Crypto is unique for being one of the only markets that individuals were able to enter before institutions.
But now, the ecosystem is changing. The pioneering retail investors — those tiny fish quickly gobbling up crypto assets — have been followed by another more discerning breed: crypto-native funds and the most adventurous of asset managers.
In turn, the first few large financial institutions are dipping their toes. Traditionally cautious, these big-ticket allocators — such as pension funds and insurance companies — are now looking to seize a diverse range of investment opportunities in the crypto market. And with deeper pockets, come more stringent requirements; these market participants need to trade through structures that are regulatory compliant, and that cater to greater sensitivities around security and liquidity.
In this post, we investigate these roadblocks to institutional adoption, and look at how Qredo is helping to welcome these traditional players by providing radical institutional-grade infrastructure.
That security features so highly on the list of concerns is hardly surprising. Hacks and heists have plagued the crypto market, and the unfamiliarity of blockchain infrastructure breeds uncertainty among investors migrating from other asset classes.
Unlike traditional finance, which typically has a distinct separation between brokers and custodians, crypto platforms are often combined — both executing orders on behalf of customers, and storing their funds in commingled omnibus custodial accounts. This can present security concerns for institutions that are unable to justify the intense concentration of counterparty risk.
"The institutions that could dramatically deepen liquidity are left on the sidelines, unable to justify the enormous counterparty risk posed by the capital requirements of unregulated exchanges: Imagine if the New York Stock Exchange asked you to send in your stock certificates before you could trade. Crazy right?"
— Brian Spector, Qredo Co-founder
To help institutions minimize counterparty risk, leading crypto exchanges are now mirroring the same structures of traditional finance. They are offering regulated custody branches, which are competing with dedicated custody offerings from well-known traditional players such as Fidelity and BNY Mellon.
Yet even these dedicated custodians have the same problem — they demand trust.
Whether relying on cold storage and hot wallet architecture, or increasingly popular multi-party computation (MPC) technology, they still require institutions to surrender control of funds and expose themselves to counterparty risk.
Qredo takes a different approach: it doesn't aim to spread counterparty risk between traditional structures, but instead to eliminate it entirely using the same technology that makes crypto transactions so secure: the blockchain.
Decentralized custody combines the blockchain's immutable structure with the magic of MPC to create standalone infrastructure that enables institutions to take full ownership of assets. They get the same control as if they held the private keys as an individual, but with the ability to set out governance policies to reflect organizational needs, and further protect assets with add-ons such as insurance.
For institutions that can't tolerate regulatory ambiguity, the haphazard patchwork of crypto regulation presents a big problem. This is another significant reason why many choose to stay on the sidelines.
However, the situation is rapidly changing. Authorities around the world are rushing to roll out regulatory frameworks, and Qredo is building infrastructure that makes it possible to easily comply with these emerging regulations — including the Travel Rule.
Qredo Network will incorporate a communications layer that enables metadata such as comments or IDs to be securely attached to transactions for easy compliance. In addition, Qredo's governance controls enable organizations to tailor transaction signing workflows to reflect compliance needs, and easily export reports for auditing.
"The legal limbo that crypto exists in is gradually becoming more navigable for institutions as regulations are rolled out. But in its current form, crypto infrastructure lacks the cohesion and information-sharing networks needed for compliance with regulations like those that govern traditional finance."
— Ben Whitby, Strategic Partnerships and Regulatory Affairs
To maneuver around the crypto market, institutions need to be able to deploy funds on thick order books with tight spreads. These are both aspects of liquidity, which measures the ease with which an asset can be exchanged for another.
Despite commanding a market cap in the trillions, the crypto market suffers from shallow liquidity. The explosion of new — and typically incompatible — cryptoassets has created hundreds of silos, leaving liquidity split between hundreds of exchanges, OTC desks and thousands of different blockchains. This not only makes it harder for institutions to trade efficiently, but also makes crypto markets more prone to manipulation and wild volatility — a problem that Fidelity found to be concerning among 54% of institutional investors.
Although liquidity has deepened dramatically over the years, it still remains an issue on both centralized and decentralized exchanges. Thus institutions are often forced to rely on OTC desks and dark pools, which are typically unregulated and lack transparency.
Qredo is building a cross chain, cross platform network that can help break down the liquidity silos between blockchains and platforms. This will enable dApps such as PowerSwap that tap into crosschain liquidity to provide a better experience for institutional traders.
"Qredo network is blockchain-agnostic, so we can work with ~95% of the layer 1 and layer 2s out there. This enables amazing stuff like cross-chain swaps, without any wrapping or pegging, and lightning-fast settlement between platforms and protocols on the network without any of the delays and costs associated with the layer 1."
— Josh Goodbody, Qredo COO
The inevitable entry of institutions will forever change crypto, bringing deeper liquidity, more mature infrastructure, and higher standards across the market.
In turn, this is likely to lead to greater connectivity between traditional finance and DeFi. More real-world use cases will emerge, and speculation can be outstripped by sustainable economic activity.