Institutional Adoption of the Crypto Ecosystem: Boon or Bane

The growing popularity and practical applications of cryptocurrencies have sparked an interest in all things crypto. Participants hope to profit from the crypto gold rush by investing in crypto assets and other opportunities. Continue reading to learn more about the cryptocurrency ecosystem, its functions, and its key components.

 

A cryptocurrency ecosystem is a network of crypto-related processes and functions. Each participant aims to complete or benefit from a variety of activities that keep the crypto environment alive and active in the crypto ecosystem. Blockchain protocols and developers, miners and stakeholders, crypto exchanges, investors, and crypto media are all important parts of the crypto ecosystem. Let us go over some of these points in greater detail.

 

Introduction to the Crypto Ecosystem?

 

A crypto ecosystem is a well-oiled machine in which a network of participants achieves their goals and meets specific needs to ensure smooth operations. The blockchain protocol is the starting point for the crypto ecosystem, where a blockchain developer creates a cryptocurrency that uses blockchain technology. At this level, the developer designs feature roles and the parameters under which a cryptocurrency will operate. Developers of specific crypto are typically in-house, but several developers may collaborate or volunteer to offer their services on occasion.

 

When a cryptocurrency is released, miners or stakeholders play an important role in updating and verifying transactions on the blockchain. Miners or stakeholders ensure that transactions are processed quickly and cheaply, depending on the engineered consensus mechanism (proof-of-work or proof-of-stake).

 

Another crucial aspect of the cryptocurrency ecosystem is that investors use cryptocurrency exchanges to buy, sell, or exchange coins. The ecosystem functions to benefit all stakeholders because crypto media provides a platform for information for all participants.

 

Blockchain was a significant, revolutionary intervention in the world of technology in 2008. Satoshi Nakamoto laid the groundwork for a peer-to-peer electronic cash system, paving the way for many groundbreaking blockchain applications in various industries. While the initial focus of blockchain was primarily on cryptocurrency applications, it has gradually evolved to programmable chains that can be tailored for a variety of use cases.

 

It is critical to note that the success of blockchain applications does not happen overnight. In fact, many visionaries with promising and innovative ideas are required, as well as technology experts with the necessary skills to translate the ideas into reality. The blockchain ecosystem definition can be found here, as the effectiveness of blockchain lies in its use for the automation of cross-enterprise workflows.

 

Blockchain ecosystems are defined as a collection of elements capable of interacting with one another and with the outside world to create an environment with desired special features. A blockchain ecosystem can also be defined as the agreed-upon governance structure for a specific use case.

 

Components of the Crypto Ecosystem

 

In general, the topic of blockchain ecosystems in 2021 focuses on various models for collaboration. However, one of the most important aspects of comprehending blockchain ecosystems is their components. So, what are the components of a developing blockchain ecosystem? The answer to this question will, of course, lead you to the various ecosystem participants.

 

Each participant plays a specific role in the ecosystem, contributing data and resources that other participants require. Furthermore, identifying blockchain ecosystem components and how they interact with one another is critical for planning the ecosystem's development.

 

Here are some of the key components of blockchain ecosystems, as well as their roles in the ecosystem.

 

1. Protocols for Blockchains:

 

The blockchain protocol, which includes cryptography, peer-to-peer networks, and consensus mechanisms, is a critical component of the crypto ecosystem. The blockchain protocol is based on the idea that by using P2P networks that save identical copies of transactions, a new network can exist on top of the internet. 

 

The blockchain protocol is completed by the use of cryptographic techniques and consensus mechanisms. Cryptography ensures the network's security and transparency. At the same time, the consensus mechanisms (proof-of-stake or proof-of-work models) make any bad actors unable to cheat or manipulate the system.

 

2. Stakeholders and miners:

 

Miners and stakeholders are the two most important players in the crypto ecosystem. Miners are involved in blockchains that use the proof-of-work (PoW) consensus mechanism, whereas stakeholders are involved in blockchains that use the proof-of-stake (PoS) model.

 

Miners are essential in the crypto-mining process because they secure the network and process each transaction. Bitcoin, Ethereum, Dogecoin, and Litecoin are examples of crypto ecosystems that use miners. Stakers lock their coins in order to be chosen to create new blocks during the staking process. Because they validate new transactions added to the cryptocurrency blockchain network, stakeholders are also validators.

 

3. Blockchain creators:

 

To understand what blockchain developers do, the two major types must be distinguished. Blockchain developers are critical to the crypto ecosystem because they lay the groundwork for cryptocurrency. 

 

Blockchain developers can be one of two types in any crypto ecosystem:

 

• Core blockchain developers: They create the blockchain system's architecture and security. These developers lay the groundwork for all other users in the ecosystem.

 

• Blockchain software developers: They create applications (apps) based on blockchain architecture and protocol. Because they create apps that can run on the blockchain, their role is similar to that of web developers.

 

• Expert developers: Blockchain developers are experts whose opinions and roles can be used to assess the legitimacy of a cryptocurrency. They can be academics with in-depth knowledge of blockchain and the technical skills to keep them running smoothly. Developers can work in-house or as freelancers.

