Crypto’s Transition: Bringing Capital Onshore

The world of cryptocurrencies and digital assets is currently in a transition phase 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 although it may seem large, offshore assets account for a very small share of total global assets.

Paul Brody is EY’s global blockchain leader and CoinDesk columnist.

It is estimated that there are approximately $700 trillion in global financial and commercial assets on planet Earth. This includes roughly $100 trillion in global stock markets, $100 trillion in bonds, $100 trillion in bank deposits, and more than $350 trillion in real estate, and that’s what you need to buy a two-bedroom apartment in San Francisco. The blockchain ecosystem of this is approximately $2 trillion in total, and approximately $20 trillion is in commodities.

Of this approximately $700 trillion, approximately $685 trillion are considered “onshore” assets; That is, they are held by persons and organizations officially and responsibly residing in the countries where they operate or exist. According to estimates by the Organization for Economic Co-operation and Development (OECD), all offshore assets are around $12 trillion. This is a huge amount of money, but in terms of global assets it is a drop in the ocean, less than 2% of the total. Currently this 2% is relatively lightly regulated or not regulated at all, and a significant portion of this consists of cryptocurrencies.

Even though that’s a lot of money, it’s not a big deal compared to the huge amounts of money onshore in structured, regulated markets. Most of the world’s liquid assets are managed by regulated institutions. California’s state employee retirement fund, CalPERS, alone has nearly $500 billion under management. TIAA-CREF, which represents approximately 5 million active and retired teachers in the United States, has another $1.3 trillion in assets. That’s more than the entire crypto asset market today, and neither firm can make large investments that aren’t subject to strict regulation.

As the world of blockchain-based digital assets becomes structured and regulated, this will lead to an influx of capital and transform the industry. Based on the available data, it is clear that we are still in the early stages of this transformation. Seven of the top 10 crypto exchanges are located in offshore environments such as the Seychelles or the British Virgin Islands, and they represent 80% of current spot crypto volume (as of February 21, according to CoinGecko).

If you go and read reports on asset allocation, you won’t even find a crypto-focused category. A few European pension funds have clear allocations to commodities and precious metals, but the vast majority of assets managed still fall into some core categories such as stocks, bonds and real estate. In other words, we have barely scratched the surface of possible future allocations to digital assets and cryptocurrencies.

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To be clear, we should not confuse less regulated or offshore money with criminal activity. Although some want to combine the two, they are not the same. However, as the scope of regulatory control grows, we should expect most of the net new growth in transactions and volumes to come from onshore businesses doing business with regulated peers in pension funds, banks and private equity.

This does not mean that the offshore component of the business will disappear or possibly fail; but this means that onshore, regulated companies are likely to be the main beneficiaries of the next wave of growth. And for companies in this space, entering local markets with local regulators has never been more important.

The challenge is present in most of the world’s largest cryptocurrency exchanges: almost all of them are located in offshore markets such as the Seychelles, Bahamas, Virgin Islands, etc. Today, offshore firms dominate the list of largest cryptocurrency exchanges. My guess is it won’t last like this.

As regulations mature, the center of gravity of stock exchanges will shift from offshore to land. Currently, there is almost no overlap between these offshore and onshore ecosystems; My point is that almost no companies offering offshore services have successfully managed onshore regulatory rules and positioned themselves in these markets.

So the transition ahead is not just where the center of gravity will be; This will also be where the dominant players in the industry focus. The challenge for companies at the top of the leadership today is clear: either enter the onshore, regulated markets or see your relevance wane in the future.