THE KEY CHALLENGES FACING INSTITUTIONALIZATION OF CRYPTOASSETS

THE KEY CHALLENGES FACING INSTITUTIONALIZATION OF CRYPTOASSETS

The crypto space has grown exponentially over the last two years. What started with the Bitcoin in 2009 is now a marketplace teeming with a myriad of cryptocurrency products and services. Today, the world has over 5,000 cryptoassets, and the number of users on exchange platforms is said to be over 40 million.

Despite these significant developments, however, cryptos still have quite the journey to cover before they can get to mainstream adoption. Experts in the sector all seem to agree that institutionalization is the necessary next step required to build trust, increase accessibility and facilitate up-scaling. Coinbase, for instance, believes crypto will mature in three stages: speculative investment, institutionalization, and utility.

To move the industry from its current speculative investing stage to the utility stage, crypto needs to become more liquid, accessible and trusted. This shift can only be achieved with acceptance from traditional banks and exchanges, broker-dealers, payment providers, fintechs and other institutions in the global financial services ecosystem.

Why is cryptocurrency institutionalization crucial?

Unlike most other asset classes in today's financial system, the rise of cryptocurrencies was fueled by retail trading rather than institutional adoption. Consequently, existing platforms and products were largely designed with retail customers in mind. It is no surprise, therefore, that factors like high-frequency, low latency matching engines, transparent and efficient price evaluation tools, and qualified custodians to facilitate the storage of assets are virtually nonexistent in the crypto space.

Financial institutions are a different kind of stakeholder in the cryptocurrency sector. Unlike retail customers, they demand a focus on transparency, compliance, and governance to comfortably transact with crypto. Growth in institutional interest would encourage the marketplace to prioritize innovations that don't compromise security, compliance and consumer protection. By aspiring to meet the standards and practices established by traditional financial institutions, crypto companies would be promoting trust, which would accelerate mainstream adoption.

Challenges facing cryptoassets institutionalization

Institutionalization could be the key to unlocking the full potential of cryptocurrencies but, thanks to several major barriers, it is hardly straightforward. Below are some of the key inhibitors of institutional involvement in cryptoassets.

1. Unestablished regulatory systems

Cryptoassets are becoming an essential part of the emerging tokenized economy and are garnering significant attention from financial services institutions. However, thanks to the lack of clear regulatory guidelines, the industry has been struggling to implement the applicable controls and processes to attract traditional brokers.

To facilitate cryptoasset trading, the market needs a trusted end-to-end clearing and settlement solution. Currently, cryptoassets lack a central clearing depository and a transfer agent to provide services like asset account transfers and set obligations for fully paid for securities. Other regulatory requirements like transaction and trade reporting and audit trail management are near impossible to adhere to in current decentralized digital models.

Institutionalization requires crypto businesses to clearly define their product offerings and align them with financial regulations. It is in the industry's best interest to get ahead of the evolving regulatory landscape and set itself straight.

2. UNDEFINED CRYPTOASSET PROVENANCE VERIFICATION

The Financial Crimes Enforcement Network (FinCEN) considers crypto exchanges as Money Service Businesses (MSBs) and thus subjects them to existing banking regulations related to money laundering, customer identification, and transaction monitoring, among other financial reporting requirements.

for suspicious activity. Counterparties in crypto transactions are identified not by names and account numbers but by cryptographic addresses that users can create anytime, anywhere. Institutions need to maintain some ability to identify and monitor the provenance of assets and transacting parties and are therefore discouraged by the anonymity in the crypto world.

On the flip side, crypto businesses can leverage the underlying blockchain technology to analyze and determine cryptoasset provenance. The blockchain preserves all transaction data and makes it publicly accessible. Traceability can be achieved, more so with aid from third-party data providers. Nonetheless, standard practices around determining provenance within the blockchain are yet to be established.

3. SECURITY CONCERNS

Because cryptoassets are natively digital and often high-value, crypto businesses are prime targets for cybercriminals. Crypto transactions also happen over the public internet, which makes both the assets and any associated services vulnerable to traditional cyberattacks like phishing or malware. Moreover, even organizations outside the industry are targets for hackers looking to steal computing power for crypto mining.

For cryptos to move to the institutionalization stage, developers need to build sufficient monitoring capabilities to proactively identify threats that could impact operations and lead to the loss of client assets.

It is not just the assets that are at risk. Financial institutions also require the safeguarding of competitive intelligence information that could be leaked through the blockchain. In traditional asset markets, transaction data is not publicly available. If it were, participants and competitors could use it for various purposes, including market manipulation. In the crypto world, however, all transactions are stored in a publicly accessible, immutable ledger. With advanced data analytics capabilities, third-parties can monitor the blockchain and gain important information about an institution. Institutionalization of cryptoassets requires that players in the sector provide a clear strategy to continuously and reliably obfuscate data posted to the blockchain.

4. TAX IMPLICATIONS

The crypto market may be rapidly growing, but guidance regarding tax compliance is still minimal. According to a notice made in 2014, the IRS views virtual currencies as digital representations of value that function as exchange media but don’t have all the attributes to make them real currencies, such as legal tender status. According to the IRS, cryptos are properties, not currencies. Therefore, when cryptocurrencies are held as assets, any gains or losses from the sale of the assets are taxed as capital gain or loss.

In addition to potentially large tax liabilities incurred on the sale of crypto, institutions getting into cryptoasset trading may also bear significant tax accounting burdens, depending on the number of crypto transactions in which they engage. Frequent transactions, either with trading bots or crypto debit cards can rack up a significant number of taxable transactions for which institutions will have to account. To establish proper taxation systems for cryptoassets, the market needs processes that distinguish between taxable transactions like a sale or an exchange of crypto for goods or services, and non-taxable transactions like transfers from one account to another.

Can cryptos become an institutionalized asset class?

Cryptoassets have always aspired to become usable, mainstream currencies but to get there, they must prove themselves as a reliable store of value. The speculative nature of the market needs to dissipate so that cryptos can achieve enough stability to attract institutional investors and traders. Crypto must show innovative qualities that improve on the current money system while dealing with the challenges above.

As the market matures, it remains unclear if crypto will be a safe-haven asset like treasury bonds or gold, or a risk asset like equities and high-yield bonds. What is certain is that cryptos have the potential to be a trustworthy option for institutions and eventually become a standard for financial transactions.

That’s why we believe PDX Coin makes a lot of sense. PDX, a globally compliant digital currency, has been structured in such a way that it will become a leading safe-harbor tokenized store of value. PDX’s value inherent in a transferable digital token will enable holders to store and preserve wealth, and seamlessly engage in borderless financial transactions.

This innovative digital currency has the backing of underlying tangible assets, that is, physical reserves of crude oil and natural gas, and other energy assets. It offers all of the advantages of blockchain-enabled digital currencies while providing a verifiable asset base to protect its value, stability and security as a medium of exchange.

Additionally, PDX is committed to working with domestic and global governmental agencies, financial institutions, traders and users of commodities to develop protocols to help facilitate PDX’s adoption as a leading digital reserve currency.

These characteristics, together with a focus on transparency and regulatory compliance, position PDX Coin to be a top safe haven digital currency capable of appealing to investors and consumers worldwide, regardless of size or sophistication.