Sam Bankman-Fried made his first gazillion dollars by arbing away the crazy premium that bitcoin traded at in Japan. He made crypto markets safer for all the rest of it in the process. Institutions are not likely to enter crypto until all those sorts of inefficiencies are mostly cleaned up.
As a market maker on an old-school trading desk, when a salesperson asked for a tradeable price in a stock, you’d immediately respond, “who for?”
(The grammatically correct “for whom” would get you laughed off the trading floor.)
Customers with a history of paying a lot of commission would get better prices. Customers with a history of running you over would get worse prices.
If it was a sizable trade, the rest of the floor would want to know who it was for, too. But you can’t divulge customers’ names, so you’d give a category.
It’d usually be either “insti” or “hedgie.”
Crypto natives might want to learn the difference.
“Insti” is short for institution, which is the term for long-only asset managers such as mutual funds and pension funds.
“Hedgie” is short for hedge fund, which is the term for the guys that run you over.
The crypto industry has been keenly anticipating the arrival of “institutional” money into the space, and each announcement by a brand name from traditional finance is taken as a sign that it’s happening.
But, so far, most of those announcements have been from hedgies, not instis.
Citadel's recently reported intention to enter crypto, for example, was celebrated as proof that institutional adoption is accelerating.
In Wall Street parlance, however, Citadel is not an insti. It’s a hedgie.
You may think that’s just semantics, but it’s a distinction with an important difference: The one type of account will be bringing money into the space and the other will be taking it out.
We all want institutions to enter crypto because it will take prices higher.
And that is what long-only institutions would do. But it’s not what hedge funds do.
Hedge funds are rent-extractors. They’re coming because they see there are profits to be extracted from inefficient crypto markets.
Which is fine!
All financial markets need middlemen to keep things orderly, and crypto markets need them more than most.
Sam Bankman-Fried made his first gazillion dollars by arbing away the crazy premium that bitcoin traded at in Japan.
He made crypto markets safer for all the rest of us in the process.
Institutions are not likely to enter crypto until all those sorts of inefficiencies are mostly cleaned up.
The more hedge funds enter the space, the faster that will happen.
But there’s no rush. We’re not really ready for instis anyway.
What’s on offer for crypto investors?
Hedgies are always first to arrive because they’ll trade anything: When you’re in and out of something on a daily basis, you don’t have to care about whether what you’re trading has any underlying value.
Instis, however, do have to care.
And what they care most about is future cash flows.
In crypto, those “cash” flows are denominated in the token you own.
In many cases, the token is simultaneously the company, the product and the revenue — which makes it difficult to assess.
When the value of a security is a function of the price of that security, your DCF model may start to feel like a Mobius strip: Contra Warren Buffett, price and value are inextricably co-dependent in crypto.
Crypto natives will counter that everything is worth only what people think it’s worth, so valuation doesn’t matter.
But not everything is a meme.
Berkshire Hathaway doesn’t pay a dividend. But it could. And that is what gives it value in the eyes of institutional investors.
So where might instis find value in crypto?
Proof-of-stake blockchains is one possibility.
Providing capital to validators performing a service (securing a blockchain), I think will make sense to instis, even if the value of the underlying blockchain is difficult to assess.
Another possibility is protocols that provide real-world utility, like Render, Helium or Livepeer. Those will look more like investable companies to traditional asset managers.
But that category of crypto will have to get orders of magnitude larger for instis to bother considering it: There is just not much of it on offer right now.
What is on offer in crypto right now is a lot of tokenomics, and that is something I don’t think instis will ever be open to.
The likes of Convex, Terra or Frax are too far removed from what traditional asset managers are accustomed to investing in.
Which is good news, in my book. Leave the tokenomics plays for us retail minnows to figure out.
Institutional money would take current prices higher, which would be nice in the short term. But higher prices generally mean lower future returns.
So, we should probably be rooting for the instis to stay away a while longer.
In the meantime, when you hear about “institutions” intending to buy crypto, ask yourself “who for?”
As long as the answer is mostly “hedgie” and not “insti,” we’ll still have the space to ourselves.