From ETFs to BTFs
For years, participants in the digital assets industry have discussed how to bring institutional money into this ecosystem. While this mission was not always the highest priority for the first-movers in crypto, increased institutional adoption has made the industry focus on meeting their requirements. The reasoning behind this shift is obvious - that’s where the money is. Institutional investors own roughly 80% of the equity market, meaning they can bring trillions of dollars of capital into this ecosystem.
Additionally, institutional adoption has other positive effects:
- Creates demand for products that exhibit operational excellence, proper investor protections, security, and transparency, which benefits all types of investors
- Provides the necessary “social proof” that this is a safe, investable ecosystem
- Increases the speed with which institutional-caliber tools are built to support sophisticated investors
Many of the initial impediments to institutional adoption have been removed (the space is too immature, crypto is full of bad actors, insufficient custody solutions, other asset classes are doing well so no incentive to look into alternatives). Yet, institutional money has only trickled into the industry.
To understand why institutional adoption has been so slow, it is helpful to examine a recent “financial innovation” in investment products - Exchange Traded Funds (ETFs). ETFs are a structural improvement over traditional mutual funds, which allows them to be traded on an exchange. Laid out side-by-side, the advantages of investing in an ETF are clear.
Even though the underlying change to the product structure was small, and the benefits to investors were huge, adoption was still painfully slow. The first ETF to launch in the market was SPDR by State Street in 1993. Initially launched with fanfare, SPDR grew exponentially the first year, but tapered off for the remainder of the decade. In fact, ETFs only started to receive renewed interest in 2001, following the launch of multiple ETF products by iShares. Even then, the main reason that ETFs started to gain traction was an extensive multi-million dollar campaign to educate investors, especially institutional investors, about the benefits of ETFs.
We can take what we have learned from the adoption of ETFs to shorten the adoption cycle of digital assets by institutional investors. One way to do this is to look at the more recent ETF educational campaigns. Over the past 15 years, instead of focusing on the “innovative aspects of ETFs”, marketing has shifted towards how “the ETF is an evolution of the mutual fund”. Instead of being revolutionary, it is evolutionary -- taking something that is well known and understood while adding elements to make it more beneficial.
Our guiding principle at Arca for new product development has been incremental innovation. Our innovation division, Arca Labs, recently launched our first product, the Arca U.S. Treasury Fund, which invests in short-duration U.S. Treasuries and issues digital shares on the blockchain, or ArCoin. We took a well-understood structure from traditional finance, a closed-end fund, and added blockchain technology to create “Blockchain Transferred Funds” (“BTFs”). Blockchain technology allows for a ‘40 Act product to be transferred peer-to-peer, expanding the utility of the product beyond just being an “investment.” While this may not seem as groundbreaking as some of the products being launched in the digital assets industry right now, we believe that this structure provides the right balance between familiarity and innovation and will follow the same trajectory as the ETF did in the early ‘90’s. . In doing so, risk-averse institutional investors will begin to understand the benefits that blockchain technology provides, which will lead to creation of increasingly useful products that will slowly displace the archaic, siloed systems that currently exist in traditional finance.
BTFs will take time to gain mass adoption, which will include releasing several other products using this new structure. But the lessons learned from the growth of ETF adoption should help accelerate the institutional adoption of digital assets and blockchain technology.