Grayscale and index funds offered by Bitwise are available through the conventional markets. However, they are limited to the leading cryptocurrencies.

Institutional-grade DeFi products

Innovators within the crypto space have identified the issues that the institutions face and are building out solutions to overcome them — particularly where compliance is concerned. The following section reviews examples of such products already on the market.

Aave is one of the original DeFi money market protocols. Aave Arc has been developed specifically with institutions in mind, as it’s a permissioned version of the Aave Liquidity Protocol. Due to compliance and regulatory concerns, regulated institutions cannot access the open-source Aave protocol. With Aave Arc, all participants are AML compliant and KYC verified. With the permissioned liquidity pools isolated from the regular Aave pools, institutions can now access DeFi without violating compliance rules.

For the Compound Liquidity Protocol, Compound Treasury has been launched. Separated from the original protocol, institutions can supply dollars to it via traditional banking, and Compound Treasury, in turn, gives those funds to the Compound Protocol. This degree of separation provides a trusted intermediary for institutions, allowing them to remain compliant with KYC and AML standards and other regulatory requirements.

Other market participants also pivoted to cater to the expected flood of institutional capital. Cryptex Tower is a product about to be launched by Cryptex Finance, which will add new hard mode vaults with a reduced collateral ratio to appeal to institutions alongside the regular mode vaults of their existing DeFi product. Gemini is supporting the offering with institutional-grade asset custody.

Additional institution-centric services in DeFi

Similar to KYC- and AML-compliant DeFi liquidity pools placement, many other services have emerged to meet institutional demand and requirements.

Asset custody 

Qualified digital asset custodians have entered the space, including BitGo, Gemini, Coinbase Custody, Copper and Anchorage. Their offerings have been developed specifically for institutions, including insured cold storage custody and peer-reviewed multi-signature security.

Crypto banking 

Crypto banks such as Seba and Signum have emerged to offer solutions to institutions looking to delve into the digital assets sector.

Over the counter markets 

Institutions that have dipped their toes in crypto already tend to utilize over the counter markets rather than the centralized exchanges that individual investors use. Many providers have entered the space, including but not limited to GSR, Galaxy Digital, Genesis Block, FTX OTC and Jump Trading.

Transaction bridging services 

Web3 wallet provider Metamask has ramped up its efforts to cater to institutional business by launching Metamask Institutional. The institution-compliant wallet offers the same functionality as its original wallet but with some differentiation to facilitate optimized trade flows.

Further reading

Information on various permissioned liquidity pools beyond those discussed in this guide

• Maple Finance – The Maple Protocol provided institutional borrowing and fixed income lending through lending pools managed by Pool Delegates.
• Alkemi Network – A permissioned liquidity pool facilitating programmatic borrowing and lending through a trusted institution-grade liquidity network.
• Centrifuge – Through a partnership with Aave, Centrifuge provides for tokenization of real-world assets, which may be accessed via permissioned pools. Businesses can tokenize trade receivables and invoices and use these real-world assets as collateral to borrow money.
• Credit – An institutional private credit marketplace incorporating a regulatory compliant framework.
• AllianceBlock – Bridging TradFi with DeFi by facilitating users to prove their identity in a trustless manner and providing for a globally compliant capital market.