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The Cryptocurrency Transition: Bringing Capital Onshore
The world of cryptocurrencies and digital assets is currently in transition from a largely unregulated world of innovation to a much more regulated and structured world of large corporations and organized product offerings.
The opportunity for blockchain-based digital assets is huge because, as large as they may seem, offshore assets represent a rather small share of total global assets.
Paul Brody is EY’s global blockchain leader and CoinDesk columnist.
It is estimated that there is approximately $700 trillion in global financial and commercial assets on planet Earth. This includes approximately $100 trillion in global stock markets, another $100 trillion in bonds, another $100 trillion in bank deposits, and over $350 trillion in real estate, and that’s just what you need to buy an apartment with two bedroom in San Francisco. Of this, the blockchain ecosystem amounts to around $2 trillion in total and there is another around $20 trillion in commodities.
Of this approximately $700 trillion, approximately $685 trillion is considered an “onshore” asset, meaning it is held by people and entities who are officially and responsibly resident in the countries in which they operate or exist. Estimates from the Organization for Economic Co-operation and Development (OECD) put total offshore assets at around $12 trillion. This is a significant sum, but in the context of global assets it is a drop in the ocean, less than 2% of the total. Right now, that 2% is regulated relatively lightly, if at all, and a good portion of it is cryptocurrencies.
As much money as that is, it is no big deal compared to the large amounts of money that reside onshore in structured, regulated markets. Much of the world’s liquid assets are managed by regulated institutions. CalPERS, California’s state employee pension fund, has nearly $500 billion under management. TIAA-CREF, which represents about 5 million active and retired teachers in the United States, has another $1.3 trillion in assets. That’s more than the entire cryptocurrency market today, and neither company can make sizable investments that aren’t highly regulated.
As the world of blockchain-based digital assets becomes structured and regulated, this opens up a wave of capital and will transform the industry. Based on the available data, we are clearly still in the early stages of this transformation. Of the top 10 cryptocurrency exchanges, seven are based in offshore environments such as the Seychelles or the British Virgin Islands and account for 80% of current spot cryptocurrency volume (as of February 21 according to CoinGecko).
If you go and read asset allocation reports, you can’t even Find a category focused on cryptography. Some European pension funds have explicit allocations for commodities and precious metals, but the vast majority of assets under management still fall into a few basic categories such as stocks, bonds and real estate. In other words, we have just scratched the surface of likely future allocations to digital assets and cryptocurrencies.
To be clear, we should not confuse less regulated or offshore money with criminal activity. These are not the same thing, although some may like to confuse the two. However, we should expect that, as the scope of regulatory scrutiny increases, most of the net new growth in transactions and volumes is likely to come from onshore firms doing business with regulated peers in pension funds, banks and private equity .
This doesn’t mean that the offshore component of the business will disappear or likely fail, but it does mean that onshore regulated companies are likely to be the main beneficiaries of the next wave of growth. And it has never been more important for companies in this sector to engage in local markets with local regulators.
The challenge here exists for much of the world’s largest cryptocurrency exchanges: almost all of them are based in offshore markets such as, for example, the Seychelles, the Bahamas and the Virgin Islands. Today, offshore companies dominate the list of the largest cryptocurrency exchanges. My guess is that this won’t last.
As regulation matures, the center of gravity of trading will migrate from offshore to onshore. At the moment, there is almost no overlap between these offshore and onshore ecosystems; what I mean is that almost no company offering offshore services has successfully overcome onshore regulatory rules and established itself in those markets.
The future transition, therefore, is not just about where the center of gravity will be; it will also be the place where the dominant players in the sector will be concentrated. For companies that are at the top of the league today, the challenge is clear: enter the onshore and regulated markets, otherwise their relevance will decrease in the future.