The Breakdown - The Institutions Come Roaring Back to Crypto

Episode Date: June 24, 2023

The theme of the last few weeks has been the institutional return to crypto. NLW fills in the gaps and puts the move in context.  Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribeto the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Saturday, June 24th, and today we are wrapping up our discussion of institutional action from earlier this week. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it. Give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us in the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, happy Saturday. One quick housekeeping note before we dive in.

As you are listening to this, I am currently off traipsing around Europe for about a week. And so while I have normal shows today, tomorrow, and on Monday, Tuesday through Thursday of next week, the breakdown will be on a summer break. If you listen to the AI breakdown, I will still have the brief that happens each day, which is just the five-minute headline news, but I probably won't. have main episodes after that. However, if you are looking for a dose of breakdown goodness and you're at all interested in Bitcoin, might I recommend that you go check out Bitcoin Builders? On Tuesday, Wednesday, and Thursday of next week, I have interviews with some of the most interesting companies from Wolf's first accelerator cohort, including a Bitcoin DeFi company that has a self-custodial version of Bitcoin Perps, as well as a gaming company that uses Bitcoin

for payouts and more. So again, for you guys who are listening here to The Breakdown, we'll be off next Tuesday, Wednesday, and Thursday, but you can catch some breakdown goodness on Bitcoin Builders. Now, today we are returning and wrapping up this week on what was clearly the big theme, which is the return of institution-based excitement. There is a long history in crypto of this narrative of the institutions coming. It started basically as early as people were applying for Bitcoin ETFs, which happened all the way back in 2013. Now, to be fair, from 2013 to 2017, it was a fairly muted narrative. And in 2017, specifically, of course,

the ICO boom and the tokenize everything, tokenized the world, really overwhelmed it in a big way. However, during the depths of crypto winter in 2018 and 2019, the institutional narrative stormed back. One of the biggest events of that time period, believe it or not, was the announcement of backed. The exchange was meant to be a regulated exchange. It was owned by the same people that owned the New York Stock Exchange.

It was going to be a big deal. Now, of course, that didn't amount to me. much, but by 2020, that institutional narrative really finally started to happen. We got Paul Tudor Jones' great monetary inflation thesis. We saw things like Mass Mutual working with Nidig to buy $100 million worth of Bitcoin. Sailor and Micro Strategy really launched the Bitcoin as a reserve asset idea, which of course came to biggest fruition with Tesla the next year. However, in 2022, as the rate hiking cycle began, obviously overall interest and engagement with crypto decreased. It wasn't just crypto, anything that had been a risk asset before was being hit. And

One of the things that was really notable in 2022 was how much institutions weren't fleeing. In 2018, after the ICU boom burst, you had all of the tourists who had come to the industry recently just absolutely vacate as fast as humanly possible. That wasn't really the case in 2022. Even as Luna went down and then blockfi, you still got drips and drabs of institutions creating new infrastructure preparing for the next bull market. Then, of course, came the collapse of FTX. All of a sudden, the space was not just less interesting, but was absolutely politically radioactive. Now, I'm not saying that everyone who had had interest in crypto before all of a sudden went away, but to the extent that institutions were planning anything, they were

very, very quiet for a period there. And reasonably so, who wants it open letter from Elizabeth Warren? However, things have changed once again. They changed a little when the narrative started to shift around the bank crises and Bitcoin did so well. And now we've got a full-on fomo movement as BlackRock has announced an ETF, Charles Schwab, Fidelity, and Citadel have launched EDX, and there is a major sense that one of the interpretations of all of these aggressive actions is the click of regulators and traditional business interests just clearing the way for TradFi to basically take over the crypto space. So what we're going to do today is look at a few of the stories that relate to this

that we haven't talked about yet because there may be a little secondary to things as big in banner headline as BlackRock, but which I still think tell part of this story. For example, last week, Japanese Investment Bank Nomura released a survey which goes some way to explaining why major Trad V firms are still building out their crypto offerings, which is, in short, that their clients are demanding it. A survey of professional investors showed that 96% of respondents see digital assets as representing a diversification opportunity alongside traditional asset classes. The survey took in opinions from investment managers working for pension funds, wealth managers, family offices, hedge funds, and investment funds. In total, representing $5 trillion in

