The future for investing in crypto.

The December Federal Reserve minutes, released this month, confirmed it would end the purchase of bonds by March and seek to raise interest rates three times this year. These hawkish comments triggered short term volatility in the US stock markets, and caused another round of selling tech names and digital assets. Bitcoin and Ethereum prices fell, with BTC breaking below $40k and ETH below $3k. Prices were also hit by the internet shut down in Kazakhstan, the world’s second-largest bitcoin mining hub.

These types of sell-offs are not uncommon in the digital asset space. Data shows that retail investors have not been as active as they were during the spring rally of 2021 and that institutions are now more involved. It can be argued that digital currencies will have a higher correlation with traditional markets, as investors tend to de-risk across the board. Coinbase’s Quarterly results show a clear acceleration of institutional interest, growing from 60% of total investment through the platform to 72%.

So, what does institutional investment look like? For some, it’s buying and holding coins, treating them like appreciating assets. For others, it’s for trading against fiat; pair trading against other cryptocurrencies; or arbitrage trading, similar to a stock or equity.

For venture capital firms, it may be longer term investing into crypto start-ups and infrastructure companies, of which some of that investment may be in cryptocurrency.

In the last ten years, the price of bitcoin alone has increased 954,760%, unimaginable returns for traditional investments such as property or gold. With no one expecting BTC to repeat that level of performance, institutional investors can still dedicate a relatively small portion of their portfolio to this new asset class to reap outsize rewards.

The inherent volatility and inefficiencies between exchanges make for interesting arbitrage opportunities. Spot and margin trading are popular, and futures and options are becoming increasingly common. The derivatives market is now over 50% of total trading volumes.

Platforms that aggregate exchanges and offer loans and leverage have long existed in the traditional financial markets, but as the ecosystem grows, so do opportunities to trade between exchanges or assets. A true crypto prime brokerage platform offers liquidity and leverage to professional investors, allowing them to develop sophisticated crypto trading strategies for the benefit of their investors.

DeFi has been the subject of much discussion over the last two years and institutions are entering the space to increase their returns via higher yields. Hence, we are seeing the rise of permissioned pools, which are KYC/AML compliant and institutional custodian solutions.

Total Value Locked in DeFi has grown dramatically to over $240 billion, but is still tiny versus the hundreds of trillions in traditional markets. Thus, the sector should continue to grow, especially as regulation around stablecoins and tokens becomes clearer, and security improves, while real interest rates remain low.

Recent years have seen asset allocators branch out into alternative investments including wine and art. The same has been seen in crypto and the NFT and gaming spaces. Some pieces of digital art, including images and music, have sold for millions, but now, NFT buyers are looking for their NFT to have a utility. This may be a usable character in a game or an item of clothing for that character. This is driving a new audience towards NFTs, crypto gaming and the metaverse in general.

Institutions are also seeing the value of buying these assets, similar to how they did with art. ‘Flipping’ NFTs, where a person or company buys an NFT in a ‘drop’ and then sells it almost immediately after for a profit, can be incredibly lucrative for a minority of investors, and some companies are seeing this as a viable strategy.

Digital assets have a number of advantages over traditional investment classes. High volatility and arbitrage opportunities mean high-frequency trading strategies can reaprich  rewards. Potential for mainstream adoption and technological innovation can also be attractive for buy and hold strategies. Volatility and historically high performance, though not a guarantee, mean even a small percentage of a fund dedicated to crypto could offer substantial returns for investors, while improving the Sharpe ratio.

The year 2021 was a turning point when the industry became more visible and was acknowledged by regulators. Mass adoption has not taken place yet, so there is still a first-mover advantage for many managers.

Institutional money is already entering the market through lots of different avenues. Some investment is going directly into tokens while additional capital is supporting the growth of businesses in the space. Institutions that are in the space are already seeing rewards and, if analysts are correct, the market looks to be healthy and buoyant for the foreseeable future.

Martha Reyes is the Head of Research at BEQUANT, the one stop solution for institutional digital assets traders. She is a fund and investment expert, specializing in emerging markets.