An Insider’s View on Digital Asset Opportunities for Institutional Investors

By John Payne for Aves Lair

Digital assets were once widely regarded as novelties. Recently, however, they have begun to emerge as practical investment vehicles for traditional institutions. But much work remains to be done to build the infrastructure to connect institutions with the growing digital asset ecosystem. Clearer regulatory guidance, robust prime brokerage offerings, and the continued development of the digital asset space will not only clear the path for traditional institutions’ participation in the digital asset class, but also shape how institutions use these assets.

Aves Lair recently hosted a panel discussion by leaders in the digital asset and decentralized finance (DeFi) space that centered on the topic of bridging the gap between traditional institutions and digital assets. Dean Somes, Vice President and Wealth Manager at BNY Mellon and former senior portfolio manager for a Dallas-based family office, moderated the discussion, quizzing the participants on a range of subjects relating to digital assets, some of which are covered here.

The panelists included James Runnels, Co-founder and CEO of Digital Lending Capital Corp (DLCC), a full-service, institutional-grade prime brokerage for digital assets and member of Aves Lair’s Winter 2020 accelerator cohort; Jeanine Hightower-Sellitto, CEO of commodity digitization and tokenization ecosystem Atomyze and member of DLCC’s Board of Directors; Kevin Kang, Founding Principal at BKCoin Capital - a digital asset hedge fund; and Darsh Singh, Co-Founder and Chief Investment Officer at digital asset and cryptocurrency-focused investment fund Hazoor Partners.

To hear the full conversation, click here. 

Summary: 

Digital assets - including cryptocurrencies such as Bitcoin and Ethereum, as well as a steadily increasing number of digitized commodities, collectibles and tokens - are a nascent asset class, but look prime for widespread adoption in the not-so-distant future as rising cryptocurrency prices and the emergence of clearer regulatory guidelines and infrastructure - especially prime brokerage - gradually align. 

Today, institutional investors hailing from the traditional finance world are only just beginning to engage with digital assets. This is partly the consequence of digital assets’ becoming “really hard to ignore,” as Jeanine Hightower-Sellitto described it, with the price of Bitcoin breaking $40k in early February after rocketing past $30,000 last month - two price levels Hightower-Sellitto described as “breakout points” - and prominent investors, including Paul Tudor Jones and Stanley Druckenmiller, “publicly announcing they’ve been investing in the space.” 

It was not the recent cryptocurrency boom per se, however, that prompted institutional investors to take note of digital assets. Rather, as Hightower-Sellitto contends, institutions had been - and, in the main, still are - “waiting in the wings, ready for the right” moment to enter the space. Hightower-Sellitto noted that traditional investors are “doing their research,” “building out [the] infrastructure” to invest in and trade digital assets, and acquainting themselves with the landscape of potential counterparties offering digital asset investment services. 

Moreover, Hightower-Sellitto posited that institutions await the emergence of tools, such as borrow-and-lend, trade execution, liquidity and research, along with clearer regulatory guidelines, to facilitate their entry to the digital asset space. 

These factors will play an essential role in the transformation of digital assets from niche investment vehicles to an asset class with buy-in from major institutional investors. Indeed, James Runnels emphasized the importance of infrastructure - particularly in the way of prime services - in securing “widespread adoption” of digital assets among traditional institutional investors. Runnels expressed that “a prime brokerage offering will help facilitate a lot of institutions coming into the space,” and argued that prime services for digital assets will also benefit asset allocators and managers. 

The goal of DLCC’s endeavor to build a prime services offering for digital assets, Runnels said, “is to help our clients institutionalize their own product,” such that clients “can start to attract some outside capital.” “A large portion” of crypto fund managers, Runnels continued, “are just managing proprietary capital; they haven’t had the ability yet [or] the resources to start attracting outside capital.” “Infrastructure,” Runnels added, “would be a significant move to really get some momentum going behind [funds’ attracting outside capital].” 

Kevin Kang suggested that buy-in from name-brand institutional investors and institutionalized infrastructure will allay institutions’ wariness about the nascent digital asset space and encourage them to allocate capital into the space. Kang named infrastructure as the “biggest catalyst” to institutions’ allocating capital in digital assets en masse, and pointed to Fidelity’s product launch in 2020 as the moment when “institutional investors started looking at [the digital asset space] more seriously.” “As more big investors start to jump into the space,” Kang argued, hedge fund portfolio managers will not be burdened with as much career risk when they decide to allocate a portion of their portfolio into a digital asset like Bitcoin.

Infrastructure may promote widespread adoption of Bitcoin and other digital assets by serving as accessible platforms that can reach mainstream consumers and sidestep some of the more arcane aspects of blockchain technology. Darsh Singh argued that widespread adoption should be measured not by the “wealthiest people using” blockchain technology, but by the “most amount of people using it.” In his view, people using an application built on top of this infrastructure without knowing that it is powered by blockchain technology, uses Bitcoin “behind its payment rail” or has a “stable coin behind it through a smart contract in Ethereum” will prove more meaningful indicators that blockchain technology and cryptocurrencies have achieved widespread adoption than the prestige or deep pockets of early adopters. 

Institutions’ concerns about digital asset trading can be mitigated by clearer regulatory guidelines, which will foster greater certainty and confidence. Hightower-Sellitto described regulatory “gray area” as a key factor behind many institutions’ unwillingness to engage with digital assets so far. “When you’re looking for investors to participate in some of these digital assets,” she went on to say, “you need to be able to list them on exchanges that can trade them where there can be valid prices” unaffected by price manipulation. 

