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How Institutional Investors Impact Crypto Markets

How Institutional Investors Impact Crypto Markets

Learn all about institutional investors, how they impact crypto markets, and what the future holds.

Retail traders only account for about 10% of stock market trading volume in the U.S. Institutional investors – ranging from high-frequency traders to massive pension funds – are responsible for most trading activity.

The crypto market is following a similar path. Like the early stock market, high-frequency traders found inefficiencies across crypto markets they could exploit to profit. Some long-term investors want to meet client demands for exposure to next-generation technologies or find that crypto assets add diversification to their overall portfolio.

In this article, you’ll learn all about institutional investors, how they impact crypto markets, and what the future holds.

Who Are Institutional Investors?

Institutional investors buy, sell, and manage assets for their clients, customers, members, or shareholders. In crypto, these primarily include hedge funds, family offices, principal trading firms, and financial institutions. Fewer pension funds and other long-term investors participate in crypto than conventional stocks and bonds.

These investors may trade the spot market or use derivatives to meet their investment objectives. For instance, hedge funds may leverage Bitcoin futures to speculate on the future price of the iconic crypto asset rather than buying and selling actual Bitcoin. That way, they can gain more leverage or hedge against risk by betting against Bitcoin.

Institutional investors also include crypto funds. For instance, the Grayscale Bitcoin Trust owns $16.8 billion worth of Bitcoin, and the Grayscale Ethereum Trust owns about $5.4 billion worth of Ethereum. These funds enable individuals to invest in crypto assets without having to deal with tokens or wallets of their own.

Institutional Trading Volume

A popular way to measure institutional involvement in an asset class is by looking at trading volume. In other words, how much buying and selling stems from institutional investors versus retail investors?

Institutional investors dominate the trading volume in crypto assets. In Coinbase’s Q1 2023 report (below), institutional trading volume clocked in at $124 billion versus just $21 billion for consumer accounts. Moreover, institutional trading fell far less than retail trading during the first quarter downturn, suggesting it’s more sustainable and long-term.

Institutional Trading Volume
Source: Coinbase 10-Q SEC Filing

Most institutional crypto trading likely stems from hedge funds capitalizing on market inefficiencies. For example, hedge funds may identify arbitrage opportunities between tokens. If the price of Bitcoin differs between two exchanges, they can buy on one exchange and sell on another exchange, netting the difference as profit.

Assets Under Management

A second way to measure institutional involvement in an asset class is by looking at total assets under management. In other words, what’s the dollar value of crypto assets held by institutions versus retail investors?

The pseudo-anonymous nature of the blockchain makes it challenging to track institutional assets under management. While Grayscale and other significant funds own billions of crypto assets, most large institutional investors hold few crypto assets. And most of the $1 trillion market likely remains in retail investors’ hands (see Bitcoin’s 2022 breakdown below).

Assets Under Management
Source: Phemex / Kevin Rooke

There are two reasons crypto remains outside:

  1. Volatility – Crypto assets are notoriously volatile compared to conventional investments. And for traditional investors, volatility translates to risk for their clients.
  2. Return – Most crypto assets don’t offer an intrinsic return, meaning there are typically no earnings or interest payments to distribute to holders. The asset is more like a commodity.

That said, crypto funds could become more prominent if and when the SEC greenlights spot Bitcoin or Ethereum ETFs. Currently, the SEC only permits ETFs to invest in Bitcoin futures contracts rather than holding the underlying coins. However, several ETF issuers have been trying to move forward with a spot market product.

What’s in Store for the Future?

The crypto ecosystem continues to evolve, and these changes could influence institutional investment in the future.

Hedge funds continue to be drawn to the market’s volatility since it offers opportunities to generate alpha through arbitrage and other attractive strategies. But, as the market becomes more efficient and volatility lessens, the institutional interest could shift from statistical arbitrage to long-term investors seeking a stable store of value or diversification.

At the same time, the rise of decentralized finance (DeFi) could help create the intrinsic return many long-term investors seek. For example, DeFi protocols make adding liquidity or lending crypto assets easy to generate income. And the yields these platforms offer could draw institutional investors seeking high-yield income investments.

Finally, clearer regulations could also pave the way for more institutional involvement. For instance, applying securities rules to crypto tokens or more tightly regulating crypto exchanges could help more prominent investors become more comfortable with the assets. But many of these rules and regulations remain up in the air.

The Bottom Line

Institutional investors play a central role in the stock and bond markets but have a limited role in the crypto markets. While hedge funds are drawn to their volatility and arbitrage opportunities, most asset managers focusing on the long-term are too risk-averse to stomach the volatility and don’t see enough intrinsic return.

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Justin Kuepper