2019 is the year we can finally say “institutions have arrived,” in the blockchain / crypto industry and in a big way. Despite being a commonly cited catalyst within the crypto space, progress has felt slow. After all, these are large organizations with significant value at risk, so they want to be careful and deliberate about embracing new innovations and opportunities. We’ve finally seen real momentum from legacy tech and financial institutions — with Square, Microsoft, Fidelity, and Facebook all announcing their forays into this space. Two years after the last crypto bull market, it is undeniable that institutions and enterprises have arrived. But why now? What does this mean for the future?
“We’ve got blockchain”
At a high level, institutions are looking to get into blockchain for a few reasons: research and development, growth opportunities, and in many cases, FOMO. For many, they are conducting research and development to understand the technology and gain a perspective on the landscape at large. As more companies decide to experiment in the space, the competitive pressures increase dramatically as institutions seek to capture early growth and revenue opportunities and fend off disruptive risk. In addition, innovation within large corporations is an important component of talent retention as more talent is leaving their Wall Street and tech roles for crypto startups.
We are also witnessing a large, generational demographic shift in financial services. Financial institutions are currently serving aging customer populations, and in many cases struggling to capture the minds and wallet share of the younger, more tech savvy customers. In an effort to understand these demographics, cryptoassets are a trend to watch. There is major FOMO — no one wants to “miss the boat” on what could be a massive growth opportunity or ignore what could potentially present existential risk to their business model. This has led to both thoughtful analysis of the space and what some call “innovation theater “— a proof of concept for the sake of “doing blockchain” with little practical utility. As more institutions embrace the space, it results in a net positive for the industry. But the details matter as we move out of the pilot and POC phase to serious implementations, products, and services. And, as an industry it is important to encourage use cases that utilize the technology optimally rather than simply instituted a new internal database.
Who are these institutions?
The term institution is overly broad — in reality, we are seeing many types of companies enter the space. For the sake of simplicity, the table below categorizes primarily U.S. institutions and enterprises. It is not meant to be comprehensive, but more representative.
While we have an extensive list of players entering the space, they can’t be treated equally. Rather, the implications will either be far reaching or stay siloed as “innovation projects” within these organizations. In order to understand potential outcomes, we consider their existing customer base, market trends they face and risk tolerance. Lastly, an important component which is largely outside of the public purview, comes down to the talent inside these organizations and how they shape the internal views of the space.
Who: Fund of funds, family offices, endowments, pension plans
What: venture fund, hedge fund, and direct investments
Examples: Stanford, MIT, Princeton
As crypto assets emerge as a new asset class, asset allocators have been forced to wrap their minds around the technology and space at large. Cambridge Associates recently published their report “Venture into the Unknown” where they evaluate crypto allocation strategies and recommend investors consider an allocation to digital assets. Their suggestion stems from the belief that blockchain investing can be likened to early internet investing, fraught with young, risky technologies that may end up spurring the next wave of capital inflows.
From the perspective of an asset allocator, exposure to the industry is beginning to play an important diversification role for their portfolio strategy. Considerations include what type of investment fits into their strategy (e.g., venture vs. hedge), which types of managers to invest in (emerging specialist or tenured generalist), and the liquidity profile of the asset class (greater liquidity with tokens but no IPOs to date given industry nascence).
Since the 2017 bull run, over $1B of dedicated crypto venture and hedge funds have been raised (Blockchain Capital $150M, A16z @$300M, Paradigm @$400M, Dragonfly $100M and more) with institutional participation. Asset allocation is an important indicator of market growth and the rate of capital formation in any new industry.
Traditional Financial Institutions
Who: custodians, exchanges, brokerage providers, asset managers, and banks
What: trade and execution services, custody, OTC desks
Examples: Fidelity, ICE (Bakkt), JPMorgan, DRW
Traditional financial institutions are cautiously watching the space, some with disregard while others leaned into the space. It wasn’t until recently many realized cryptoassets could pose both a serious threat and opportunity for their existing businesses. Regardless of their position, it became a strategic watch area inside virtually every financial services institution. Historically, financial services has been slow to respond to digitization that is prevalent in other industries. However, fintech is already eating at their products and pricing strategies with the rise of online robo-advisors and digital banking. These institutions are all facing similar trends: an aging investor base, fee compression across all products and services, decreased brand allegiance with millennials, largely outdated infrastructure, and of course, increased customer demand for more crypto education and access. From their strategic agenda, institutions are constantly looking for opportunities to diversify revenue streams with large growth markets and higher margin products. The balance here comes into play with risk tolerance and their ability to make decisions quickly and adapt to the market with their existing infrastructure.
At Matt Walsh noted — the best institutions will cut through innovation theater and really try to understand how they can leverage the technology. On one end we have Fidelity who is diving in deep to understand the entire ecosystem (mining, trade execution, custody, etc.) and have taken steps to offer custody and eventually execution services. On the other end of the spectrum JPMorgan’s enterprise coin is more conservative, by creating a proof-of-concept internal tool, rather than a revenue generating or customer facing product. While still a net positive for understanding and awareness, I’m paying closer attention to the Fidelity’s of the world.