With respect to regulatory guidance, Hightower-Sellitto argued, the more, the better. Under the present paucity of clear guidance, investors are left with no choice but to speculate - like looking to Biden administration appointments for clues on the future direction of digital asset regulation. “The certainty to operate,” Hightower-Sellitto concluded, will make it easier for institutions “to adopt these assets.”

Growing institutional participation in the digital asset space may nonetheless be already “forcing regulators’ hand,” according to Runnels. As the number of regulated entities “getting involved in at least Bitcoin, whether it’s Fidelity...PayPal [or] State Street,” grows, pressure will mount on regulators to release clearer and more comprehensive guidelines. Moreover, Runnels suggested that regulation will likely have a positive effect on the industry, protecting consumers and clients, and even creating efficiencies. The latter is especially true at the “broker-dealer level,” Runnels argued, and will help pave the way for “more widespread adoption,” since most institutions work with a “broker-dealer or a bank” when they get involved in a new asset class. 

Clearer, more robust regulatory guidelines will shed light on how broker-dealers and banks can participate in digital assets and offer an “on-boarding ramp” to their clients. DLCC and other proactive players intend to adapt some legacy norms and best practices for the digital asset space, which “would allow for more traditional finance to...participate in [a] manner that they’re accustomed to.” In Runnels’ view, the convergence of foresighted companies such as DLCC tailoring their service offerings to meet traditional finance’s standards and more thorough regulatory guidelines on digital assets will create a more “robust offering” benefitting all parties involved. 

Traditional prime brokerage for an asset class that is anything but “will be a perfect starting point,” Kang agreed, “to provid[ing] institutions services that borrow from best practices and regulatory frameworks familiar to institutions. Kang cited BKCoin’s practice of working with Copper for some of the fund’s investors, ensuring that the fund “can only move assets with their permission.”

The decentralized nature of digital assets like cryptocurrencies, Singh cautioned, means regulatory clarity may prove slippery for assets that lay “largely beyond the bounds of traditional finance and regulated institutions.” Singh pointed to permissionless money transfers - especially cross-border money transfers - that take place outside of a regulatory framework as an example of the myriad ways that digital assets circumvent traditional approaches to governing the use and exchange of assets. 

The lack of a comprehensive prime services offering for digital assets in today’s market, in Runnels’ view, prevents liquidity from flowing into emerging crypto assets. “There [are] a lot of talented teams out there that are offering...a tremendous amount of liquidity in the space, but it’s not necessarily tech-driven yet; it’s more driven by traditional phone calls or social media apps,” Runnels continued, suggesting that this presents an opportunity for prime services offerings with the technology needed to link up liquidity and the digital asset space - especially locate, margin, and borrow and lend capabilities - to bridge the gap. Kang pointed to margin as a particularly important area where digital asset prime brokerage can meet the needs of institutional investors. The ability to “manage the margin in a centralized place, instead of...across ten different exchanges” would be “a huge step forward,” Kang asserted.

Digital asset markets differ from traditional ones in many ways - making it all the more necessary, Hightower-Sellitto argued, for institutions interested in participating in the space to do so with counterparties, such as those offering prime services. Cryptocurrency marketplaces are “highly fragmented” and devoid of interoperability - in the Bitcoin marketplace, for instance, multiple providers create a consolidated price. Hightower-Sellitto stressed that “the right technology” could cut through the confusion of multiple prices on different exchanges. Moreover, many cryptocurrency exchanges “are fully funded or have very little margin or leverage available on them,” which might mean that an investor who wants to sell on an exchange has “got to have [their] cash there or [their] other crypto...to buy another crypto” on that exchange. This idiosyncrasy of many digital asset marketplaces can stifle the efficiency of investors’ capital, which, Hightower-Sellitto expressed, underscores the value of “technology and providers” who can maximize the bang investors get for their buck (or coin).

“I think...big names will be coming into the [digital asset] space,” Hightower-Sellitto posited, particularly banks and investors that are currently on the hunt for opportunities. In five years’ time, she envisions a host of DeFi options that can both “meet investors’ needs in terms of compliance, but...also bring some of the advantages of a DeFi environment to digital assets.” 

More ways that mainstream consumers can adopt digital assets represents an exciting area of possible growth in the “next one...or two years,” according to Runnels. These applications could include “the ability to utilize a stable coin for payment, dollar-to-dollar, one-to-one,” or NFTs (non-fungible tokens), which can take the form of collectibles or other scarce digital items - like baseball cards, or even a piece of art, in digital form. 

Kang envisions digital assets becoming an institutional, investable asset class with macro hedge funds having large-cap and mid-cap crypto specialists, and institutional investors exploring a wider range of investment strategies, such as borrow and lend, or allocation to a “momentum...or trend-following strategy to accumulate more Bitcoin.”

Singh contends that the availability of “provably scarce digital assets” will spur a “wave of innovation” resembling that which followed the advent of the internet. Singh expects enterprises and leaders who can figure out ways to make it “easier for people to access and navigate” the world of digital assets to benefit from this expected surge of groundbreaking technology and applications. 

Traditional institutions are increasingly interested in digital assets. Among multiple factors, infrastructure, especially to facilitate institutional-grade prime services in the digital asset space, clearer regulatory guidance, and innovation will pave the way for mass institutional participation in digital assets.