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Digital Assets: Who holds the keys to institutional money?​

With the arrival in earnest of institutional money in the digital assets space, the question of how these holdings will be custodied has never been more important.

Whether it's another lawsuit involving the SEC or even fake news stories about Bitcoin ETF approvals, the theme of institutional investment is never far out of the news. Indeed, a broad swath of opinion across the digital assets industry believes that it is institutional investment, and in particular the approval of the US-based spot Bitcoin ETF, that holds the keys to providing that critical impetus for a sustained bullish trend – at the very least until the already much-anticipated halving event occurs in April 2024.


Has institutional money finally arrived?


While most would agree with the prevailing consensus that the next big wave of institutional capital for allocation into digital assets is at the ready and waiting for an end to the SEC's dithering over the spot Bitcoin ETF, there is also data pointing to waning enthusiasm for the asset class. For example, a recent Goldman Sachs survey of family offices found that while 32% expressed an interest in digital assets (including cryptocurrency, blockchain tech, and NFTs), interest in investing in the future had decreased from 45% to 12% primarily over a lack of confidence over cryptocurrencies effectiveness as a store of value, among other reasons.


Despite these findings, a large body of data highlights that the increased institutional interest is real and here to stay. A Coinbase institutional survey from November found that 64% of current crypto investors expect to increase allocations in the next three years, with 45% of without crypto allocations expected to allocate in the next three years. Interestingly, 57% of institutional investors surveyed believe prices will move higher in the next 12 months, compared to just 8% who shared that view in October 2022.


Digital asset investment product flows are on the up


Supporting these survey results is the most recent data on investment product flows. According to the most recent data from Coinshares, inflows into digital asset financial products totalled $346 million in the week ending November 24, the largest weekly inflows in nine consecutive weeks. Furthermore, as the premium digital asset, Bitcoin dominates the landscape accounting for 90.1% of global fund inflows with Ethereum capturing the rest of the share.

Figure 1: recent spikes in inflows suggest that the institutional momentum is building

Another dimension that sharpens the Bitcoin ETF picture is that Canada accounted for the largest proportion of inflows at $105.7 million (30.5%), followed by Germany with $52.9 million (15.3%). While the former certainly reflects the fact that Canada successfully launched an ETF back in 2021 ago which has undoubtedly attracted US capital, the latter underscores what is already a highly sophisticated market for crypto ETPs in Europe, currently valued at approximately EUR16 billion.


Who will be holding institutional keys?

With all the signs that institutional money is flowing, one of the more interesting areas is what institutional players are doing concerning the custody of their digital assets. This question is made even bigger by the wave of systemic failures of centralised exchanges (CEXs) and crypto lenders witnessed during the two-year bear market, from FTX to Blockfi and Celsius, a period during which the “not your keys, not your coins” rallying cry became the dominant refrain from those in the Bitcoin community keenly reminding investors of the importance of self-custody.


But even with all these structural failures, institutions have not shunned centralised exchanges. Binance study of 200 global institutional investors from June found that 58.2% of institutional investors store their crypto assets on CEXs, with 20.2% preferring institutional custodians (e.g. Ceffu, Fireblocks, Zodia Custody) and only 17.5% utilising self-custodial cold wallets (Figure 2).

Figure 2: The preferred custody medium for institutional investors

Though this data will surprise some given the ravages of the bear market, the reality is that institutionals still see several advantages to CEXs, including but not limited to:

🏛️ Liquidity – CEXs have higher trading volumes and liquidity and lower slippage (compared with OTC and DEXs)

🏛️ Regulatory Compliance – CEXs often have established compliance procedures and operate under regulatory oversight (in some countries) and this can help institutionals meet regulatory obligations.

🏛️ UX – Institutional investors may find it more convenient to use these platforms compared to managing wallets and private keys themselves.

🏛️ Access to Derivatives and Advanced Trading Products – CEXs offer a wide range of trading products (futures, options, and lending) that appeal to institutions looking to hedge or leverage Bitcoin positions.

Of course, there are also downsides as we've already seen with exchange insolvency, regulatory changes, and potential downtime, and institutional investors must evaluate these factors and may diversify their cryptocurrency holdings across different custodial solutions. 

For institutional custody, size does matter

Beyond the headline numbers, there's also significant variability in the data according to factors such as assets under management (AUM) (Figure 3). For example, institutional custodians rise in preference as a medium for custody amongst funds with an AUM of $50M - $75M (54.5%), whereas funds with more than $100M in AUM employ various mediums to safeguard their assets. Self-custodial hot wallets are a minor share of institutional choice across all fund sizes.

Figure 3: The preferred custody medium for institutional investors split by AUM

What does this data mean? Firstly, it's hard to explain the sharp variability in the preference for CEXs between $50-75M and $75-100M in this Binance study (perhaps a larger sample size would shed more light on this), but it's clear AUM does have an impact on custody preferences. Moreover, larger investors tend towards institutional custody and CEXs and this is the key battleground in which 'custody wars' will be fought- as highlighted by Coinbase Custody's strategic partnerships.

Finally, this data suggests that a one-size-fits-all approach won't work for custody providers or institutional-grade crypto product issuers, and tapping into specific concerns of institutionals by AUM and type (family offices vs hedge funds etc.) will need to be an evolving effort as security, reputation, and regulation around crypto custodial solutions continue to develop.


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Disclaimer: The information contained within is for educational and informational purposes ONLY. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision. No commercial relationships or partnerships exist with any of the technology providers, manufacturers, or suppliers herein.

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