assets under management. 303 asset managers across 21 countries in total were surveyed. Survey respondents said they were prepared to allocate as much as 5% of their funds to digital assets. Again, while that might seem small at first blush, if all of them did that, that would be 500 billion in assets right there. Now, the study was conducted by Laser Digital, the digital assets arm of Numura, which was established last September. This Goliath Japanese Investment Bank has been one of the institutions that has continually built out crypto products over the last few years. The launch of the dedicated digital assets unit in May last year was the culmination of several years of interest. In 2020, for example, the investment bank fostered a crypto custody product in partnership with

ledger and coin shares, and that year they also dabbled with underwriting a small tokenized bond offering and developed a Japanese crypto index. Late last year, the firm began actively trading crypto and built out their staffing for the digital assets unit. Their core offering of crypto custody expanded to include a clearinghouse and has begun signing up crypto-native firms, including Exchange OKX. Now, moving back to the survey, Nomura's key insight was that investment managers are keen to establish an allocation to digital assets, but they don't want to do it without trustworthy institutional-grade infrastructure in place. 90% of respondents said it was important to have the backing of a, quote, large traditional financial institution before they would

invest their clients' money into any crypto fund or investment vehicle. Jez Mohedin, the CEO of Laser Digital, said that the survey showed that institutional investors see a, quote, clear role for digital assets in the investment management landscape and the benefits they can bring, such as greater diversification of portfolios. 88% of those surveyed said their clients were considering making an allocation, but three-quarters of survey respondents said that, quote, legal or regulatory restrictions could stand in their way in making crypto investments. Mojadine added that this lack of regulatory clarity was clearly playing into the hands of jurisdictions outside the U.S. He said, Asia benefited from what

happened in the U.S. and realized the things they needed to avoid. Now, as for how the professional investors view the myriad ecosystem of digital assets, unsurprisingly, the strong emphasis is Bitcoin and ETH. ETH. 82% of respondents, said they had a positive outlook for the two largest crypto assets. And the investment managers seem to be buying in heavily to the hard money narrative for crypto assets. Ninety-one percent of respondents said they saw digital assets as providing all-weather income strategies to cope with the risk of inflation and the debasement risk of fiat currencies. Now, unsurprisingly, the way they want to get exposure to that positive price action is regulated products like

ETFs. So overall, the survey spoke to the idea that few people are concerned about the legitimacy of digital assets themselves. They just have a lack of trust in the crypto industry to responsibly take on institutional money. Now, another institution in the U.S. also wrote a report about how regulatory issues are hurting the U.S. industry. Bank of America's latest report on the digital asset space talked about opportunity in the U.S. if regulators and lawmakers can find a way to allow it to happen. They noted that the SEC's crackdown has severely damaged sentiment in the U.S. saying, quote, digital asset sentiment remains poor as the SEC enforcement actions create regulatory uncertainty, pressuring token prices. The report went on to explain that the regulatory issues

spot Bitcoin ETFs being stuck in purgatory, and the specter of illicit activity was, quote, overshadowing the rapid development and integration of distributed ledger and blockchain technology infrastructure. B of A's crypto research has surprisingly had their figure on the pulse in recent years, and this time around they pointed to private, permission distributed ledgers and blockchain subnets, claiming these technology developments within the industry could pave the way for the tokenization of traditional financial assets. Bank analysts said that they expect this technology to, quote, transform financial and non-financing infrastructure and markets over the next five to ten years. So this theme of tokenization of traditional assets is something to keep an eye on,

both on its own terms, but also the extent to which these institutions are saying that that is the real value of blockchains, or just that that is an additional value of blockchains outside of digital assets themselves. Now, while the SEC has been sucking all the oxygen out of the room, last week another regulator made some very interesting comments about where he saw the crypto industry going. Michael Sue, the head of the office of the comptroller of the currency, delivered a speech last Friday at the American Bankers Association to emphasize the importance of digital asset technology. He took the position that tokenization of assets is a real and necessary evolution in financial infrastructure, but that achieving decentralization,

security and scale all at once, is, quote, not possible with the public blockchain. As a result, he said, the crypto industry remains largely self-referential and disconnected from the real world. Now, the OCC is one of the major banking regulators in the U.S. and and participated in January's chokepoint warning shot. When joint guidance was issued to the banking sector, that crypto assets were not likely to be compatible with safety and soundness principles. Sue said on Friday that despite this negativity towards the open crypto ecosystem, quote, centrally operated, trusted blockchains have the potential to deliver security and achieve scale efficiently. He added that tokenization does not require decentralization and trustlessness.

