Following a momentous 2021, another promising year is upon us as the digital asset ecosystem hurtles toward institutional adoption. The industry is at a pivotal turning point and is primed to build on notable milestones that defined 2021. Hyper growth in fundamentals has been fueled by the myriad applications leveraging blockchain technology across industries. Formerly skeptical institutional investors have witnessed the acceleration of a nascent ecosystem into a vibrant economy. In 2022, I expect the following themes to be at the forefront of the market narrative.
1. Legacy terminology will die a fast death
Terms like AltCoins, used to describe literally anything that isn’t Bitcoin, will fall by the wayside as more sophisticated capital enters the market. While I do believe that Bitcoin will continue to grow and increase in value versus the dollar, true institutional investors are not looking at this exposure as a macro or beta play, but as an investment allocation to a growing technology that spans a broad swath of sectors and industries. This will lead to adoption of terminology and taxonomies that fit within our existing investment landscape.
Classification systems, like the one developed by Arca, will educate investors about the intricacies of digital asset investing, and will prompt institutional strategies beyond the bucketing of investments into “yes I do”, or “no I do not have digital asset exposure”. Investors are already examining how digital assets can fit into their existing framework, and this trend will accelerate in 2022. Investors may not immediately dive deeply into the various sectors of the ecosystem, but they will surpass binary exposure.
2. RIAs and financial advisors will play catch-up
The majority of financial advisors have been slow to present their clients with a thoughtful digital asset allocation strategy. While those at the wirehouses will likely continue to fall behind, wealth managers with more flexibility in their manager models will be adding active management strategies—including both liquid and venture capital—to their clients’ investment allocations. This will continue to put pressure on banks and slow-moving RIA custodians.
Wirehouses and larger banks are always slow to adopt change and new technologies. Digital assets are further complicated by the fact that they are not considered securities and are not able to be custodied by traditional broker-dealers. The regulation of the asset class is inevitable, and ultimately will further boost this rising tide. That said, this current period presents a significant opportunity for RIAs and multi-family offices with a more open investment architecture.
3. Institutional capital will enter the market in a flurry
Over the past year, we’ve seen headlines with references to investors buying the most well-known digital assets—Bitcoin or Ethereum—and that’s been a nice narrative. Behind the scenes, the institutions that manage the overwhelming majority of global investable assets have gone from uninterested to exploratory, and most recently, to a period of deeper due diligence. We will begin to see the culmination of that diligence as billions of dollars in new capital flow into the digital assets market.
Pensions are already testing the digital asset waters. While the Texas Association of Public Employee Retirement System—with more than $32 billion in AUM—hosted multiple crypto expert panels at its latest educational forum, the Houston Firefighters’ Relief and Retirement Fund made an initial investment of $25 million into digital assets. This is the start of a rampant trend for 2022. Compared to the $122 trillion and $327 trillion market caps for global equities and real estate, respectively, digital assets—with a current $2 trillion market cap—are only in their infancy.
4. The bull run in digital assets will continue and strengthen
Next year will serve as further proof that digital assets are part of a secular shift, not a short-term trade. The industry has introduced new sectors with fast growth trajectories, like DeFi, gaming, sports, NFTs, and web 3.0—all of which have completely different factors and token economics that contribute to their returns. The identification of digital assets as having real revenues, real cash flows, and real fundamental economic value will increase token prices and expand multiples to a point where institutional capital will increase its collective awareness in a hurry.
Professional investors’ familiarity with the varying digital asset opportunities will help them understand how specific value can be calculated. Even though a digital asset valuation methodology is far from universally accepted, there are many ways to fundamentally evaluate an investment. The assumption that digital asset valuation is impossible will dissipate. Investors will start to ask detailed questions about business models, revenue streams, and risk. As institutional capital enters the market in an exponential fashion, the marginal buyer will far outpace the marginal seller.
5. Bitcoin volatility will decrease
As more capital flows into the asset class, and reliable exchanges aggregate larger flows of supply and demand, Bitcoin’s price volatility will fall. As institutions begin to dip their toes in, the largest and most established digital asset, Bitcoin, will likely see a disproportionate share of these inflows—at least at first.
Additionally, the derivatives market for digital assets now exceeds the value of the spot market. Arbitrage relationships between these two markets lead to liquidity introduced via the derivatives market to reduce the volatility of the spot market. Further, a closing of arbitrage opportunities across the various exchanges also helps create a more unified market, reducing volatility. A substantial inflow of assets, combined with an increasingly unified market, will help reduce Bitcoin volatility going forward.
Peter Hans is Managing Director at Arca.