Bitcoin has been around for over a decade, and up until the recent past few years, Bitcoin and other cryptocurrency is a digital asset containing cryptographic protocols that make transactions secure and immutable. Crypto…”>cryptocurrencies, have not had much popularity, especially in the traditional institutional market.
The world’s first cryptocurrency is known for its highly volatile nature and along with other cryptocurrencies, are known for their implications in illicit activities. In the past few years, many institutions have started looking into Bitcoin’s underlying technology, blockchain, and found its transparency and immutable nature to be valuable. With the rising demand for digital payment systems and the emergence of the coronavirus pandemic, cryptocurrencies have started to create a place for itself in the financial ecosystem.
Blockchain.News spoke with Christine Sandler, the Head of Sales and Marketing at Fidelity Digital Assets to understand more about the concerns institutional investors may have and the barriers to entry to the cryptocurrency market. Sandler has had extensive experience in the traditional capital markets and has been involved in the electronification of the equities business. Before joining Fidelity, she entered into the digital asset field by joining Coinbase in 2018.
“When I looked at digital assets, I thought we could potentially be witnessing the birth of a brand new asset class. What I found most compelling given my background was the difficulty in trading these assets,” said Sandler.
With the lack of transparency and homogenous markets, Sandler felt that she could contribute to the new asset class with her past experience. She added:
“So it was the dysfunction in the market that drew me to the asset class and what kept me here is the diversity of not only the community but the overall experience. Even before I joined Fidelity, I viewed the company’s entrance into digital assets as something that was not only supportive of the overall ecosystem, but supportive of traditional investors’ adoption of digital assets.
Sandler explained that her goal at Fidelity Digital Assets is to help traditional institutions to begin to adopt and incorporate digital assets into their portfolio.
Barriers to entry to the crypto market
Bitcoin and other cryptocurrencies have had the reputation of being mixed up with illicit transactions, which has set the barrier for institutional investors for entry into the market. “As digital assets have matured, we’ve seen validation in the market, around emerging investment theses and diversification opportunities, amid global macro trends.”
In order for the cryptocurrency industry to grow, Sandler believed that the industry needed to appeal to more traditional institutions and to begin to mitigate the frictions that were present. She explained that an institutional investor might be willing to accept the risk of loss based on a poor investment decision, but not for technical flaws or operational glitches.
During late 2019 to early 2020, Fidelity Digital Assets surveyed 774 institutional investors across the United States and Europe and found that 80 percent of the participants found something of value in digital assets. 60 percent of the participants said that they would incorporate digital assets into their investment portfolios. 90 percent of the survey respondents were traditional investors.
Sandler said, “Traditional institutional investors want to see other traditional institutions as service providers in the space. We found that as a traditional institution providing those services, we found that to be particularly encouraging. We’ve also seen the value of our brand attributes resonate in the marketplace, customer focus, strong operational processes, and focus on risk management.”
Addressing concerns in the crypto market
Sandler explained that one of the main reasons for concern from investors in adding digital assets to their investment portfolios is price volatility. Ironically, for the past few months, Bitcoin has experienced a significant period of very low volatility, and she added, “maybe institutions are listening.”
“We’ve had a remarkable period of low volatility, particularly in Bitcoin. Maybe the low price volatility could be something that draws institutions into the space.”
Another concern, as Sandler explained, was market manipulation in the crypto sector, as opposed to the transparency investors are used to in the traditional markets. The infrastructure remains nascent in digital assets, where market centers, including exchanges and liquidity providers, are not very centralized. The lack of construct and market data may lead to concern regarding market manipulation. Whether it is the belief that market manipulation exists, or that the market is not as transparent as traditional investors would like it to be, remains a barrier to entry into the crypto sector.
Investors understand that there are potential risks for adding digital assets to their portfolio, there are always potential risks of loss. To address these concerns, robust operational procedures will be needed, said Sandler. “Fidelity Digital Assets is fully audited by a big four accounting firm.”
Sandler revealed that Fidelity Digital Assets has already gone through two cycles of SOC 1 audits. She added, “It’s not just about establishing those policies and procedures, but living up to those policies and procedures. SOC 1 Type 1 is the initial review of those procedures to ensure they work as designed, and SOC 1 Type 2 demonstrates that we are adhering to the intent of their implementation.” By successfully completing multiple SOC audits, institutional investors understand that Fidelity is approaching risk management the same way they would.
