Digital assets as the new alternative for institutional investors: market dynamics, opportunities and challenges is a research brief written by Economist Impact and sponsored by OKX.
The brief presents insights on four key considerations for institutional investors that emerged from an Economist Impact roundtable discussion that took place in Dubai in the second quarter of 2024, which was supplemented by expert interviews and desk research.
These fundamental areas are:
- Institutional asset allocation
- Custody
- Regulatory development
- Risk management
This research discusses the maturing ecosystem of market participants and serves as a guide for investors to navigate the digital assets landscape by informing their decision-making.
The research brief explores several key findings highlighted below:
- Institutional investors view digital assets as a promising class that is set to expand substantially: Increasingly mature blockchain technology and digital security infrastructure, ongoing efforts to achieve global regulatory clarity, and digital innovations such as tokenised real-world assets are driving institutional adoption. According to a 2023 survey, 69% of institutional investors anticipated increasing their allocations to digital assets and/or related products in the next two to three years.1 They also expect digital asset holdings to constitute 7.2% of their portfolios by 2027.2 “Asset management and banking clients are seeking exposure to digital assets. Diverse investment tools and products are emerging to meet this need, such as exchange-traded funds (ETFs), exchange-traded notes, blockchain platforms powered by decentralised Web 3.0 technology and crypto phones,” highlights Thijs van Boven, head trader of digital assets at VanEck.
- Institutional investors plan to ramp up portfolio allocations to crypto products through diverse investment strategies: The most popular strategies include investments in spot cryptocurrency, mutual fund/ETFs that invest in companies tied to the blockchain/digital asset industry and PE/VC-style investments in firms.
- The rise of institutional-grade custodians is enabling investors to benefit from digital asset opportunities: The demand for third-party custodians is particularly prominent among institutions — it is the first choice for 80% of crypto hedge funds and traditional hedge funds.3 Regulated qualified crypto custodians that abide by stringent compliance and licensing requirements are emerging as trustworthy partners.
- The convergence of developing regulatory frameworks will be key to addressing market uncertainty and ensuring consumer protection for institutions: “How do you treat fiat currencies operating as tokens on distributed ledger technologies? Is it still deemed a currency [for regulatory purposes] or is it an asset? What, therefore, are the legal implications and what are the considerations from a tax perspective?” asks Jagadeshwaran Kothandapani, head of MEA and MEP Payments at Citi Services. Cross-border co-operation including consistent supervisory and enforcement mechanisms and information-sharing requirements to ensure international compliance are crucial. The European Union’s Markets in Crypto-Assets Regulation—the first cross-jurisdictional regulatory and supervisory framework—showcased a successful step towards standardisation. Institutional investors need to maintain a keen understanding of the evolving and maturing regulatory environment. According to Anthony Scaramucci, founder and managing partner at Skybridge Capital, “The onus is really on regulators to embrace the future and finalise sensible regulation that protects consumers and cultivates responsible innovation.”
- Risk management is a crucial step for digital asset allocation to become entrenched in institutional portfolios: Digital assets adoption can involve risks such as operational, market, counterparty, regulatory and compliance. Institutional investors need to manage risks intrinsic to the technology infrastructure of digital assets as well, including hacking, ransom attacks, transaction irreversibility and systems failure. Similar to traditional finance, value-at-risk models, scenario analysis, stress testing, reverse stress testing, independent third-party audits, proof of reserves and reporting requirements are important risk management considerations. Technological advancements allow for emerging strategies tailored to digital assets including machine learning to monitor blockchain transactions and automate anti-money laundering processes and new-age software tools to generate smart contract risk assessments and audits.
References
1 EY, “Driving meaningful opportunity: tokenization in asset management”, https://assets.ey.com/content/dam/ey-sites/ey-com/en_us/topics/financial-services/ey-driving-meaningful-opportunity-tokenization-in-asset-management.pdf?download
2 EY, “How tokenization in asset management is driving meaningful opportunity”, https://www.ey.com/en_us/insights/financial-services/tokenization-in-asset-management
3 PwC, “Rebuilding confidence in crypto”, https://www.pwc.com/gx/en/new-ventures/cryptocurrency-assets/5th-annual-global-crypto-hedge-fund-report-july-2023.pdf
