Cryptocurrency performance continues to attract attention from institutions such as banks, hedge funds, asset managers and family offices. In fact, dedicated cryptocurrency funds returned more than 16 per cent in 2019, according to a survey from Eurekahedge, which contrasts with a traditional hedge fund strategy yield of 10.4 per cent, according to Hedge Fund Indicies (HFR). We spoke to Bitfinex CTO, Paolo Ardoino about strategies to support further institutional take up of digital assets.
How do you see the institutional market evolving in terms of appetite for trading digital assets?
For many years the crypto community has talked about incoming institutional support for cryptocurrencies, however it is only now, in 2020, that this is taking off. Previously only select hedge funds and banks with higher risk portfolios engaged with crypto. Serious levels of investment did not flow in. The crypto market was in a testing phase and there was a bubble of ICOs and projects that didn’t deliver, not unusual for a new market. If there is too much uncertainty, institutions will simply not take the risk.
This phase taught the crypto market a good lesson – better infrastructure and tools need to be built to bring institutional money flowing in and while many crypto companies have come and gone, what is left is robust and provides the tools and services to support institutional take up. For example, Market Synergy manage co-location services for Bitfinex’s institutional clients and offer a FIX feed and ISP link to the digital asset gateway. In the first months of 2020 Bitfinex has seen huge interest from institutional investors, in particular from hedge funds and I predict this trend to continue.
What are the key changes we are currently seeing/will see in the near future to drive further uptake amongst institutional clients?
Market evolution came from an understanding that exchanges, at times, had too much concentrated risk. In traditional finance, exchanges are just trading venues, while custodians are segregated – they are different entities. So, if you trade with a traditional exchange you execute there, but use another entity like State Street or similar as your custodian. This provides an independence between the different entities. However, in crypto – a new and unregulated market, people focused on the exchanges, many of which were hacked, leading to security concerns. A new approach was required offering crypto custody solutions.
Put simply, cryptocurrency custody solutions are third party providers of storage and security services for cryptocurrencies. Their services are mainly aimed at institutional investors who hold large amounts of bitcoin or other cryptocurrencies. The solutions generally incorporate a combination of hot storage, or crypto custody with connection to the Internet, and cold storage, or crypto custody that is disconnected from the Internet.
This has led to the formation of new companies offering a segregated approach for hedge funds, in terms of risk. So the idea is that exchanges will not hold all the collateral / cryptocurrencies for the users, but will instead let traders use a third party crypto custodian. Crypto exchanges will be more and more like trading venues, so we can replicate the same structure that institutional clients use in traditional financial markets.
For Bitfinex this has been the most requested feature in the first few months of 2020. We have been approached by numerous hedge funds asking Bitfinex to support as many third party crypto currency solutions as possible. So cryptocurrency support, robust co-location from Market Synergy and a focus on performance are all preparing the ground for more and more institutional market entrants.
What trends are you seeing in digital asset trading which you think brokers, banks and hedge fund managers should be aware of?
Bitfinex is one of the most secure exchanges but understands concerns that ‘concentrations of risk’ are still too high. Hedge funds and banks want to see specialisation in terms of duties. If you are a crypto custody provider, your only feature and focus is to provide cryptocurrency quickly. If you are an exchange you will offer trading services and be dedicated to that, without spending time and effort to provide custody solutions. Binfinex is large enough – with a fully dedicated security team – to be able to provide crypto custody solutions too. In fact we have billions of dollars under management in the crypto exchange. We see this trend for diversification as a positive for the market and one that will bring in many more institutional users.