SWFs should not be investing in crypto yet
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A RECENT white paper by BNY Mellon noted that leading sovereign wealth funds (SWFs) are seeking new investment opportunities, including in tokenised assets, in a bid to meet financial obligations in this inflationary and acutely low-yield environment.
Indeed, digital assets and tokenisation - where physical or intangible assets are represented in digital form on blockchains - have drawn great interest in recent years. Many governments, including Switzerland, Germany and Australia, have provided or are in the process of considering, regulatory and tax clarity for digital assets. But while the digital asset space has gained traction, it is debatable how these stewards of public wealth should approach this asset class and how much risk they should be taking when it comes to searching for alpha in emerging alternatives.
So far, none of the SWFs and other public asset owners have invested directly in cryptocurrencies, given the lack of regulatory certainty and investment security. Those keen have turned to indirect investments in the digital currency space, exploring new digital forms of money that have the potential to provide cheaper and faster payments, enhance financial inclusion and facilitate cross-border transfers.
That is a relief. The recent failure of Three Arrows Capital, which used borrowing to turbocharge its bets on cryptocurrencies such as Bitcoin and the now defunct Luna token, is yet another reminder of the boom and bust nature of speculative digital assets. The case also highlights the scale and reach of the prominent crypto investment firm’s borrowings across the sector, and how trouble in the virtual world can transcend into the real economy. Three Arrows was among those that had helped prop up Terraform Labs co-founder Do Kwon’s crypto empire, which collapsed in a US$40 billion wipeout in May. Spectacular as it was, the collapse of the TerraUSD stablecoin was not unprecedented. Defi token Titan, which was used to finance the partially collateralised stablecoin Iron, crashed to near-zero last year, in what project creators described as “the world’s first large-scale crypto bank run”.
Today, the market value of the leading 500 crypto tokens has crashed from a high last November of US$3.2tn to under US$1 trillion. Victims of the fallout range from everyday-Joe investors to crypto miners. Nasdaq-listed Core Scientific, Marathon and Riot have all tumbled nearly 80 per cent in the year-to-date and many operators have been selling down their reserves, either to fund operating costs or meet debt covenants.
Data firm Chainalysis estimated that roughly US$14 billion in fraudulent transactions occurred in the crypto world in 2021, up almost 80 per cent from a year earlier. Scams tied to cryptocurrencies and digital assets may well be the biggest threats facing investors this year.
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Clearly, the digital asset realm is still evolving, and the advantages of their underlying technologies, such as the potential for more inclusive financial services, should not be overlooked nor dismissed out of hand. But in the search for alpha, stability and safety are still paramount when it comes to handling public funds. Crypto is not yet at the stage, if ever, where SWFs should invest in them.
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