Wealth managers must navigate choppy crypto waters

Should private banks dip their toes into the cryptocurrency shallows or take the plunge into the depths of the digital ocean?

Investment patterns are undergoing constant transformation, driven by changing demographics, technological advancements and macro narratives.

Nowhere is this more obvious than for digital assets. As global wealth shifts from baby-boomers to more tech-savvy generations, while macro narratives of inflation and ballooning government debt continue, crypto markets are bound to get a fair share of the action.

It is also evident that participating in the digital asset space is demanding for industry actors. It is not just a matter of investing in a new market segment, using familiar instruments and tech stacks. Getting involved in managing digital assets means competing in one of the fastest evolving industries, while dealing with significant security considerations. It means learning how to navigate new seas, in a new kind of boat.

Luckily for wealth managers, there are now crypto ETFs serving as bridges into cryptoland. These are familiar instruments they can easily offer to clients, without need to operate wallets and consider complexities of crypto custody. This is reflected in massive success that US-based bitcoin ETFs have had, with total net inflow of $19bn since launch in January.

The ETFs will suffice in this first phase of mainstream crypto adoption, ensuring several per cent can be allocated to the two main crypto assets, bitcoin and ethereum.

However, crypto ETFs will not meet the growing needs of sophisticated investors for long. Access to specialised strategies and additional assets will be required. This is where crypto hedge funds come in. The constantly evolving crypto landscape means there are plenty of market inefficiencies and fragmentation, which lends itself particularly well to actively managed crypto funds, that utilise arbitrage and market making strategies.

Carefully selected crypto hedge funds will offer an edge in any portfolio over the next few years, for those willing to take the risk.

While ETFs and hedge funds provide immediate solutions for wealth managers to gain crypto exposure, they are merely interim measures to delay the inevitable. Just as there is no benefit to printing emails on paper, reliance on funds as a proxy for direct crypto exposure will diminish. Over time, financial assets will evolve into programmable tokens. Assets, that we do not even think of as “financial” today, will make up large portions of the markets. Smart contracts will be the common format for financial assets and investment strategies, and with that, the operating environment for wealth managers will change – a shift requiring innovation and adoption.

At some point, wealth managers will have to abandon their old tech stack and get their hands directly onto the assets they manage.

Teenage tricks

Although a shift to blockchain infrastructure may still seem distant for everyday asset management, for many it is already a reality.

Consider this: a teenager with a smartphone can set up a wallet and trade crypto assets on an automated marketplace within minutes. It only takes a YouTube tutorial to learn how to apply leverage and initiate a liquidity provider strategy to earn additional yield. All this is done using only open-source software, with no intermediaries. In contrast, employing similar activity in traditional finance would require years of experience and a complex array of services and third parties.

Only a tiny fraction of economic activity taking place on blockchains today is in traditional assets, such as stocks, bonds or funds. The reason for the slow uptake of existing financial assets is that the anti-money laundering and financial sanctions, measures that politicians around the globe require, have been at odds with radical openness of public blockchains. But these incompatible features are about to be bridged.

Ringfenced environments are being built, where anti-money laundering and financial sanctions measures can be enforced, enabling inflow of tokenised, regulated financial assets on public blockchains like Ethereum.

BlackRock’s launch of its tokenised money market fund “BUIDL” is a key example. The blockchain economy, as we have known it until now, can be seen as beta-testing of technology and business models, using only crypto assets. Now, so called "real world assets” can enter.

As these compliant environments gain traction, the shift is coming closer. New roads for financial assets will open, bypassing established value chains. It will be a delicate matter of timing to diligently manage opportunity and risk, while maintaining a competitive edge throughout this shift. When the race starts, bets should already be placed, and private banks need to be at the starting line. This opportunity is not to be missed.

Oskar Åslund, chief strategy officer, AKJ