Can institutions save crypto before retail vanishes?

Will retail stick around just as interest rates rise and liquidity dries up?

In what felt like a flash in 2022, the macro environment transformed from a near-perfect environment for speculative assets on pandemic-induced liquidity to an ugly reversal. To tame soaring inflation, the Fed raised interest rates from near zero to above 4 percent in the span of less than a year, causing other central banks around the world to follow suit. To make matters worse, the Fed initiated quantitative tightening to decrease the liquidity in markets by shrinking its balance sheet.

The rate hikes in 2022 reduced liquidity and further deflated the frothiest speculative markets of 2021. In hindsight, in early 2021, retail hands had started running dry of fresh ‘free’ pandemic stimulus money to plough into crypto. Note, for example, the first huge peak in Bitcoin and other crypto assets was within several weeks of the last and largest US stimulus check, after which the subsequent volatility saw many crypto traders burning out.

From this point forward, if retail continues to withdraw capital from brokers, the crypto market is likely to be hit the hardest, as crypto has never existed in such a macro environment and because of weak participation from professional and institutional investors. In our view, retail will not likely pull out of the market immediately, as the almost 15-year perception that money is cheap must be erased from the dominant, younger generation of retail crypto traders. If liquidity stays tight as central banks fight inflation, the model of retail supremacy to not only keep the crypto market afloat but also the model of crypto brokers selling shovels in a gold rush will break down.

From retail to institutions

In the past few years, crypto market advocates have touted the impending arrival of serious institutional participation. Relative to the ‘don’t-touch’ attitude that institutions largely held towards crypto until 2020, some respected institutions have dipped their toes into the space, trading the market themselves, offering it to clients, and in some cases executing various transactions directly on-chain. While this is a step in the right direction, the institutional interest in crypto has been relatively modest, as it is still dominated by relatively few institutions. As a consequence, institutions are not likely set to arrive in sufficient force in the near-term to offset retail’s crypto exit, particularly for the smaller and less liquid cryptocurrencies.

Nonetheless, less retail activity may lead the market to a less speculative but more robust and sustainable model long-term, although most cryptocurrencies may not survive the wash-out of speculative activity. To bring about a sustainable model for the market to thrive in the future, crypto must return to its roots by offering unique decentralised use cases and mature into more economically sustainable assets. On the latter, last year was encouraging in demonstrating that cryptocurrencies can be economically sustainable assets by generating dividend-like returns, following Ethereum’s transition from proof-of-work to proof-of-stake last year. During the transition, Ethereum drastically decreased its issuance of new Ether, so it nowadays offers holders a reward of up to 7 percent yearly by verifying transactions but without increasing its supply, as the reward is fundamentally funded by transaction fees. Hopefully, other cryptocurrencies and tokens follow in Ethereum’s footsteps in turning into more economically sustainable assets, altogether leading the space to become less speculative.