Understanding the Institutional Lens of Web3

You've heard it from us. You've heard it from them. TradFi institutions are aping into Web3. As the industry (im)patiently awaits the approval of Bitcoin ETFs, we take a look at why Web3 has suddenly become so appealing to institutional investors.

This article was prepared in collaboration with Franklin Templeton.

This time last year, TradFi asserted its superiority while the cryptocurrency sector suffered at the mercy of FTX. Now, if broader narratives are to be believed, TradFi participants are clamouring over each other for access to digital assets.

According to Binance's Institutional Crypto Outlook Survey, half of those surveyed said they are expecting to increase their allocation over the next year, whilst 63.5% are positive about the crypto outlook over the coming year.

Bitcoin ETF Hype

Bitcoin ETFs are all the rage at the moment, inspiring Bitcoin's recent surge to its yearly high. BlackRock, WisdomTree, Invesco, Fidelity, Valkyrie Digital and ARK Invest are among the growing list of institutions filing for Bitcoin ETFs with the SEC.

TradFi veterans are keen to establish access to digital assets through their own vehicles, which in turn, will unleash a wealth of opportunities.

Gemini co-founder Tyler Winklevoss explained to Blockhead, "ETFs are going to bring a ton of liquidity and price discovery."

"We have many institutional customers, and they range from proprietary trading firms to large macro hedge funds," he continued. "And I think we're going to see 10x that once ETFs arrive."

Bitcoin ETFs essentially serve as the elusive Web2-Web3 bridge we've all been searching for, in finance terms at least.

Investment Opportunities

No two companies are the same. Nike and Adidas are both sports brands but offer different and unique investment opportunities. Now, investors have an even more divisive factor to consider: Web2 companies vs Web3 companies.

As Franklin Templeton explains in their report Understanding Web3—a primer on the emerging digital asset ecosystem, making investment decisions is "considerably more complex in the crypto domain" than traditional businesses.

Aside from the regular fundamental due diligence practices such as financial analysis, cash flows, market prices and value, there are several "unfamiliar dynamics and entirely new considerations that must be evaluated and actively managed" when evaluating a crypto firm.

Crypto ventures, for example, are often not companies as per the traditional definition and do not have a dedicated management team. Instead, they are overseen by DAOs - decentralized community-based networks. For better or worse, it's an incredibly foreign concept for TradFi investors.

Whilst the lack of management might make traditional investors fearful, crypto firms offer a sense of transparency not seen in traditional companies. Thanks to the blockchain, anyone can play witness to transactional data. Rather than relying on reports, investors can monitor finances on the blockchain.

Unlike companies of the past, crypto firms can generate their own economy through tokenization. FTX may have tarnished this feature of Web3 firms but when utilized correctly, a token-based economy can "reflect the value of the underlying enterprise," Franklin Templeton states. It's a 2.0 version of valuing a company through equity shares. Of course, regulation needs to be improved on this front. Thanks, SBF.

Diversification to safeguard portfolios has been a key strategy for investors. Web3 now offers these investors an even wider breadth for their diversity.

TradFi Beware

Even for the most seasoned Web3 native, crypto can be quite the minefield. We needn't look any further than SBF to demonstrate how criminals can operate in plain sight, with the ability to hustle the entire industry.

TradFi investors, who might be newcomers to the Web3 sector, should thereby tread cautiously. Franklin Templeton highlights that the most important risks are system-related risks and participation risks, as well as investment risks.

A prime example of system-related risks is business model risks. Decentralized business models are novel for many investors, even self-proclaimed Web3 experts. By its nature, the business lacks central authorities for management, accountability or conflict resolution. Additionally, apps and platforms are created by Web3 participants who may lack experience in financial understanding.

Other system-related risks unique to Web3 are smart contract risks and interoperability risks. Both are integral to the core mechanics of Web3 but are far from fool-proof. Of course, security poses a threat too. Hacks are almost synonymous with Web3 by this point. $700 million in digital assets were stolen in various security incidents in Q3 alone.

Participation risks include investment risks in terms of lacking a full understanding of Web3 structures like tokenomics. Safe-keeping risks involve storing digital assets safely and the reliance on digital wallets or conversely, the safety of centralised exchanges.

Stablecoins are not always as reliable as they seem to be, just ask Do Kwon. Liquidity risks are real here. Finally, while regulation is still up in the air and the SEC decides exactly what a digital asset is, investors remain at their mercy. That said, recent strides in the industry have been regarded as victories against regulatory pushback. Earlier this month, the SEC dropped its charges against Ripple's top executives, Chris Larsen and Brad Garlinghouse; the move shocked the industry for the better.