 

4. Retail and institutional investors:

 

There are both institutional and retail investors in the cryptocurrency ecosystem, each with its own set of objectives. Institutional investors have vast sums of money at their disposal that they can direct toward active investment. Because of their size and diverse shareholder base, these investors have slowly adopted cryptocurrency. Nonetheless, institutional investors such as endowment funds, foundations, insurance companies, and hedge funds hold a sizable amount of cryptocurrency in the market.

 

Individual investors who enter the crypto game for personal gain are referred to as retail investors. These investors make up the majority of the crypto community, and their decisions can influence the rise and fall of cryptocurrencies. When retail investors lose faith in a particular cryptocurrency, they may sell their shares, affecting the cryptocurrency's value.

 

Challenges faced by Institutional Adoption of the Crypto Ecosystem

 

The adoption of cryptocurrencies (or "crypto") by institutional investors has been a hotly debated topic in the wider crypto community in 2019. We know that a few financial institutions and highly specialized alternative asset managers already operate in crypto, but we have yet to see relevant institutional investor adoption and capital allocation to crypto as an asset class.

 

Although cryptocurrency is small in comparison to other asset classes, retail investor demand has increased rapidly in recent years, resulting in significant growth in the valuation and profitability of companies in the ecosystem. Some of the major challenges faced are discussed below:

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Challenges faced by Institutional Adoption of the Crypto Ecosystem

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1. The lack of a TradFi-DeFi bridge:

 

No matter how green or scalable a blockchain network becomes, institutional adoption will only skyrocket once TradFi solutions can integrate seamlessly with DeFi protocols. We have yet to see a DeFi solution that supports SWIFT, FIX, or other messaging protocols commonly used by TradFi platforms for value exchanges, trading systems, and operational processes.

 

Of course, DeFi players may decide to support existing messaging protocols. Traditional finance firms could also create new front and back office platforms from scratch. However, while the former contradicts the very concept of decentralization, the latter is a resource-intensive solution. And we cannot expect TradFi players to abandon their tried-and-true procedures and mechanisms in favor of crypto-native solutions simply to connect these two ecosystems.

 

2. Cryptocurrency as an asset class:

 

The regulatory framework for cryptocurrency as an asset class is unclear in countries that host major financial centers. Regulators have mostly issued guidance on the legal treatment of cryptocurrency as an asset class, but no specific legislation has been passed. 

 

This is one of the most significant barriers for institutional asset managers with a low-risk tolerance, as any initiative is likely to be barred by their legal department, effectively shutting down the project. Asset managers with a higher risk tolerance will assume that regulatory guidance will be close to legal treatment in the future, particularly for Bitcoin and Ethereum, which are not viewed as regulated securities but rather as utility tokens powering decentralized networks.

 

3. Allocation of capital:

 

When operating crypto with multiple counterparties, asset managers face significant capital allocation inefficiency. Between banks, exchanges, custodians, and OTC providers, there needs to be more infrastructure and services required to manage crypto and fiat currencies, resulting in relevant operational burdens and exposure to unwanted risk.

 

In traditional financial markets, capital allocation efficiency is based on counterparties who act as intermediaries, managing and operating assets on your behalf. Prime brokerage houses and central clearing counterparties are examples of these intermediaries. In the crypto world, these institutions as we know them today will be obsolete, as they will be mostly automated by software and various intelligent contract standards. The modern DeFi movement, which promotes autonomous financial smart contracts, is still far from meeting institutional asset managers' needs.

 

4. Risks of Centralization:

 

Traditional, centralized financial institutions can approve and execute transactions unilaterally, but in decentralized finance, transactions are approved by the network's governance and consensus algorithm. This can be a significant barrier to adoption for centralized organizations unfamiliar with decentralized approval processes.

 

Centralization risks exist in the form of protocol access to admin keys, which can be used to lock user funds, change system parameters, or approve/deny other operations unilaterally. Custodial risks are included in this category. This is why secure smart contracts and efficient key management solutions are critical.

 

5.  Crypto ecosystem risk factors:

 

When analyzing their investment process, asset managers typically consider the following risk factors: market, credit (counterparty), liquidity, operational, and security risks. The challenge for institutional asset managers in the crypto ecosystem is primarily related to credit (counterparty), operational, and security risks.

 

In the traditional financial market, counterparty credit risk is the most closely scrutinized risk factor. The credit risk of exchanges, OTC providers, and related banking partners is mostly overlooked by current institutional players in the crypto world because most counterparties are unwilling to disclose relevant information. In the event of a severe market downturn, unnoticed credit risk could pose significant systemic risks to the crypto ecosystem.

 

Also Read | What are Stablecoins? Everything You Need To Know

 

Final Thoughts:

 

Institutional investors were not among the first to embrace blockchain technology, but they have finally recognized the obvious benefits of cryptocurrencies. As institutional investments in blockchain and cryptocurrencies increase, there will be a greater need to bridge the gap between traditional legacy systems and a new financial order powered by blockchain and cryptocurrencies.

 

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