Noelle Acheson is a veteran of company analysis and member of CoinDesk’s product team.
The following article originally appeared in Institutional Crypto by CoinDesk, a newsletter for the institutional market, with news and views on crypto infrastructure delivered every Tuesday. Sign up here.
Open pretty much any mainstream financial media source and it’s hard to feel cheerful. Economic growth is slowing. The yield curve is flattening. Trade tensions are tensing. There’s plenty for an institutional investor to fret about.
Yet none of those worries are top-of-mind for institutional investors these days when it comes to their crypto investments. Along with most of the blockchain sector, they’re more engrossed in the drama unfolding around the death of the CEO of a Canadian crypto exchange.
In case you missed the story on CoinDesk, the CEO of beleaguered Canadian crypto exchange QuadrigaCX, which was already in trouble because of frozen accounts, passed away unexpectedly in India in December. Leaving aside the suspense over the encrypted laptop, the debated existence of cold wallets and the exact role of the chihuahuas in all this, the attention-grabbing detail is that he apparently was the sole keeper of the password that could access client funds. When he died, he took the password with him.
On the surface, it doesn’t look like this has much to do with institutional investment. The exchange was not exactly geared up for rigorous checks and oversight. But its fate, and that of its clients, points to a fundamental truth about crypto investing for institutions, one that both colors allocation decisions and shapes emerging infrastructure.
It’s this: The crypto market is the only market out there at the moment where operational risk is greater than market risk. And this highlights both crypto investing’s weakness and its opportunity.
Readers of this newsletter know that every week there’s positive news about infrastructure development for institutional transactions. Sometimes it’s a listing or a launch, occasionally a partnership or merger, and the array of items usually comes together to create an impression of constructive evolution.
Often the news is security related. Licenses are sought after and awarded, which implies greater oversight; compliance processes are boosted, which reassures regulators; and new products and services stress tighter security, which addresses market concerns. The general tone is one of raising overall standards to meet institutional expectations.
Obviously, these moves (and plenty more like them) are necessary. The nascent crypto market is still largely unregulated, as official institutions around the world wrestle with the choice between fitting the new asset class into existing obligations, or creating new ones.
Meanwhile, institutional investors do not like ambiguity when it comes to processes. Few can afford the risk of fines or public embarrassment as a result of not having retroactively complied with rules when they eventually emerge.
What’s more, businesses built on new technologies are generally feeling their way along the development curve. As anyone involved in cybersecurity knows, it’s almost impossible to foresee and protect against all possible attacks. With traditional securities, there is generally some recourse or walk-back. But most cryptoassets are still bearer securities, which implies a whole different level of custody risk.
This unique condition of the crypto market is not a disadvantage. On the contrary.
First, the “progress principle” and its impact on motivation is well documented. The tangible and identifiable steps forward in sector development engender a constructive atmosphere, which brings in even more brain power and keeps the momentum going, regardless of price movements.
Second, the focus on security highlights the market’s youth as well as its potential. While improving the security of crypto holdings may seem like a basic beginner step, the chance to participate in the creation of a new asset class is rare.
What’s more, the risk-return profile of cryptoassets as a whole becomes even more asymmetric as the operational base of transactions – the technology, regulation and quality of market participants – continues to evolve. And the bear market is giving a much-needed breathing space for the construction to advance, the security to improve and investors to become even more familiar with the fundamentals.
This entry-level progress sets the stage for more sophisticated risks as the market matures.
To many this may rhyme with the well-known song of parenting: We focus on making our young feel secure, so that as they grow they have a solid emotional base from which to deal with what life later throws at them.
While extremely painful to many, the lessons learned from QuadrigaCX’s lax security and almost non-existent governance are an important part of this evolution. Beyond the unwelcome education, serious mistakes serve to highlight vulnerabilities, focus attention and hone priorities. This makes the sector stronger.
Meanwhile, crypto infrastructure continues to evolve, and any interest that has been scared away will return as the sector’s increasing professionalization calms concerns over operational vulnerabilities.
Eventually, institutional investors in crypto assets will be able to get back to doing what they do best: fret about market risk, and take positions accordingly.