Expert Insight

What the crypto world should know about traditional investors

"For those involved in the crypto world for several years, many of the fundamentals seem basic, even obvious. However, it is still an immensely complex sector"

The crypto sector has an unhealthy obsession with day trading. One glance at the news sites dedicated to crypto that have sprung up in the past five years, or even the Facebook groups, highlights the fixation with the myriad reasons behind minute-to-minute price movements or, at the other end of the scale, simple HODLing and hoping.

Currently, most retail investment in cryptocurrency is more akin to forex speculation based on a new asset class that is near impossible to price accurately, or gold and silver hoarders awaiting the end of the dollar standard. Too many crypto trading enthusiasts enter the market at its peak with no experience – other than reading price predictions of questionable crypto ‘expert’ blogs while exuding ‘positive energy’ and proceed to lose their student loans, pensions, or nest eggs.

The bulls, who boasted there would be huge upswings when institutional money entered the market, mostly were left confused when mass take-up failed to materialise, some turning to conspiracy theories to explain it. One of the problems is that there are a worrying number of people involved in crypto – both the developers and their ‘investors’ – who lack any experience of the real world of investment.

By real investment, I mean regulated financial instruments that invest in dividend-paying products and services, not speculation on tokens that offer no equity share and only a very long shot of ever returning any money. Here are some of the most common misunderstandings of the traditional space.

Risk aversion

Firstly, unlike crypto enthusiasts, traditional investors tend to be risk averse, and their money managers have a mandate to preserve their wealth and build an income-paying portfolio – not ‘shoot the moon’ so they can ‘buy a Lambo’.

Przemek de Skuba Skwirczynski, CFO and co-founder of Quazard, a gaming crypto firm, says: “Traditional investors tend to be quite risk averse and hence, if at all, they might consider cryptocurrencies as a way of diversifying their portfolios, rather than go all in. Similarly, they should be expected to cherry-pick the most predictable, liquid cryptos and disregard the rest.”

The idea that there is no one in control is not attractive to the traditional investor. They want to have recourse if something goes wrong. Until crypto finds a way to offer some kind of backstop to investor error (like losing private keys) and ultimately provide a third-party point of final responsibility for maintaining client investments, the disinterest will continue.

Crypto custody is especially important to the traditional investment sector. A recent paper by BNY Mellon highlighted this:

“There is increasing demand in the market for a traditional, established custodian to provide custody of cryptocurrencies… it may be preferable to go to a partner with whom they have an existing relationship, but often the main driver is the increased comfort found with the backing of a significant institution with a strong governance and control framework, as well as a sizeable balance sheet.”

Philosophy

Likewise, traditional investors don’t have the cypherpunk post-Lehman’s sense of a new world order being created. Many in crypto like Roger Ver and even Satoshi Nakamoto have spoken of the need to take back control of the financial world from global financial institutions and governments. The ethical philosophy and libertarian drive that attracts many to crypto doesn’t exist in traditional investing. If they think a sovereign debt crisis and collapse is coming, they buy gold and silver, not crypto.

Similarly, the attraction of many in crypto of holding their own funds in a hard wallet is largely a negative in a sector the values custody and security of assets over independence. Many traditional investors consider regulation an essential part of any investible sector. In a recent eToro survey, 76% of financial advisers said they want to see regulation put in place for crypto-assets.

Steve Andrews, Head of Managed Services at Focus Solutions – who develop and deliver financial planning and investment software to the financial services sector – says:

“What financial professionals want is technology that enables them to engage with and deliver reliable investment advice and returns to their client in a regulation-compliant, secure, and easy-to-understand manner. That doesn’t exist in the crypto world currently, but that doesn’t mean to say that it won’t do one day.”

Complexity

For those involved in the crypto world for several years, many of the fundamentals seem basic, even obvious. However, it is still an immensely complex sector. Paul Lindsell of Quazard says: 

“Those in the crypto space often forget that it’s not that easy to get into crypto and to understand it. At first glance it can be quite daunting and confusing. Everyone in the space raves about how crypto is accessible to anyone but, let’s face it, it’s not easy if you’ve never done it before and the barriers to entry are still quite high with a steep learning curve too.”

Until someone invents the Windows 95 or Google of crypto – and makes a billion pounds in the process – it will remain relatively niche compared to the traditional investment sector.

Pricing an asset

How do you price a brand new asset, especially when many of them don’t yet have an MVP? You can’t do so reliably and without a dividend payment. Money managers will tend to look elsewhere. ICOs especially will be a non-starter for almost every traditional investor.

Przemek continues: “The fact it is near impossible to fundamentally analyse cryptos is a major hurdle for traditional investors – security tokens are, of course, easier to value due to their intrinsic equity element. However, they are not particularly liquid – blue-chip STOs would be the obvious solution.”

The crypto oxymoron

There is an inherent problem here. To attract big investments, crypto needs an element of regulation, oversight, and at least a little restructuring of its investment processes. Yet the very essence of crypto is its unique independence from those controls.

David Hesketh, COO at TradingHub, says:

“The main point of cryptocurrencies is that they have no trusted central authority and that they facilitate anonymous transactions. These tenets are diametrically opposed to the requirements of regulators that regulated entities perform KYC and money laundering checks and that all counterparty and transactional information be reported to central authorities. It is hard to see these obstacles being overcome without losing the essence of what makes cryptocurrencies attractive.”

Conclusion

Crypto is big on ideas and promises but light on real-world adoption for the mass market. The next two years is the time when the sector has to sort out its governance and compliance structure if it wants to attract big money. It won’t be easy to do this while maintaining its core USP. The deflating of the speculative bubble of the last two years offers a chance to put proper financial structures in place rather than chase dumb retail money. If crypto does that, large-scale traditional investments will follow.

Matthew Morris,

Partner at Carr Consulting & Communications.

 

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