Investment managers remain cautious regarding cryptocurrencies and Blockchain
Elon Musk, the high media profile boss of SpaceX and Tesla, announced in early February that he had invested over a billion dollars in Bitcoin. Other American companies and pension funds have also indicated that they are investing in cryptocurrencies. What are European investment managers doing in this respect?
To find out, in February 2021, SGSS undertook a survey on investments in cryptocurrencies, such as Bitcoin and Ethereum, and the uses of Blockchain (the Distributed Ledger Technology, or DLT, used by the Blockchain) among some fifteen European investment managers, asset managers and institutional investors.
These highly qualitative interviews focused on four topics: cryptocurrencies, registries, financial instrument issuances and other uses of DLT, striving, for each topic, to detect their vision of the market, the characteristics and motivations of their projects as well as their expectations vis-à-vis securities services providers.
Regarding the general perception of the technology and the maturity of the players, three interesting phases should be noted:
A first phase of curiosity, developed to a greater or lesser extent depending on the players;
A second phase of appropriation, leading to very different approaches from player to player:
A conservative approach: rejection of cryptocurrencies, as in the case of Warren Buffett1;
A wait-and-see approach: waiting to see pioneers emerge before diving in, which is most institutional investors’ attitude;
And a fairly uncommon opportunistic approach: an attempt to develop, like the asset management firm TOBAM, which has launched a Bitcoin fund2.
The objectives mentioned in terms of appropriation are:
- Operational efficiency, i.e. a reduction in costs, in particular intermediary costs; or, more simply
- The creation of a framework for activities that are currently poorly structured, such as trade finance,
private equity funds and real-estate investment funds.
A third phase of maturity, which is almost reached. It normally occurs when the technology is used for dedicated applications which are core. When the challenge is no longer to use this technology as an object of curiosity but rather to facilitate exchanges, a new milestone is reached.
In European countries, the regulations that apply to uses of this technology are currently divided between liberal frameworks (Luxembourg, Switzerland, France and Germany) and more conservative ones (Italy, Central Europe).
On a European level, cryptocurrencies, and in particular stablecoins, will be subject to MiCA (Market in Crypto-Assets) regulations3. This project, the aim of which is to establish a European regulatory framework applicable to providers of digital asset services, was published in September 2020 and should be adopted in the summer of 20224. Institutional investors are thus waiting for its adoption.
To benefit from this technology in investment, payment is a crucial issue. Most players want to carry out transactions with the immediate exchange of goods and money, i.e. in delivery-versus-payment mode. To do this, it is necessary for payments to be able to be carried out in DLT. A representation of a common currency, called a stablecoin, or a currency directly issued by a central bank, called a Central Bank Digital Currency or CBDC, must therefore be available in DLT.
But all in all, whether their attitude is wait-and-see or opportunistic, players have understood that the DLT makes exchanges flow better with the possibility of immediately sharing all of the documentation when making transactions. They do see the potential value of using it.
Investments in cryptocurrencies
At this stage, the majority of companies investing in cryptocurrencies are American; Tesla, Blackrock, Fidelity, Microstrategy and Mass Mutual have stated in the press that they have invested in cryptocurrencies. In Europe and Asia, demand is mostly from private clients. European institutional investors have adopted a wait-and-see approach; they are waiting to be able to benefit from the protection offered by MiCA regulations. The few European players who are experimenting are doing so for marginal amounts.
Fund management companies, meanwhile, are seeing no significant demand from European institutional investors to invest in cryptocurrencies. Very few have already launched a cryptocurrency fund, and their assets under management remain very low.
In most cases, taking a position in a cryptocurrency means taking a direct risk on a cryptocurrency exchange platform, such as Coinbase, Kraken or Binance, entities that are unregulated in Europe. However, there are ways of investing by taking risks on regulated entities by using:
Futures contracts on Bitcoin or Ethereum, like those listed on the Chicago Mercantile Exchange;
Exchange Traded Notes;
Or regulated investment funds.
It should be noted that all the major American securities services providers5 have, or will have, a cryptocurrency custody solution. Some European players, such as SIX and Deutsche Bank, are currently launching offers aimed at individual and institutional investors. In most cases, these players use a third party fintech.
Investment fund registry
There is a global consensus that DLT is an appropriate technology for investment fund registries. The model has been tested and works.
Today, volumes are not growing because there is no usual currency available on DLT, like dollar or euro. Typically, the introduction of a CBDC will be a real catalyst for growth for registrars, with the possibility of undertaking delivery-versus-payment transactions.
A number of players also indicated their belief that pioneers such as IZNES and Calastone would grow exponentially if they would better know how to use intermediaries, rather than attempt to reduce their role. Intermediaries are early adopters, unlike institutionals who are generally more conservative.
At this stage, there are very few initiatives to create investment fund units denominated in cryptocurrencies.
Tokenisation
A token is the representation in DLT of a financial instrument.
There are a number of experiments to issue tokens. Players are issuing financial products in DLT, but so far there are no norms and standards, and the process is therefore not efficient.
Some investors indicated that they occasionally have to use DLT because certain issues are only carried out in tokens.
Among the comments made by those we surveyed, two appear to accurately summarise the general feeling: "The market will not develop until there is at least one credible intermediary" and "there’s still a long way to go".
Other cases
For those we surveyed, of all the possible applications in finance, the greatest potential lies in the ability to meet KYC (Know Your Customer) requirements. Indeed, KYC is a banking process that is still fragmented, manual and undertaken in a similar way in every institution. Using DLT would make it possible to unify the process and, more importantly, to share public information on clients.
However, there is no emerging solution yet at European level in this regard.
Moreover, the traceability and transparency offered by DLT were brought up. Indeed, some DLTs need to use trusted third parties to host DLT nodes6 to ensure the viability of their chain. These third parties could be securities services providers, auditors or even regulators who could directly access the data that needs to be verified.
Conclusion
European institutional investors do not currently wish to prioritise new expertise or take the risks associated with DLT back-office, whether it be cryptocurrencies or any other financial instrument. They would rather continue using intermediaries who are both the experts and the trusted third parties for these products. As one of those who contributed to this survey said:
With DLT, the Securities Services industry is no longer a critical size business and is becoming an expert activity once again.
It is these intermediaries who will have to provide solutions to mitigate the new risks associated with DLT.
The future will begin in Europe with MiCA andits regulation of coins7.
4 Knowledge of the Pilot regime proposed by the European Commission for listed securities is also needed: https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52020PC0594&from=EN
5 BNYM, State Street, JP Morgan, Citi, the world’s four largest securities custodians, have announced that they will have a cryptocurrency custody offer. BPSS, HSBC and Northern Trust have also announced similar projects.
6 A node is a copy of a DLT’s entire database.
7 Stable coin or CBDC to be able to carry out deliveries versus payment within the DLT