Crypto's future depends upon traditional finance (TradFi) investors. I'm not talking about banks and asset managers but the pension funds, endowments, foundations and large family offices that control large pools of discretionary, patient capital. If crypto is to realize its transformative potential, it needs these institutional investors to start writing checks.
To understand how these investors view crypto, I asked 15 asset owners, none of whom could even be remotely described as a crypto zealot and each responsible for managing or advising multibillion-dollar portfolios, "Given the events of 2022, what would give you the confidence to invest in crypto-related opportunities, and what type of opportunity would you consider?" I added the caveat that their answer could not be "better regulation."
Angelo Calvello, Ph.D., is co-founder of Rosetta Analytics, an investment manager that uses deep reinforcement learning to build and manage investment strategies for institutional investors.
Their responses revealed five key insights for the future of crypto:
'Crypto and blockchain are here to stay.'
This group's confidence was not shaken by the crypto-related events of the 2022 "pullback" of bitcoin (BTC), ether (ETH), and other coins, the crypto credit crisis or the ensuing contagion. Their reactions to these events ranged from sanguine ("the events of 2022 … do not mean much to me or crypto") to fatalistic ("it [crypto] will bomb a few more times before it becomes institutional before we can trust actors know what they are doing") to gleeful ("I'm all for the crash"), with several others viewed the events as a "necessary capitulation" that would result in a better, healthier ecosystem. More generally, none thought 2022 spelled the death of crypto. On the contrary, they generally agreed with an endowment chief investment officer (CIO) that "crypto and blockchain are here to stay." However, they all agree that for them to commit meaningful capital to crypto, the future of crypto must look much different from the past.
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'Cryptocurrencies are a solution in search of a problem.'
The future of crypto will not include investments in cryptocurrency trading strategies, according to the allocators. The managing director at a large family office forcefully pointed out that "we have no interest in crypto as a currency." The head of alternatives at a corporate pension plan added that he viewed crypto trading as "degenerate gambling."
The group also uniformly rejected the usual economic arguments for a core allocation to cryptocurrencies (it's an uncorrelated asset, a store of value, or an inflation hedge). One large endowment characterized these arguments as "hypothetical."
'It's time for crypto to put on big boy pants.'
The future of crypto will be good crypto businesses, not good crypto products.
For these investors, 2022 was a watershed year for crypto. While this group views crypto writ large as a transformative technology that could lead to genuine and much-needed innovation, to date, these investors view the crypto ecosystem as "a giant crypto circle jerk that incentivizes people who contribute very little value creation." An investment consultant described the ecosystem prosaically as a "hobbyist industry consisting of a limited group of technically sophisticated users. … What's hot in crypto is not what institutional investors care about."
To attract institutional capital, this must change. As one family office investor told me, "It's time for crypto to put on big boy pants. Crypto people must stop building products for other crypto people." Another allocator added that “We're at a stage of dreaming and optimism.” A person responsible for venture capital investments at a family office said that moving from illusion to reality requires the ecosystem to start building "Web3 solutions (infrastructure plus applications) that are better than current solutions at solving real world problems outside of the Web3 ecosystem/echo chamber (faster, cheaper, better user experience, better ability to capture value, etc.)."
Allocators agreed that to qualify for an allocation, these solutions must be supported by definable, sustainable business models. (And just for clarity, these business models are not decentralized autonomous organizations (DAO): "DAOs are not a way to run a business and what the hell is a governance token?")
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These institutional allocators have grown weary of the pitches from crypto evangelists and consultants that "show a total lack of consideration of the difference between a product and a business." One allocator was unequivocal: "This year, when I hear a crypto pitch I will stop the speaker and ask them if there's a business model. In the past few years, there has been a total lack of consideration of the difference between a product and a business."
Critically, all agree that the business model must be scalable. For one allocator, this means "decentralized projects and investment opportunities aimed at the general public that more effectively distribute the economics of behavior better than centralized alternatives." Another asset owner was more specific: These must be "projects and investments with a total addressable market of 10 million or 100 million people," adding for emphasis that "crypto needs its browser moment."
'We need a generational change for crypto and the underlying technology to be adopted.'
The future is far away. Allocators identified several structural barriers that will impede their deployment of capital, including the difficulty and time it will take to build sustainable, scalable crypto businesses and the opposition of legacy institutions that benefit from centralized structures.
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Several also identified a less obvious but more formidable barrier: institutional investors' current worldview. These allocators assert that broad-based crypto investing will require a two-part "generational shift." For decades, TradFi allocators' investment worldview has been circumscribed by the canon codified in CFA and MBA curricula, which, as the CIO of a public pension plan said, "do not support crypto-related investments … If we get rid of these ideas, in five years, we'd have innovation, the innovation we desperately need."
Second, investors need to move beyond their ethnocentrism and realize that developing markets, especially "the great unbanked" in the global south, will likely be the source and beneficiaries of many scalable investment opportunities. An investment consultant pointed out, "an investment committee in Boston is not thinking about crypto in the same way as young people in the Global South."
'It is absurd what passes for due diligence.'
The future must include better due diligence. Confidence that crypto investment opportunities are grounded in sound, scalable business models requires rigorous due diligence. This group generally gains private market exposure through funds, so they expect their fund managers to use proprietary, time-tested diligence processes to vet crypto investments thoroughly.
Yet, the failure of many well-regarded funds and asset owners to identify (or to just ignore) the numerous red flags associated with crypto lender Celsius Network and the FTX exchange has caused these allocators to lose some confidence in their funds’ general partner's diligence processes. For example, an endowment CIO said, "It is absurd what passes for due diligence."
The managing director of investments at a Canadian pension plan agreed: "A lot of people got really lazy, and they didn't go deep enough."
These allocators acknowledge that crypto investment opportunities present unique challenges that require specific knowledge that even the most sophisticated investors might lack. Referencing Caisse de dépôt et placement du Québec's investment in Celsius and Ontario Teachers' Pension Fund's investment in FTX, the CIO of a U.S. public pension fund pithily noted, "Not even the Canadians are capable of doing the due diligence on something they don't understand."
More generally, many share the view of a corporate pension fund CIO that funds are putting undue pressure on limited partners to make an allocation decision: "A lot of the deals are going so fast that you get a call, and you have to make a decision almost immediately and, as a fiduciary, FOMO is not a reason to invest." Another pointed out, "FOMO only works when you have a tailwind."
This informal survey reveals that while institutional investors are bearish on cryptocurrency investment strategies, they are long-term bullish on crypto as a transformative technology, provided the technology is demonstrably scalable and supported by a viable business model. Sourcing these technology-based opportunities will require a shift in their worldview; vetting them will require an improvement in their due diligence.
The crypto ecosystem historically has chafed under the yoke of TradFi conventions, but this yoke is one it must shoulder to earn the trust necessary to attract the institutional capital necessary to transform itself from a guild into an industry.