Market participants in the digital assets space are divided when it comes to analysing performance during the Covid-19 pandemic.
However, there is optimism that the worst of the impact has now passed.
“Since the crypto industry is decentralised and not dependent on offline activities, the impact caused by the pandemic has been much less significant,” said James Wo, founder of the Digital Finance Group. “After two and a half years of a bear market, and applications like decentralised finance growing larger, investors have reason to feel confident in future market performance."
Yves Longchamp, head of research at Swiss bank, SEBA, took a more cautious approach: “To start with things were not good, but the situation has since recovered. Bitcoin was seen as a safe haven asset and people were disappointed,” he said. “This was a misunderstanding as there was a flight to liquidity, not a flight to safety.”
With market players now looking for liquidity, Longchamp said that market participants must remain in the traditional market. “No government body or central bank has intervened to help with crypto assets, in comparison to quantitative easing that has been offered to traditional currencies.”
Lewis Cohen, partner at DLx Law, suggests that there has been a missed opportunity to establish bitcoin as a safe haven of first choice during the crisis. “Though there were some modest increases in the bitcoin price, which indicated increased demand for the crypto-assets, the thesis that you buy bitcoin when everything else is going wrong was just not substantiated,” he said.
Cohen added that this highlighted the industry’s relative youth, with many investors uncomfortable allocating meaningful amounts of their portfolios to bitcoin, or other digital assets.
Dentons partner Robert Michels agreed. “During the crisis we have seen the same movement, which can sometimes be explained, if sometimes not. The big hope for this industry to be a safe harbour is not yet a reality.”
The main struggles for crypto asset players have not been legal, and instead stem from a lack of capital allocation. “There has been uncertainty among capital funds and others about what the future will bring and what the post-Covid world will look like,” said Cohen. “This has meant that funding has been slowed down and committing to a new crypto project may not be the biggest priority.”
This highlights the problem that digital finance still has – a lack of buy-in from traditional institutions.
"The biggest problem for the crypto industry is the lack of trust and the lack of regulation"
“There remains a lack of understanding between different stakeholders,” said Michels. “You have the nerds and the enthusiasts who don’t yet understand the financial markets or its history over the last 30 years.”
Michels suggested that because tech players believe they have a new product the law must be re-written. “It is clear that any serious financial market must remain technology neutral, whether you have a security token or a fiat currency,” he argued. “A lot of the industry currently fails to understand that it must comply with traditional rules, while most lawyers and accountants don’t understand the industry or its concepts enough.”
Retail and institutional investors will also need a better understanding of what a product such as bitcoin can offer – a difficult task given the stigma surrounding its legitimacy. “It is possible to trace bitcoin on the blockchain from its creation, which helps to combat money laundering. What it also has is pseudonymity, which can raise issues relating to transparency, making traditional institutions less interested in investing,” added Longchamp.
“However, as more institutions engage with it, the more transparent that it will become.”
Bank buy-in has been a slow process, but a lot of banks are now offering trading and custody storage. “The more banks are involved, the better you can improve the quality of the products. The whole ecosystem around bitcoin is developing pretty fast, and heading in the right direction,” said Longchamp.
However, Michels cautioned that he did not think that the financial community has the passion for products such as security tokens anymore. “There are doubts and question marks hanging over the market,” he said. “The biggest problem for the crypto industry is the lack of trust and the lack of regulation. It is far from being transparent or regulated, and the hope that crypto can be decoupled from traditional assets has not proven to be true.”
Banks are slow to embrace crypto and blockchain
Dechert partner Timothy Spangler added that even if banks were to educate themselves on digital finance, as it stands the current system works in their favour and there is little incentive to change that. “Look at where they sit in the ecosystem, they like the status quo,” he said. “If this was done on a popular vote most traditional market participants would vote against tech disruption, but this doesn’t mean that there isn’t a growing awareness.”
Spangler further argued that technology will provide alternatives and encourage momentum. “We should consider it as something similar to Amazon or Facebook. These were market alternatives that have continued to grow,” he said. “There will be winners and losers in this process, and that will take people by surprise.”
The disconnect does not stop with the market either, as regulators grapple with just how to treat digital finance.
As some countries like Switzerland and France move faster than others there is a risk of market fragments – underlined in Europe by the recent high level report on the Capital Market Union (CMU) project in the EU, which called for a stronger legal framework for digital assets.
“Harmonisation of laws and regulation is something that has to be improved to ensure we speak the same language on this,” said Longchamp, calling for policymakers in the industry to come together to fully understand the technology so that it can develop safely and successfully. “At the global level you can see that many of the developments are going in the right direction.”
Many stakeholders – whether policymaker, politician or regulator – throughout Europe are not yet educated enough to assess crypto currencies and blockchain in detail. “Policymakers are doing what they can to consolidate the market and hire people who understand the technology, but it is hard to distinguish between what is traditional and what is new,” Michels said.
Companies opening operations in countries that have embraced digital finance but don’t necessarily have a banking history are also cause for concern. “I am sceptical of whether it is sensible to start operations from countries such as Malta that do not have deep financial markets, and, after 1-2 years, it may appear unwise to use these places as a base for operations,” he said. “One place that does stand out is Switzerland. In the European Union, Luxembourg could be transformed into a hub in the future as it is flexible and small enough to react.”
However, while continued uncertainty has hindered interest from traditional players, Cohen said that it has not deterred those within the crypto industry. “Most of the people working on these projects don’t seem to care particularly about developments such as, for example, what precise definitions for digital assets the EU or other jurisdictions come up with,” he said.
“Regulation has yet to stop people innovating at the coalface.”