Global stockbrokers, neobankers and financial institutions are all slowly onboarding crypto into their asset portfolio and it’s probably a matter of time before WealthTechs do the same, according to analysts.
Crypto is becoming harder and harder to ignore. The last few months have been a rollercoaster and after the crypto boom earlier this year, a slew of financial organisations have become noticeably more open to blockchain technology and digital assets.
In the past, a defined line was drawn between wealth management firms and cryptocurrency. But with an increased appetite for digital assets from consumers, that line is now blurring. A growing number of incumbents as well as startups are succumbing to the lure of surging crypto markets and adding cryptocurrencies to their list of asset classes. For instance, Goldman Sachs, UBS, Fidelity and Morgan Stanley all announced that they will be offering cryptocurrencies to their clients. Even digital bank Revolut stole a march over its European rivals by launching crypto trading alongside Berlin-based neobroker Trade Republic, which launched crypto trading. As NorthRow CEO Adam Holden said, “Companies must look at the wider opportunity and review their previous reticence to become involved. With investors demanding greater access to digital assets and crypto, companies must look to extend their portfolio strategy.”
Indeed, as investors become more interested in cryptocurrencies, financial advisors are feeling a new urgency to offer investments to clients. According to DigitalBlock director David Thomas, “There is no doubt that digital assets are here to stay and as adoption in the mainstream grows, so too will interest from the broader market.” In fact, about 49% of advisors said clients asked about cryptocurrencies in the past six months, up from 17% in 2020, according to the Financial Planning Association and the Journal of Financial Planning. A quarter of these financial professionals plan to increasingly recommend cryptocurrencies in the next year, it said.
The underlying reason driving the popularity of digital assets is the vast potential scope and power of blockchain, especially for the finance and wealth management sector. According to Polymath CPO Thomas Borrel, the traditional securities lifecycle is inefficient, limits scale, cuts into profit and constrains service offerings for wealth management firms. “This is where asset tokenisation can really shine and improve business strategies. Breaking asset ownership down into tiny fractions – rather than just being owned by a single person or entity – democratises access to wealth creation for smaller investors,” he said.
It’s therefore a matter of transforming business strategies that have been in place for decades to make way for blockchain’s potential. And with the escalating popularity of digital assets, wealth management firms can expect accelerated access to new assets that enable dynamic portfolio operations and cost-savings. “Doing so will enable new forms of investment, lending and dynamic asset structuring/rebalancing. The sheer speed at which the assets can be traded will be the driver for asset managers to upgrade their operations to be more data-driven and data-aware,” Borrel said.
To crypto or not to crypto?
Today, crypto is a tempting prospect for any FinTech firm despite being an extremely volatile, heavily hyped market. As well as increasing transparency across record keeping and asset ownership, one of the benefits of asset tokenisation is liquidity, which is vital to attracting investors to assets that typically lack it. Digital assets can be further leveraged via staking, lending, yield farming in a way traditional assets like stocks and bonds can’t.
Only brands that add digital assets to their product portfolios will be able to take advantage of this growth opportunity, Holden said adding that, “Firms that engage with this asset class understand that by participating, they’re sending a clear message to the market, that they’re paying attention and are willing to adapt to the desires of a shifting demographic during the largest generational wealth transfer in history.”
Tellingly, onboarding digital assets will be a natural evolution to meet both the investor demands and the industry’s change in outlook on digital assets. Nucoro head of strategy and partnerships Nikolai Hack believes that bitcoin, particularly, will appreciate indefinitely versus other asset classes such as fiat currencies, stocks, bonds, real estate, etc. He explained, “In a world of limitless money printing, negative central bank interest rates and extremely loose fiscal policies, scarce assets are the only thing that will allow consumers to preserve their purchasing power.
“At a lower stock-to-flow ratio than gold after the next halving, bitcoin will soon be the scarcest asset in the world. Adding to its other properties of divisibility, durability and transportability, it is arguably the hardest money in the world,” Hack said. As a result, once its adoption becomes even more mainstream, there will be a major outflow of funds from all other asset classes which will very likely indefinitely depreciate versus bitcoin.
Hack added that “any wealth manager who has their clients’ best interest at heart needs to consider giving them an exposure to bitcoin.”
