Demand for cryptocurrencies is anticipated to grow this year though this is being stalled by regulatory uncertainty. James McKay looks back at the cryptocurrency market in 2021 assesses the bullish trends in mass institutional demand and obstacles in the market and looks to what lies ahead.
The booming cryptocurrency market
With increasing adoption having fuelled a quadrupling of the total cryptocurrency market cap in 2021– which briefly touched US $3 trillion in November of last year– 2021 has seen both the cementing of major market drivers such as rising institutional interest, the continued growth of NFTs, regulatory uncertainty, as well as a host of new developments. These included the long-anticipated launch of the first Bitcoin-linked ETF, the rapid rise of the metaverse, and the first sovereign nation adopting Bitcoin as legal tender.
Looking back at 2021, despite an extremely bullish start for crypto that saw Bitcoin run from US $29K in January, all the way up to US$64K in April, a 50% correction in May signalled the arrival of the summer doldrums. As usual, many different theories for the sell-off emerged including excessive leverage and China’s total ban on both Bitcoin mining and cryptocurrency transactional services provided by banks and payment companies.
Regulatory developments
Whatever one’s view on the causes of the intra-year bear cycle, few could dispute that the continued regulatory uncertainty in relation to the status of cryptoassets played no small role in keeping cryptocurrency markets in a prolonged state of directionlessness.
The focal point of this regulatory insecurity can be traced to the US Infrastructure Bill, which sought to radically expand the definition of a cryptocurrency broker to be applied to everyone, from miners to node operators to liquidity providers, and which essentially re-classified cryptocurrencies as securities. The perception was that this regulation was designed to help pay for the Infrastructure Bill itself through the introduction of new tax-reporting requirements – an ostensibly bearish signal
Despite what many in the industry perceive to be US Securities and Exchange Commission (SEC) Chair Gary Gensler’s unfavourable stance on cryptocurrencies, the highly anticipated launch of the first US-based Bitcoin-linked ETF by ProShares on October 19 2021, did signal a tentative end to the regulatory impasse and provided the necessary momentum for Bitcoin to eclipse its previous all-time high.
How will ETFs impact the wealth management industry
It has long been accepted that the launch of the ETF would have significant implications for the wealth management industry through the facilitation of greater market participation via pensions and investments as well as being a positive indication for the overall health of the market. For example, in a survey conducted last year by Bitwise/ETF Trends of nearly 1,000 financial advisers 47%, said the launch of a Bitcoin ETF would make them more comfortable with cryptocurrency exposure, up from 37% the previous year.
However, the fact that the first Bitcoin ETF is futures-based has proven controversial within the wealth management industry for several reasons.
Firstly, even though the SEC is ultimately responsible for final approval, futures-based ETFs cater predominantly to the institutional segment, meaning that much of the regulatory due diligence is undertaken by the Commodity Futures Trading Commission (CFTC) and centred on the proper functioning of the bitcoin futures, not the underlying market.
Approving a physical Bitcoin ETF would arguably offer better protections than what’s available on the markets today. Gabor Gurbacs, Director, Digital Asset Strategy at VanEck
This is fundamentally different from the SEC’s mandate to ensure the soundness of the actual underlying physical markets (given its overseeing of retirements, pensions, and investments that go into the retail segment) and several market participants have decried the SEC’s decision to rubber-stamp a Bitcoin futures-based ETF but not a Bitcoin spot-based ETF as “arbitrary and capricious”.
Finally, while the trust and confidence that comes with an SEC-regulated product has been a net positive, the appeal of the futures ETF has been muted among more conservative-minded wealth managers due to the costs associated with rolling futures contracts.
Of course, the ETF equation is just one part of the wider narrative of increasing cryptocurrency adoption in wealth management, and a rapid attitudinal shift has been underway within the industry since 2018.
Read more: Our Economy’s Problem with Fiat Currencies and not having a Plan B
Exposure to more digital assets
During this time, many asset managers have flipped from a risk-based shunning of digital assets on the grounds of “fiduciary obligations,” to initiating crypto exposure so as to not miss out due to the very same fiduciary duties.
For example, CIO of emerging markets at UBS Global Wealth Management, Michael Bollinger, has stated that a significant number of the enquiries about cryptocurrency are from clients expressing a fear of missing out, and these sentiments are echoed by Commonwealth Bank of Australia’s CEO, Matt Comyn.
We see risks in participating, but we see bigger risks in not participating.
Similarly, more family offices are seeking exposure to digital assets not only due to sectoral outperformance but also in order to position themselves for persistently low interest rates and high inflation.
This is highlighted in the global family office survey conducted by Goldman Sachs, in which 40% of family offices globally indicated that they are thinking about currency debasement, with 42% investing in digital assets as a core part of their strategy to position themselves for these macro realities vs. 37% in precious metals.
Data points to a gradual break from a more conservative asset exposure in wealth management which has to a large degree been prompted by pressure from the clients themselves, as seen above, and this will likely only increase as more reports of high-profile family offices announce their entry into the cryptocurrency/blockchain sector.
Another key trend we noticed last year was the counter-cyclic movement in the cryptocurrency space, with Bitcoin dominance (i.e. the totality of crypto market cap owned by bitcoin relative to altcoins) steadily declining throughout the year.
Soaring demand and interest for cryptocurrency
This trend reflects the reduced influence of the macro inputs (e.g. FED policy, inflation, stock market performance) that typically impact the price of bitcoin, on the broader cryptocurrency market due to Bitcoin’s falling proportion of the total market.
Secondly, it reflects that more people are starting to differentiate Proof of Stake (PoS) from proof of work (PoW) protocols, as evidenced by the bullish price action of layer one blockchains such as Ethereum, Solana, and Avalanche whose value is largely determined by the network effect derived from the number of transactions taking place within ecosystems.
Institutional preferences have begun to mirror this maturation of the cryptocurrency/blockchain industry, with a growing number of product launches reflecting the rising interest and understanding of the altcoin market. For example, ETF issuer and asset manager, WisdomTree, recently launched a new crypto index that includes a swath of altcoins such as Terra, Polygon, Uniswap, Aave, Sushi Swap, Yearn Finance, Decentraland, Enjin, Chainlink, and others.
In a further sign of this “institutionalisation” of the altcoin market, FTSE Russell in London announced in December that 43 assets had been vetted to be added to the FTSE Digital Assets (DA) index in 2022, further pointing to the need for accurate pricing data as more institutional players enter the market.
Wealth managers keen to explore cryptocurrencies
While we have yet to see cryptocurrencies become ubiquitous among institutional portfolios, there is little doubt that rising investor demand and a growing understanding of a wider spectrum of digital assets is impelling wealth managers to increase their exposure to this sharply rising asset class, despite residual concerns. Further underscoring this investment demand is the notable development of more investment offices of wealthy families focusing on the innovation and investment potential of cryptocurrencies at the expense of ESG-related investments.
At the same time, improving regulatory clarity will accelerate the number of regulated products available for both retail and institutional investors which will soon include spot-based ETFs not only for Bitcoin, but potentially also for major altcoins such as Ethereum.
Taken together, these factors alongside a buoyant retail market are the fundamentals that will set the cryptocurrency markets up for more major moves this 2022.
