The Barriers to Institutional Entry Into Cryptocurrency

  • Some hopeful investors believe that big financial institutions are waiting on the sidelines with trillions of dollars, ready to jump into the cryptocurrency markets as soon as certain conditions are met. While the floodgates of money might not open that simply, some big players are preparing to invest, not just in futures contracts and derivatives, but actual coins and tokens. However, many legal and cultural barriers remain to widespread direct institutional investment into the cryptocurrency sector.

    Major regulatory hurdles prevent institutional capital from directly investing in cryptocurrency. First, the legality of various tokens is still uncertain. Although the Securities and Exchange Commission has ruled that Bitcoin (BTC) and Ethereum (ETH) are not securities but commodities, numerous tokens could be classified as unregistered securities. Such unregistered securities risk federal prosecution and blacklisting by legitimate exchanges.

    Second, fiat/cryptocurrency custody is a work in progress. Institutions do not like the idea of giving custody of large amounts of cryptocurrency to exchanges. They want to know how their funds are stored, secured and insured. They prefer regulated cold storage to reduce the risk of theft and loss.
    Third, counterparty risk is still worrisome. Though exchange security has improved since the days of Mt. Gox and BTC-e, this year’s hacks of Coinrail, Bithumb and Bancor demonstrate that malicious actors have grown emboldened and exchange security can be further optimized.

    Fourth, cryptocurrency liquidity remains relatively low. Compared to the New York Stock Exchange’s average daily volume of $50 billion and the USD/EUR market’s average daily volume of $575 billion, cryptocurrency’s average daily volume is a drop in the bucket. Institutional investors do not want to move markets unexpectedly or be stuck in large illiquid positions, so actual trading volume is attractive.

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