Roadblocks in the crypto path
For companies jumping on the crypto bandwagon, it is key to understand what it entails. The bitcoin whitepaper, written by the cryptocurrency’s creator under the presumed pseudonym Satoshi Nakamoto, is a great place to start. According to OSOM Finance CPO Mathieu Hardy, unlike stocks, digital assets include store-of-value assets like bitcoin, utility-based assets like ethereum, or even governance tokens, and yield-baring tokens. “It’s important that businesses are able to understand and explain what it is they are going to be offering,” he said.
Furthermore, FinTech and WealthTech firms are going to have to make a solid case as to why customers should go through them, instead of going it alone. “Digital assets know no bounds, meaning competition is global. And, unlike the stock market, there’s no closing bell,” Hardy said.
An important factor to consider before adding crypto is infrastructure. While technology can automate processes and reduce administration, there will always be a need for internal resources to manage the systems. At present, there are little to no connections to existing rails, Hardy said. “Everything from exchanges to custody is built from the ground up. It’s unrealistic to imagine that each WealthTech company is going to rebuild custody, trading, portfolio management and trading infrastructure,” he added. In addition, managing the technology and selecting the right digital asset platforms WealthTechs align themselves to, will be important for their reputation and impact their opportunities for future growth.
Another risk is that certain traditional asset classes may not be right for the blockchain yet and vomiting cryptocurrencies would do clients a great disservice. “There’s a misguided trend,” said Borrel, “that claims that blockchain technology should be introduced into every corner of the finance space. However, digital assets should be introduced where it brings value to investors or institutions. Blockchain is all about augmenting and supplementing the marketplace – not overhauling it, or at least not until the incumbent systems no longer keep up with demand.”
According to Borrel, instruments with well-established frameworks, for instance, publicly-traded stocks already have very well-formed, battle-tested rails in place. Therefore, in some instances, onboarding digital assets could cause greater disruption and costs than benefits, he added.
For institutional investors, there will remain a traditional market onboarding mechanism for a while as pension funds, banks and other highly regulated entities can’t easily buy products outside of the traditional exchanges. Consequently, ETPs, ETFs, Trusts and other funds will most likely keep existing. Hardy said that whilst the security provided by those venues is important for institutions, “we see no reason why a retail customer should pay 2.5 or 3% annually on management fees for holding a crypto-based ETP as opposed to holding crypto outright.”
Regulatory risks
Apart from the aforementioned roadblocks, providing advice around digital assets is currently a complicated exercise as it’s a regulatorily grey area. Unclear regulatory environment and limited platforms for advisers to implement holding cryptocurrencies in client portfolios makes it complex for WealthTech firms.
Currently, firms must be aware of some of the AML regulations before they invite crypto into their portfolios. The fifth anti-money laundering Directive (5AMLD), the first AML EU directive to comprehensively define breaches of law via the use of cryptocurrencies, so crypto custodians, exchanges and wallets based in the EU need to adhere to the 5AMLD.
The 6th AMLD follows on from the single market’s 5th anti-money laundering Directive (Directive (EU) 2018/843) (5AMLD), the first AML EU directive to comprehensively define breaches of law via the use of cryptocurrencies. EU has also introduced an Action Plan to prevent money laundering and terrorist financing, beyond the standards adopted by the FATF.
Elsewhere, The US Department of Justice suggested strategies to combat illicit uses of cryptocurrencies including promoting law enforcement awareness and expertise in cryptocurrency technology to efficiently conduct investigations.
This will change as crypto matures as an asset class and regulators adapt. We are already seeing a change as more governments are beginning to realise the benefits of digital coins. While cryptos are yet to be in a position to be readily and widely accepted as a standard form of payment, El Salvador became the first country to make bitcoin a legal tender. Time will tell whether this move will prompt other nations to give way to the growing demand for alternative mediums of exchange.
Despite these challenges, refusing to incorporate digital assets into portfolio management might make life easier, but probably not for long, Hardy said. “Volatility and questions around legitimacy may have put some investors off, but barring a customer from accessing these nascent markets may do more harm than good,” he added. “Those who refuse to consider offering alternative assets will probably see customers flee elsewhere.”
According to Hardy, cryptocurrencies deserve a place in everyone’s portfolio, whether in the form of lending on DeFi or exposure to the tokens of Web3 companies vying to rebuild the tech industry.
“It’s more a question of when than if, Hardy concludes. “Of course, it all depends on the customer’s risk profiles. But there is no good reason to stay out entirely.”
