Abdiel Santiago
At last month’s Wyoming Blockchain Symposium enlightening discussion unfolded about the evolving landscape of blockchain and digital assets. The conversations not only highlighted opportunities, but also the stark realities institutional investors face in this relatively nascent sector.
A major theme was the impact of current regulatory approaches on the cryptocurrency industry. The prevailing method of “regulation through enforcement” has proven to be more stifling than nurturing. For institutional investors, this underscores the need for a strategic shift toward clearer, more consistent regulatory frameworks to protect investments and support sector growth. The stability of blockchain investments and, by extension, digital assets, significantly hinges on future regulatory clarity.
Skybridge Alternatives, or SALT Conferences, and by Payward Inc., better known as Kraken, a cryptocurrency exchange, hosted the symposium.
Potential Strategies
For institutional investors looking to engage with this sector, several pathways exist:
Direct investment in digital tokens allows institutions to buy cryptocurrencies like Bitcoin and Ethereum directly on digital asset exchanges. Futures are also available for a select number of cryptocurrencies on exchanges, providing opportunities for risk hedging and income generation strategies without owning the assets outright.
Investments through exchange-traded funds represent a more “sanitized” method of investing in cryptocurrencies, predominantly available for Bitcoin and Ethereum. The recent growth in Bitcoin ETFs, capturing about 14% of its total market capitalization (according to CoinMarketCap), underscores the stability of the asset.
However, as with direct investment in digital tokens, ETFs face custody challenges. Typically, a digital asset exchange would use “cold wallets”—crypto wallets not connected to the internet—for enhanced security against hacking. This is not very efficient due to their susceptibility to human error. This scenario has prompted concerns about the risks associated with the concentration of custodial services. In the U.S., some members of Congress advocate for allowing traditional banks to offer custody services to mitigate these risks.
For asset allocators, investment through private funds that focus on cryptocurrencies may be more appealing. These funds largely operate like hedge funds, actively investing in so-called Layer-1 assets, focusing on what they consider attractive, regardless of the underlying “use case” of the digital asset.
Venture capital presents another avenue for investing in this asset class, directly or through funds. The range of venture investing is broad: One option is investing at the blockchain level (below Layer 1, or at Layer 0) for enhanced interoperability and communication, or in supporting other digital assets in Layer 2 and even Layer 3, the application layer where developers build actual applications using the underlying frameworks provided by Layers 1 and 2.
Associated Risks
These strategies, while potentially rewarding, come with their own idiosyncratic risks.
Tokenization (the process of converting rights to an asset into a digital token on a blockchain) seeks to streamline processes and reduce costs and risks associated with intermediaries, holding great promise for both decentralized finance [DeFi] and traditional finance [TradFi]. For instance, the adoption of tokenization in DeFi showcases tokenization’s revolutionary approach to bypassing traditional financial systems, whereas in TradFi, it integrates with existing financial structures to enhance operational efficiency. While tokenization’s potential for efficiency and scalability could be rewarding to users and investors in both verticals, the lack of supportive policy and definitive regulatory guidelines poses a risk to the full realization of these benefits.
One of the least-discussed areas of digital asset investing is energy infrastructure for digital asset miners. Opportunities here are touted as pursuing global sustainability goals, yet conflict with the insatiable need for high-power computing capabilities, especially in the face of artificial intelligence power consumption. Global demand for mining infrastructure is growing, which makes owning and operating sustainable power sources crucial to leverage zero-carbon energy sources like nuclear power.
Finally, the debate about central bank digital currencies and the role of digital assets in national economies underscores the need for countries to future-proof their monetary systems. For institutional investors, these developments could dictate new norms in liquidity, risk and asset management.
‘Sensible Approach’
When considering asset allocation to the digital asset space, a sensible approach might be a “decile drawdown” allocation to cryptocurrencies. Taking 10% of your worst historical (pick how far back) 12-month return and using that as a maximum allocation to the asset class could be prudent. For instance, if your worst 12-month return has been 10%, then 1% could be your maximum allocation to crypto assets. Of course, this allocation, however small, must be weighed against the liquidity profile and risk appetite of the asset allocator.
In the end, discussions at the conference underscored that the intersection of traditional finance, digital assets, energy and blockchain technology is bustling with opportunities, yet fraught with unanswered regulatory questions. The push for clarity and innovation is strong, reflecting a dynamic, yet challenging, frontier for those navigating this space.
Abdiel Santiago is CEO and CIO of the Fondo de Ahorro de Panamá. The views and opinions expressed in this article are solely his own and do not necessarily reflect the official policy or position of the Fondo de Ahorro de Panama or the government. This content is provided for informational purposes only and should not be interpreted as investment advice or a recommendation on behalf of the Fondo de Ahorro de Panama.
This feature is published to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of ISS STOXX or its affiliates.
Tags: Abdiel Santiago, asset tokenization, Bitcoin, Blockchain, decentralized finance, Ethereum