Custody issues hold institutional CIOs back from cryptocurrencies

Cryptocurrency companies would like to expand their reach into institutional portfolios—endowments and pension funds—but right now there’s “only downside risk in cryptocurrency.”

So says Blake Estes, counsel, financial services, and coleader of blockchain and distributed ledger technology at Alston & Bird LLP, New York, in a report from Pensions & Investments. Estes adds, “It would take a leap of faith with a new custodian with no brand recognition. That presents a real risk for them.”

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While there’s more experience among retail-oriented custodians, such as Kingdom Trust and Coinbase Inc., the report says, thanks to their capabilities in bitcoin, ethereum and other cryptocurrencies, that’s not the case for institutional custodians.

The biggies, such as Bank of New York Mellon Corp., Northern Trust, J.P. Morgan Chase & Co. and State Street Corp., haven’t been expanding into crypto, and if another firm came out of the woodwork, it would be a company that hasn’t yet built up the trust required for chief investment officers to take the plunge.

While they might take a flyer on crypto via an index, according to Matthew Hougan, vice president and global head of research at Bitwise Asset Management Inc., San Francisco, it’s not likely that any deeper involvement in the asset class is likely to come any time soon for those institutional investors.

Hougan is quoted in the report saying that while the high-net-worth and family offices might be willing to make a crypto venture, pension funds, endowments and foundations “are the furthest away from making substantial allocations to this space. They have the most questions on the fundamental drivers of returns. They’re also in the position of career risk. The drawdowns that can happen in cryptocurrency can be difficult to bear career-wise.”

Three chief hurdles—not just cybersecurity, but also regulatory hurdles and liquidity—stand in the way of broader investment in cryptocurrencies.

But even an index investment in crypto is a bridge too far for most, according to the report, which said that “No asset owner investment executives contacted for this story would comment on the record.” In fact, it added, one CIO “said cryptocurrency index funds were a nonstarter for the pension fund investments he oversaw because ‘you don’t know what’s backing the assets.’ Added another pension fund CIO: ‘I wouldn’t want to take a chance on this. Where’s the assets backing this? How secure is it? And who is watching it?’”

However, once crypto conquers the custody issue, the situation will change, the report suggests. But for now, with the security of custody still such an issue, perhaps that’s not such a bad thing—particularly for pension funds.