It is interesting to sit between traditional investors and the crypto-native communities: one has just started on the Bitcoin adoption curve while the other might already consider Bitcoin to be a ‘boomer coin’.
- Institutional investors have been paying much more attention to cryptocurrencies
- Besides Bitcoin, alternative coins have shown phenomenal growth
- Decentralised finance and non-fungible tokens have surged
Even during the last bull market of 2017, the crypto investment landscape was largely dominated by tech-savvy retail participants. However, since early 2019, institutional investors have entered this space with increasingly meaningful participation, as the crypto market has grown from $780bn (€686.9bn) to $2.56trn (€2.3trn).
First with Bitcoin and later Ethereum, institutional investors have started to realise the added diversification benefits and how a small percentage of crypto allocation could enhance the risk metrics of a multi-asset portfolio. It also helps to add the potential for outsized returns that is rarely found in other asset classes.
As the crypto ecosystem continuous to mature, the alternative coins (altcoins) outside Bitcoin, Ethereum and their spin-offs have experienced astronomical growth and now take up to 39% of the total crypto market cap, pushing Bitcoin’s market dominance to under 45%. Many institutional investors see no reason to look away from this opportunity and increasingly seek to diversify into altcoins.
Since early 2020, there has been a surge in the decentralised finance space, where decentralised applications offer the same functions as traditional financial institutions. Examples include lending (including firms such as Compound), borrowing (Yearn.finance), trading (Uniswap) and derivatives (Synthetix). Decentralised finance activity has tripled in 2021 with $253.5bn in adjusted total value locked in the network, and it now represents about 5.6% of the crypto market, up from virtually nothing just a year ago.
Another trend in the past year saw investors pile into non-fungible tokens (NFTs), which are digital collectibles covering art (firms such as CryptoPunks), gaming (Axie Infinity), and other digital properties (Decentraland). NFTs attracted over $2.5bn in the first half of 2021, accompanied by eye-grabbing headlines such as Christie’s auctioning an NFT artwork, The First 5000 Days, for $69.3m.
Smart contracts as a driving force for the crypto market
Decentralised finance and NFTs have represented the two most tangible, real-world use cases for crypto technology, and we have started seeing investment in smart-contract platforms that support these applications as a thematic play.
The building of the decentralised applications has mostly focused on Ethereum, resulting in heavy network congestion and skyrocketing gas fees – the fees paid to coin miners to facilitate transactions and execute smart contracts. As people find more uses for smart contracts, the demand for network utilisation will only increase. This is a known challenge and a planned Ethereum 2.0 upgrade is slated for this year, which will introduce ‘sharding’, a process aimed at improving scalability, and switch to proof-of-stake, which will make the network more efficient and environmentally more sustainable.
But core protocol upgrades aren’t the only way to solve this. The ecosystem is evolving quickly to respond to these needs, which has seen several alternative protocols rise to prominence in recent months.
Ethereum alternatives, such as Cardano, Solana, Fantom, Avalanche and Polkadot, all aim to provide better base protocol structures. Cardano gained traction among investors in the lead-up to the network’s recent Alonzo upgrade, which implemented new smart-contract functionality, turbocharging Cardano’s performance in 2021 compared with Ethereum or Bitcoin. Solana’s price increased from $1.5 to a November high of $260 in 2021, fuelled by increased adoption speed and institutional investment inflows, before dropping back in the recent sell-off.
Investability is still a hurdle for institutional investors as the liquidity of most altcoins is often limited. The median market cap for the top 20 coins, other than Bitcoin and Ethereum, is around $36bn, which is significantly less compared with Bitcoin ($1,099bn) and Ethereum ($523bn). Accessibility is another consideration. Unlike traditional assets, where traders can access liquidity across various exchanges, crypto exchanges are less interconnected and require extensive due diligence for traders to choose and onboard credible counterparties.
Charting a path forward
Some investors have overlooked smaller altcoins in the past and focused mainly on Bitcoin and Ethereum because of their longer track records. However, as the blockchain industry shows more use cases and other high-quality competing projects, altcoins have provided exponential growth that attracted attention from investors who start to take more comfort in the broader crypto space and begin to view risk differently.
Some investors have invested in individual decentralised finance applications and NFTs projects with high conviction, while others have chosen the smart-contract platforms as a thematic play. This cements a vision that we think will be a multi-smart-contract-protocol future, and it is hard to call a winner at this early stage; those that offer an attractive ecosystem for people to build on (scalable, cost, speed) will likely win. Smart contracts will drive the next phase of expansion in the crypto space, and investors could consider taking a diversified approach to capture this potential success.
Alice Liu is a senior research associate for cryptocurrency investments at WisdomTree