Post FTX Collapse, How TradFi Investors Are Reevaluating Crypto

Crypto’s future depends on traditional financial investors (TradFi). I’m not talking about banks and asset managers, but pension funds, endowments, foundations and large family offices that control large amounts of discretionary patient capital. If crypto is to realize its transformative potential, it needs these institutional investors to start writing checks.

To understand how these investors view crypto, I asked 15 asset owners, none of whom could even be described as a crypto zealot and each responsible for managing or advising multi-billion dollar portfolios, “Given the events of 2022, what would give you the confidence to invest in crypto-related opportunities, and what type of opportunity would you consider?” I added the reminder that their answer could not be “better regulation.”

Angelo Calvello, Ph.D., is the co-founder of Rosetta Analytics, an investment manager that uses deep reinforcement learning to build and manage investment strategies for institutional investors.

Their answers revealed five key insights for the future of crypto:

This group’s confidence was not shaken by the crypto-related events of 2022 “withdrawal” of bitcoin (BTC), ether (ETH) and other coins, the crypto credit crisis or the subsequent contagion. Their reactions to these events ranged from sanguine (“the events of 2022 … don’t mean much to me or crypto”) to fatalistic (“it [crypto] will bomb a few more times before it becomes institutional before we can trust the actors to know what they’re doing”) to happy (“I’m all for the crash”), while several others saw the events as a “necessary capitulation” which would result in a better, healthier ecosystem. More generally, no one believed that 2022 meant the death of crypto. On the contrary, they generally agreed with an endowment chief investment officer (CIO) that “crypto and blockchain are here to stay.” all agree that for them to commit meaningful capital to crypto, the future of crypto needs to look much different than the past.

The future of crypto will not include investment in cryptocurrency trading strategies, according to the allocators. The CEO of a large family office forcefully pointed out that “we have no interest in crypto as a currency.” The head of options at a corporate pension plan added that he viewed crypto trading as “degenerate gambling.”

The group also uniformly rejected the usual economic arguments for a core allocation to cryptocurrencies (it’s an uncorrelated asset, a store of value or an inflation hedge). A large endowment characterized these arguments as “hypothetical”.

The future of crypto will be good crypto companies, not good crypto products.

For these investors, 2022 was a watershed year for crypto. While this group sees cryptotext as a transformative technology that can lead to genuine and much-needed innovation, these investors see the crypto ecosystem to date as “a giant crypto circle drive that motivates people who contribute very little value.” One investment consultant prosaically described the ecosystem as a “hobbyist industry consisting of a limited group of technically sophisticated users. … What’s popular in crypto is not what institutional investors care about.”

In order to attract institutional capital, this must change. As one family office investor told me, “It’s time for crypto to put on big boy pants. Crypto people need to stop building products for other crypto people.” Another awardee added that “We are at a stage of dreams and optimism.” One person in charge of venture capital investments at a family office said that moving from illusion to reality requires the ecosystem to start building “Web3 solutions (infrastructure plus applications) that are better than today’s solutions to solve real-world problems outside of Web3- ecosystem/echo.chamber (faster, cheaper, better user experience, better ability to capture value, etc.).”

Awardees agreed that to qualify for an award, these solutions must be supported by definable, sustainable business models. (And just to be clear, these business models are not Decentralized Autonomous Organizations (DAOs): “DAOs are not a way to run a business, and what the hell is a governance token?”)

These institutional allocators have grown weary of the pitches from crypto evangelists and consultants that “show a total lack of regard for the difference between a product and a business.” One allocator was unequivocal: “This year, when I hear a crypto pitch, I will stop the speaker and ask them if it is a business model. In recent years, there has been a total lack of consideration of the difference between a product and a business.”

Critically, everyone agrees that the business model must be scalable. For one allocator, this means “decentralized projects and investment opportunities aimed at the general public that more effectively distribute the economy in behavior better than centralized alternatives.” Another asset owner was more specific: These must be “projects and investments with a total addressable market of 10 million or 100 million people,” adding to emphasize that “crypto needs its browser moment.”

The future is far away. Allocators identified several structural barriers that will hinder their deployment of capital, including the difficulty and time it will take to build sustainable, scalable crypto businesses and the resistance of legacy institutions that benefit from centralized structures.

Several also identified a less obvious but more formidable barrier: the current worldview of institutional investors. These allocators argue that broad-based crypto investing will require a two-pronged “generational shift.” For decades, TradFi allocators’ investment worldview has been circumscribed by the canon codified in CFA and MBA curricula, which, as the CIO of a public pension plan said, “does not support crypto-related investments … If we get rid of these ideas, in five year we want innovation, the innovation we badly need.”

Second, investors need to move beyond their ethnocentrism and realize that developing markets, especially “the great unbanked” in the Global South, are likely to be the source and take advantage of many scalable investment opportunities. One investment consultant pointed out, “an investment committee in Boston doesn’t think about crypto the same way as young people in the Global South.”

The future must include better due diligence. Confidence that crypto investment opportunities are rooted in solid, scalable business models requires rigorous due diligence. This group typically gains private market exposure through mutual funds, so they expect their fund managers to use proprietary, time-tested due diligence processes to thoroughly evaluate crypto investments.

Nevertheless, the failure of many reputable funds and assets to identify (or simply ignore) the many red flags associated with cryptolender Celsius Network and the FTX exchange has caused these allocators to lose some confidence in the care of the funds’ general partners. processes. For example, one endowment CIO said, “It’s absurd what passes for due diligence.”

The managing director of investments at a Canadian pension plan agreed: “A lot of people got very lazy and they didn’t go deep enough.”

These allocators recognize that crypto investment opportunities present unique challenges that require specific knowledge that even the most sophisticated investors may lack. Referring to the Caisse de dépôt et placement du Québec’s investment in Celsius and the Ontario Teachers’ Pension Fund’s investment in FTX, the CIO of a US public pension fund ruefully noted: “Not even the Canadians are capable of doing due diligence on something they don’t do. understand.”

More generally, many share the view of a corporate pension fund CIO that funds put undue pressure on limited partners to make an award decision: “A lot of the deals go so fast that you get a call and you have to make a decision almost immediately, and as a trustee, FOMO is not a reason to invest.” Another pointed out: “FOMO only works when you have a tailwind.”

This informal survey reveals that while institutional investors are bearish on cryptocurrency investment strategies, they are long-term bullish on crypto as a transformative technology, provided the technology is demonstrably scalable and supported by a viable business model. Acquiring these technology-based opportunities will require a shift in their worldview; assessing them will require an improvement in their due diligence.

The crypto ecosystem has historically chafed under the yoke of TradFi conventions, but this yoke is one it must bear in order to earn the trust necessary to attract the institutional capital necessary to transform itself from a guild into an industry .