He continued, with tokenization, the instruction, transaction, and settlement can theoretically be collapsed into a single step, removing those frictions provided, of course, that the technology is interoperable with central bank money and real-world settlement systems. The legal foundations of tokenization need to be developed. Okay, so here, going to that question we just asked about whether tokenization is something that's in addition to digital assets or in substitute, one of the regulators most closely associated with Operation chokepoint 2.0 is clearly in the camp of replacement. Sue and the OCC don't want to see digital assets flourish. They want to see digital representations of traditional assets that are bought and sold on an exchange that they have control over, because that

is not scary. Now, one other thing that related to this theme of tokenization, a research report released last week on Tuesday by Bernstein said that the tokenization of real-world assets could be a $5 trillion opportunity over the next five years. The report foresaw tokenization being led by stable coins and CBDCs, private market funds, securities, and real estate. Placing representation of real-world assets on the blockchain, Bernstein said, could unlock operational efficiencies, improve liquidity and accessibility. They estimated that within five years as much as 2% of the global money supply would be tokenized around $3 trillion. Analysts wrote, quote, over the next five years, we expect to swell in the stable coins in the CbDC tokens in circulation,

led by China's CBDC program. Stablecoins and CBDC tokens, coupled with yield farming and decentralized markets, will compete with bank deposits as an investment or saving instrument. Now, the report called out policy uncertainty as the issue that could stand in the way of the market fulfilling its promise. They wrote, tokenization using blockchain can only succeed when policymakers appreciate the benefits of blockchain and how crypto tokens are an indispensable part of blockchain operations. Essentially, they're saying crypto tokens themselves are a vital part of blockchain infrastructure, so regulatory crackdowns on tokens could prevent the underlying blockchains from maturing sufficiently

to support tokenized assets. They wrote simply, how policymakers regulate blockchain-based businesses will determine how they view tokenization of real-world assets. Regulations may blunt the advantages of tokenization. So here we have a very different take on tokenization than we got from Michael Sue in the OCC. One more interesting report to discuss before we close out today. On Tuesday, Ratings Agency Moody's released a scathing report on the lack of progress on coherent crypto regulation in the U.S. They said that, quote,

failure to reach bipartisan agreement and to advance digital asset specific legislation could make the United States comparatively less attractive for both firms and investors, particularly in a context where many other jurisdictions are moving forward with comprehensive rules. end quote. Now, of course, if you've been listening to this show, you know that although Congress showed some signs of interest in coming together on crypto policy last year, the first half of this year saw efforts stall out in a pretty significant way. Establishment Democrats have taken a highly obstructionist stance to getting anything done whatsoever. A comprehensive market structure draft bill, published by House Financial Services Chair Patrick McHenry, in collaboration with House

Ag Chair Glenn Thompson in early June, was the most fleshed out legislative work the U.S. has seen on crypto policy to date. However, in hearings to discuss the bill, most Democrats seem entirely entirely uninterested in engaging with the topic. To the extent that there's any progress, it seems like it's around stablecoins. After dismissive appearances in multiple recent hearings, Democrat Financial Services' ranking member Maxine Waters, seems to have warmed to the idea of getting back to work on them stating last week, I do believe that Mr. McHenry and I have gotten a long way in dealing with stable coins, and I'm sorry that it got interrupted somehow, but I'm looking forward to getting back and negotiating to see if we can move stable coins forward.

Now, I think that the really interesting question that comes next is to what extent these Radfi actors, now that they are actively applying, petitioning, and pushing, will start to force regulators to feel like they have to come back to the table and get something done. It's one thing when it's a bunch of us jerks on podcasts yelling at the SEC. It's a whole different thing when Larry Fink is hitting up your cell phone at 2 a.m. It's not to say that he's actually calling Gensler, but I kind of like to imagine him calling and waking him up to yell at him. Anyways, guys, that is the story.

Institutionalization is the theme. It's the big thing happening. And, as I said, one more reminder. next week, Tuesday, Wednesday, Thursday. The breakdown will be off, but Bitcoin Builders will be very on. Go check it out. Hope you're having a great weekend. And until next time, be safe and take care of each other. Peace.