Bitcoin only, are other cryptos next?
Although market manipulation remains a concern for many traditional investors, Bitcoin is a vast, and diverse network compared to altcoins. Some altcoins may be tightly held with specific governance infrastructures and may have price fluctuations with the announcements of partnerships. Sandler added, “Clients that are looking to add digital assets to their portfolios — typically the first asset, is Bitcoin. Presently, our service is single asset-based — Bitcoin only. It seems to be really resonating in the market.”
Fidelity’s report also found that while a quarter of the institutional investor surveyed are holding Bitcoin, 11 percent of the respondents have exposure to Ethereum.
When asked whether Ethereum would be an asset Fidelity would consider providing services to, Sandler responded, “It’s in the plan. If Bitcoin is the number one question in terms of asset coverage, clearly, Ethereum is number two. Ethereum as a protocol, there’s vast potential. Institutions don’t like uncertainty, I think our ability to support Ethereum might help investors to adopt Ethereum as a part of their portfolios as well. It’s the second thing we’re typically asked and we do have plans to add it.”
With Ethereum being considered as the next asset being supported, ERC-20 tokens could be another potential cohort of assets to be considered as well. “I do think ERC-20 tokens will be supported, and looking beyond Bitcoin, we see a world where a lot of assets are being potentially digitized. We are in the beginning stages of seeing that whether they are illiquid assets or bespoke assets,” she elaborated. “There’s an opportunity for us to provide infrastructure beyond Bitcoin and for us to partner with other financial institutions on the next wave of digitization as well.”
Aside from Ethereum, Fidelity could also potentially consider adding stablecoins. “It’s important for us not only to listen to our constituents — our clients and prospective clients, but also taking the signals that we are seeing from the market and evaluate them as well to anticipate and grow our business. We have no opposition to stablecoins, they’re proving they have value in the marketplace,” Sandler added.
“If volatility is the chief concern, then stablecoins might be a way to mitigate volatility while participating in the digital ecosystem. We’re going to see a lot of different types of stablecoins and use cases for stablecoins — so not out of the question for us to support them as well.”
Was COVID-19 a catalyst for institutional adoption?
Sandler believes that the COVID-19 pandemic has highlighted the benefits of cryptocurrencies. With physical contact and paper money being a medium of transmission of the disease, Sandler said that an opportunity presented itself for digital sovereigns, and discussions around the topic have seen a rise. She said, “The combination of global macro conditions and the appeal of an uncorrelated fixed supply asset is a signature narrative. I don’t think physical money will go away, many digital sovereigns alongside traditional paper money will emerge.”
Leveraging Fidelity’s rigorous institutional infrastructure
Fidelity recently announced a sub-custodial deal with Kingdom Trust to offer Bitcoin cold storage for the company. Sandler added, “We’re also working on a number of deals to provide infrastructure to more traditional players who don’t necessarily have established or emerging digital asset businesses.”
Kingdom Trust has been a long-standing player in the digital assets space and was the first firm to offer digital assets in self-directed individual retirement accounts (IRA) for its clients. Kingdom Trust is also a South Dakota regulated trust company. Sandler elaborated on the partnership:
“We found the opportunity to work with Kingdom Trust to be compelling, as the IRA market is quite significant. We are not a retail platform, so we can’t offer services directly to retail investors, but we can empower Kingdom Trust’s infrastructure so their end customers have the opportunity to benefit from our rigorous risk management and controls.”
Expanding beyond the US and Europe
Based in the United States, Fidelity has obtained a state-chartered license in New York. The company has also expanded to Europe in late 2019. According to Sandler, Fidelity is still looking to expand to other jurisdictions. Sandler elaborated that based on client demand, “We’ll explore the regulatory requirements that we would need to comply with — in that specific jurisdiction before we would offer services.”
Lastly, Sandler found that research has been a key focus in terms of Fidelity’s business development activities. By interacting with clients and presenting research tailored to specific segments of the industry, it gives the opportunity for Fidelity to understand client demand, and what presents concerns.