Crypto's Cascading Effects: Investors are turning to those they trust
Given the abundance of “the next big thing” schemes born in crypto hype cycles, it may be challenging for investors to distinguish between the good, the bad and the ugly. The harsh realities of a bear market force investors to make choices that reveal where true value lies. To minimise the risk of frozen accounts and potential bankruptcies, their flight to quality is a natural behaviour that demonstrates which services are trustworthy during times of uncertainty.
This January, the crypto market saw its best start since 2013, with Bitcoin (BTC) reaching pre-FTX collapse levels and ending the month with a 39.8 percent increase. Many altcoins followed suit and several new crypto-friendly regulatory efforts emerged. All eyes were set on a positive path ahead for the crypto industry.
However, the Securities Exchange Commission's (SEC) recent actions against the crypto industry, like the lawsuit against Binance stablecoin (BUSD) issuer Paxos Standard and forcing Kraken to shut down its staking services, have left many investors wary of the negative impact it could have on the market. Additionally, the ongoing Fed’s quantitative tightening, the U.S. debt ceiling and the threat of a potential recession continue to put trust in the global economy at risk.
But not everyone is fearful
Despite these risks, many traditional institutions and investors remain positive on crypto’s long-term potential. Notable market leaders, like Goldman Sachs, BNY Mellon and DekaBank (to name a few), have publicly expressed their growing interest in the crypto space, from buying out crypto companies to offering crypto services to their clients.
In fact, these companies are part of a larger trend, as various surveys reveal that the majority of institutional investors either plan to increase their crypto portfolios or begin investing in crypto in the coming years. For instance, a recent Coinbase survey (Q3 2022) found that almost 60 percent of institutional investors plan on increasing their crypto investments even if they don’t expect the markets to recover for at least another year.
The rise in crypto exchange-traded funds (ETFs) and other crypto-based products offered by traditional institutions should also not be overlooked, and with significant inflows into crypto and DeFi, many banks have recognised the need to adapt, or risk being left behind.
This trend only reinforces crypto’s place in future finance while its traditional reputation for volatility and company busts are doing little to diminish investor interest and the fast-paced growth of the industry.
Priming the crypto industry for robustness
A rising number of crypto investors believe that the recent collapses will only help the industry recover stronger. Deleveraging events and cascading effects are a natural part of any emerging industry’s growth, leading to a more robust and secure market where strong businesses thrive, others adapt and survive, and unsustainable ones fail.
For instance, the late 90s dot-com bubble was shelled by speculative investing, venture capital (VC) funding and dot-com companies with little tangible output. When the bubble burst, nearly USD 5 trillion worth of investments were erased, wiping out companies with poor business models (like Pets.com) and paving the way for the success of internet giants (like Amazon, Cisco and Google).
The string of crypto collapses in 2022 were no different, but the aftermath has already brought some positive developments to the industry. Here’s what we can see:
Ecosystem robustness: Strong business models will remain and thrive, becoming immune to market shakeouts, periods of uncertainty and demonstrating longevity
Reliable innovation: Crypto companies are adapting to market conditions and ensuring their business models are robust and future-proof, leading to a focus on solid fundamentals and real-world use cases
Development and maturity of new trends: Innovative trends, like regenerative finance and the tokenization of real-world assets are gaining traction, as well as the maturity and growth of stablecoin usage and decentralised finance (DeFi) protocols
Removal of unsustainable business models: Companies with questionable value and risky business models have already failed and others will eventually die out too, a natural part of any market cycle
We have seen a similar dynamic play out in the past. The 2017 ICO bubble was fuelled by speculation with hundreds (if not thousands) of projects and coins of questionable quality. But the 2018-2019 bear market saw the emergence of real innovation, like Layer 1 (L1) blockchains, stablecoins and DeFi protocols, which later became the driving forces for the most recent bull run. Throughout last year’s market turmoil, both stablecoins and DeFi were able to function seamlessly as reliable hedges and trustless technologies respectively.
Flight to Quality
Given the abundance of crypto projects born in hype cycles, it can be challenging for investors to differentiate between reliable and unreliable players. Bear markets provide a bitter truth but they also reveal where true value lies.
Last year’s market volatility and company collapses led many investors to turn to trustworthy service providers. To reduce the risk of having their funds frozen or lost entirely, investors moved towards regulated crypto players that offer security, off-balance sheet storage and legal certainty. This trend is a flight to quality that spotlights high-quality services with features that clearly set them apart from the more commonly used centralised crypto exchanges (CEX).
Whether one is moving from riskier to less risky crypto assets, having a trustworthy service provider is a must. Recent events have shown that trust can easily be broken, even from some of the most popular crypto service providers in the space (FTX, Alameda Research, Celsius, Genesis, Voyager, BlockFi, and Three Arrows Capital, to name a few).
As we have said before, many centralised crypto entities causing harm were either unregulated or operating in weaker jurisdictions, while the role of regulation is becoming increasingly clear in driving (and determining) ecosystem growth. Crypto companies in regions with more advanced crypto-friendly regulations (like Switzerland) have seen growth in both value and size. This underlines why responsible regulation in supporting a healthy crypto ecosystem is essential, and why it is typically seen in regions with a history of economic and political stability.
Institutional investors need to identify dependable regions that offer both crypto-innovative freedom and trustworthy services. This means crypto companies with legal accountability and strong management within regions that embrace crypto assets with regulatory clarity. Jurisdictions that are still in dispute over classification issues will continue to pose risks for investors who want the guaranteed safety of crypto asset exposure.
Post-FTX collapse, investors needed a safe place to protect their assets but interestingly, they did not turn to centralised crypto exchanges, which saw heavy outflows during this period. Instead, investors sheltered to regulated counterparties, like Sygnum Bank, which received USD 920 million in net new money (NNM) inflows during the fourth quarter of last year.
In times of crisis, integrity and trust become ever more important, and although the potential benefits of trustless systems are yet to be fully explored, investors have shown that their “flight to safety” involves entrusting their assets to regulated, reliable counterparties. But being a reliable counterparty is no easy feat, as it requires a strong foundation of continued trust and integrity from within.
This document is purely for educational purposes and has been issued by Sygnum Group. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor is it aimed at any person or entity to whom it would be unlawful to address such a marketing communication. It does not constitute an offer or a recommendation to subscribe, purchase, sell or hold any security or financial instrument. It contains the opinions of Sygnum Group, as at the date of issue. These opinions and the information contained herein do not take into account an individual‘s specific circumstances, objectives, or needs. No representation is made that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes personalized investment advice to any investor. Therefore, you must verify the above and all other information provided in the document or otherwise review it with your external advisors. Some investment products and services, including custody, may be subject to legal restrictions or may not be available worldwide on an unrestricted basis. The information and analysis contained herein are based on sources considered as reliable. Sygnum Group uses its best efforts to ensure the timeliness, accuracy, and comprehensiveness of the information contained in this document. Nevertheless, all information indicated herein may change without notice.