The crypto market has grown to include more than 13,000 coins with an aggregate market capitalization of $2.5 trillion. While that's just a fraction of the broader financial markets (the global bond market is worth $119 trillion), cryptocurrencies are one of the fastest-growing asset classes in the world, driven by retail traders and investors.
Let's look at some of the trends driving the crypto space and what investors can expect over the next couple of years.
Cryptocurrencies represent one of the fastest-growing asset classes in the world—here's where they're headed in 2022 and beyond.
Innovation has been the most important growth driver for the crypto market.
The Decentralized Finance or DeFi movement has grown to over $100 billion in contract value by taking over conventional financial services. For example, Compound enables peer-to-peer lending, Uniswap offers a decentralized exchange, dYdX supports derivative markets, and Tornado Cash simplifies payments. These companies are eliminating the need for centralized authorities and intermediaries while enabling crypto holders to generate a yield.
In addition to DeFi, non-fungible tokens, or NFTs, have opened the door to many more markets. According to NonFungible, there have been more than 1.2 million sales worth more than $2 billion during the month of October 2021 alone. Most of these transactions consist of games and art, but the same technology could revolutionize real estate and other transactions that represent unique pieces of physical or intellectual property.
Finally, other innovations are addressing fundamental crypto shortcomings. For example, the transition from proof-of-work to proof-of-stake algorithms addresses concerns over the climate impact of cryptocurrencies. Ethereum 2.0 incorporates these changes to address congestion issues on its network, disk space issues for those running a node, and energy issues created by the proof-of-work algorithms that are becoming increasingly difficult.
The crypto market has grown to more than $1 trillion in size, drawing the attention of regulators around the world. For example, China and at least 14 other countries severely restrict or ban cryptocurrency transactions. The U.S. and other countries have ambiguous cryptocurrency rules as regulators struggle to understand and govern the new technology. Of course, new regulations could have a significant impact on the crypto market and its growth prospects.
Most regulations focus on deterring the use of cryptocurrencies by criminal enterprises by increasing transparency. Other rules aim to oversee security-like offerings, such as initial coin offerings (ICOs) to prevent fraud. And of course, tax agencies want to ensure that cryptocurrency traders and investors pay their fair share of taxes. Crypto companies, traders, and investors must ensure that they’re keeping up with the changing rules.
While new rules and regulations could introduce barriers, they could also remove roadblocks constraining the industry’s growth. Many large institutions, such as banks, are hesitant to embrace cryptocurrencies without clear guidelines, since it could impact their other operations. Clear regulations could provide these organizations with clarity and enable more prominent businesses to enter and grow the market.
New Crypto ETFs & Securities
Most cryptocurrency traders and investors use Coinbase or other exchanges to buy and sell assets. While many of these applications are easy to use, many investors prefer to use diversified funds and financial advisors to manage their portfolios. They prefer steady growth over the long-term without worrying about short-term fluctuations. Fortunately, new exchange-traded funds (ETFs) offer a more straightforward option.
The ProShares Bitcoin Strategy ETF (NYSE: BITO) and the Valkyrie Bitcoin Strategy ETF (NASDAQ: BTF) launched in October 2021. BITO's assets under management soared to over $1 billion in less than two days, reflecting significant individual and institutional demand. These funds make it easy to add Bitcoin exposure to a portfolio with a stock purchase, although they use futures contracts (rather than Bitcoin itself) and charge a management fee.
At the same time, institutional money managers require sophisticated tools to create products for institutional and retail investors. Bitcoin futures were a step in the right direction, but cryptocurrencies lack conventional futures and options market access. Fortunately, the approval of Bitcoin ETFs could open the door to more regulatory flexibility. Other major cryptocurrencies could see their own futures and options markets.
Consumer Crypto Adoption
Many large companies have started to embrace cryptocurrencies. For example, AMC recently announced that it plans to accept Bitcoin payments by the end of the year, while Square makes it possible for all kinds of merchants to accept cryptocurrencies. As more businesses support cryptocurrencies, consumer adoption rates could rise amid greater awareness and availability, particularly among those that already dabble in crypto.
At the same time, a new crop of stablecoins aims to provide a more dollar-like experience for consumers. After all, nobody wants to withdraw $100 from an ATM only to have the value of the withdrawal fall to $50 a week later. So, for example, Facebook's Diem aims to provide a stable source of value that's pegged to the value of the U.S. dollar. The company recently partnered with Paxos and Coinbase to let users send and receive the new coin.
Finally, the rise of crypto debit cards has made it easier to spend cryptocurrencies anywhere. Crypto.com's debit card, for example, provides rewards of up to 8% on purchases and enables you to liquidate cryptocurrency holdings for U.S. dollars at any ATM. The increasing ubiquity of using credit cards as a form of payment means that card-like payments will become a necessity before cryptocurrencies can go fully mainstream.
Potential Risks Moving Forward
Cryptocurrencies may have a bright future, but there are some key risks to keep in mind. For example, cybercriminals continue to target cryptocurrency users and exchanges. In August 2021, hackers stole over $600 million in the biggest DeFi heist in history, taking advantage of vulnerabilities in the Poly Network and the Binance Smart Chain. Compounding the risk, cryptocurrency transactions are generally irreversible by design.
Stablecoins could also become an Achilles heel for the market. For example, Tether, a stablecoin with about $70 billion in circulation, has been reluctant to provide much information about the assets backing its coin. With 65% of its reserves classified as "commercial paper," some experts are worried that it could be one of the largest players in the relatively illiquid commercial paper market, and may even have exposure to China’s ailing property market.
The Bottom Line
Cryptocurrencies have become a $2.5 trillion market over the past few years, making them one of the fastest-growing asset classes in the world. With increasing regulation and greater sophistication, cryptocurrencies could become integral to the financial ecosystem, but the pace and success of the transition will depend on externalities, such as innovation, new regulations, the securitization of cryptocurrencies, and consumer preferences.