Who: technology focused, financial services providers
What: brokerage services, portfolio management
Examples: Robinhood, Square, SoFi
Fintech aligns well with crypto — both having a shared goal of using technology to reach underbanked or hard to access populations, with cheaper and accessible products. There is also a demographic overlap with younger, tech-savvy, less financially wealthy consumers. This backdrop coupled with nimbler operations and an updated tech infrastructure makes fintech players extremely well poised to capture crypto interest. Initially we are seeing brokerage products like Robinhood and POS systems like Square make the first leaps into the space — indeed, Square’s latest annual earnings report show they did $166M in revenue from bitcoin in 2019, with a net profit of $1.69M. The motivations here are less about disruption, and more focused on how they can use the technology and assets to spur new growth and address customer demand.
Who: credit cards companies, payment processors, remittance services
What: strategic investments via venture capital and partnerships
Examples: VISA, PayPal
Payments or becoming a “medium of exchange” is one of the original use cases for cryptoassets. Over time, we’ve realized that the payment rails for most of the developed world actually work incredibly well, and may not benefit from introducing crypto for a few reasons. The most commonly cited is the traditional scale question, with blockchains unable to handle the scale of millions of transactions that Visa processes. However, more importantly, the additional friction of going from fiat to crypto, and then converting again at the other side of a cross-border remittance (dubbed the “last mile problem”) largely outweighs any value derived from processing payments with crypto today. The scenario where this starts to make more sense, is when people are holding the digital assets alone and able to transact with them more freely.
At this point, one major question for payment companies to consider is how a macro trend in holding and transacting with digital assets may impact their business model. In other words, how are their existing customers going to use digital assets in the future and what impact will this have on their market. A few scenarios include a world where consumers use multiple digital wallets regularly, conduct commerce in both fiat and crypto, or choose to self-custody some or all of their digital assets. Until now, payment companies have been slower to respond to the potential of crypto. But it would not be surprising if many significantly increase their engagement in efforts to identify the appropriate opportunities as these macro trends accelerate.
Who: messaging applications, social networks
What: wallet infrastructure, tokens
Examples: Facebook Libra, Telegram, Kakao
The overlap of social media and cryptoassets is one of the most interesting trends to watch today. There are two ways to consider this — coming from a crypto perspective and then from within social media platforms. On the crypto side, social media adoption of digital assets has the potential to massively open up distribution channels around the world. This has implications for onboarding new users, building out infrastructure, and spreading acceptance and awareness. Facebook’s Libra is not viewed as competitive to bitcoin, but rather a gateway to more users adopting bitcoin.
The second angle, is how digital asset adoption will change social media business models. Social media platforms are moving from sharing user-generated information to offering user-generated products and services. Instagram already made this leap with thousands of influencers building social media based businesses and their newest payment feature for shopping in-app. With Libra, Facebook is making a strong move into financial services to complement their massive adtech business. Similar to the way direct messaging or “DM-ing” competes with email for millennials, will social media digital wallets compete with the brokerages and banks of the world?
On the other hand, social media giants represent what crypto evangelists are trying to fight against (i.e., centralized monopolies). Centralized powers with unequal access to consumer data and privacy controls. Therefore, the way in which social media companies embrace crypto will be important. If successful, it could shift their models from centralized powers to open platforms with greater privacy protection for its users.
Who: SaaS, infrastructure
What: enterprise blockchains, supply chain use cases, identity
Examples: Microsoft, Salesforce, IBM, Amazon
Software enterprises have historically fallen into the innovation theater category. From their perspective they are trying to understand how public vs. private blockchains could be useful for their business models. In many cases this has led to private blockchain proof-of-concepts and not much more. However, there is a great deal of pressure to address the space (along with other technologies like artificial intelligence and machine learning) as a way to stay competitive and relevant. One of the better examples we have seen comes from Microsoft with the announced their decentralized identity tool building on bitcoin. Hopefully the industry will see initiatives like this geared at working with the open source community and understanding applications of public protocols rather than closed private implementations.
Where do we go from here?
We have major categories of institutions entering into the space, each with their own angle and value proposition. The industry has seen well over $1B of capital allocation to dedicated crypto funds, which will spur the next wave of startups and capital formation in the space. As more institutions enter we will see increased liquidity and onramps, massive distribution channels, and utility focused products & services. Perhaps most importantly, the professionals inside of these organizations will be forced to understand the space, debate its merits and learn. This will allow blockchain and crypto to move from a buzzword and proof-of-concept phase, to becoming truly understood and incorporated into strategic product roadmaps. The space is slowly moving into the mainstream, and with projects like Libra, it’s about to see a lot more institutional participation.