Digital Assets Report


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Transparency and trust are a must for meaningful institutional investor crypto adoption

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Hedge fund managers looking to attract allocations from institutional allocators will need to take several proactive steps – including increasing their levels of disclosures and education – if they are going to build trust among prospective investors.

By Mazen Jabban, founder, CEO and chairman, Vidrio Financial – We are still a long way from seeing meaningful institutional investor uptake in crypto and crypto-related offering and something as simple as greater transparency will go a long way to providing the peace of mind institutions need.

Until notable regulatory risks are addressed, and meaningful levels of transparency and understanding are reached, many investors will likely remain on the sidelines.

This August, Vidrio surveyed a wide swath of institutional investors – including OCIOs (17 per cent), asset managers/insurance (33 per cent) and 50 per cent other (family offices and investment consultants) – with over USD100 billion in combined alternative assets under management in both the US and Europe.

We discovered that 50 per cent had zero exposure to any crypto currency or crypto-related currency investments. Moreover, we identified that within Vidrio’s client base itself, investors had a total net exposure of 0.0000015 per cent exposure to crypto coins, exchange traded funds, and other crypto-related investments.

Additionally, since we issued our findings last month, we have witnessed more headlines related to the most popular part of the crypto marketplace, crypto currencies.

These developments related to crypto price volatility and about global regulators, including the Securities and Exchange Commission (SEC), have likely eroded levels of trust and potentially has sparked more reluctance among investors who are more fearful of this emerging asset class regardless of some of the other important elements of the digital marketplace and the evolution of blockchain technologies.

We believe that while the marketplace matures, hedge fund managers looking to attract allocations from institutional investors will need to take several proactive steps including increasing their levels of disclosures and education if they are going to build a level of trust that potentially will be able to convert these prospects into investors down the road.

While the SEC mulls its next steps – which may include bringing some of these digital currencies into line with publicly traded stocks and bonds, including how they are treated from a taxable and wash sale rule perspective – we realise that the whole digital infrastructure that exists today, as part of the decentralized finance movement, is still in its infancy.

It has a long way to go if investors are going to become more comfortable with allocating to digital assets in general.

The biggest sales hurdle we have seen so far for managers pitching institutional investors in this space is not having the appropriate alignment of transparency and risk management systems that will engender further trust and adoption, especially when it relates to crypto-related trading strategies.

While notably two Virginia public pension funds gained access to digital assets through an investment in what it classified as a venture capital fund two years ago have dipped their toes, institutional pickup generally has been limited.

At Vidrio, we are still convinced that there will be winners and losers in the digital assets (crypto) space and the value of trading that strategy, we are concerned that for these cryptos to represent a store of value, similar to gold, much needs to be done on the infrastructure and education side of the ledge to engender meaningful institutional uptake.

Looking to bridge these gaps in the marketplace with our own technology platform, we have divided the crypto and crypto-related market into three areas.

These include pure cryptocurrency trading strategies, digital assets that allow you to transform any asset including non-fungible tokens into a digital format that you can trade without an intermediary, and lastly into strategies related to digital infrastructure that are being created to disrupt existing businesses.

It is worth recalling that back in the nascent days of investing in hedge funds, there are many instances that litter that landscape – including, notably, Amaranth Advisers in 2006 – that illustrate that with each new investment opportunity there are risks for investors to evaluate closely.

If Amaranth’s investors learned one key lesson, as did we at the time, it was that while the returns generated by the manager were headline-making, the transparency and understanding of how those investment returns were being made and the risks the manager was taking could not be realised until the USD9.5 billion hedge fund declared over USD6 billion in natural gas futures losses and subsequently closed.

As with the failure of Amaranth, we believe that investors cannot react to information if that data is not available. In the case of crypto currency and digital assets broadly, we anticipate they will look to firms like ours to do the heavy lifting.

Transparency has been the key demand for institutional investors since the formation of the hedge fund industry and we see this trend remaining firmly in place.

Moreover, just as we have expanded the processes we employ for clients to meet their increased due diligence and transparency needs over the years, we feel there is also a natural crossover as to how institutional investors have increased their demands for more data related to understanding environmental, social and governance (ESG) factors. We see a natural fit with the demands allocators are making for more information in the digital asset space. 

In addition to the extra due diligence they are normally seeking on any manager in the ESG space, we see potential allocators needing to do due diligence in other specific areas including how each crypto-related manager is storing its digital assets to its current risk management systems and the security-related protocols it has in place to ensure these digital assets are being stored appropriately.

In closing, on the specific question we asked in our August survey of “Relative to other asset classes, do you think allocating to crypto assets is too risky?” Half (50 per cent) of respondents thought the risk was too high for their portfolios, while 33 per cent were not really concerned but were working closely with their risk teams to make sure they have a sense of the potential risks they’d be taking on.

However, 17 per cent of the investors said they were not at all concerned, and felt that crypto and crypto-related assets were in line with the risk levels of other asset classes in their portfolios. 

In our view, these findings show that the majority of investors have yet to reach a level of comfort with this asset class and we believe it will take a lot more education and due diligence work to get to a position where we will see meaningful uptake when basic information is still lacking.

At Vidrio, we always seek to dig deeper for our clients so they can invest with a level of confidence, which is a must when trying to help them meet their long-term investment goals.

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