3 Challenges Shaping the Future of Crypto

What You Need to Know

The emerging asset class faces challenges in the short, medium and long term, Morningstar analyst Madeline Hume says.
The biggest near-term concern is regulation.
In the long term, cryptocurrency will likely be integrated with incumbent financial players, Hume predicts.

Predicting how the cryptocurrency industry will develop over the next decade may seem nearly impossible, given the ongoing market meltdown. Crypto critics, enthusiasts and analysts offer a broad range of views on the nascent market, from dire forecasts to bets on a golden era.

“We are in the early innings of crypto and digital currencies, but we clearly see it as a major part, and a redefinition of, the financial system,” PayPal CEO Dan Schulman said at a crypto conference last week, per a report from Fortune. “The next five to 10 years are going to bring massive change.”

Madeline Hume, senior research analyst at Morningstar, recently offered some context on the near-, medium- and long-term outlook on the industry.

Morningstar doesn’t rate digital assets, she noted, citing a shortage of academically substantiated methodologies on how to value the tokens. The research firm, however, does explore the landscape to help investors understand the space.

Morningstar recommends significant caution for any investor purchasing cryptocurrency. Buying digital coins is a way to engage with the underlying technology, Hume told ThinkAdvisor. “Whether or not that translates to a sound investment case is still unclear at this point.”

The sweet spot would be buying cryptocurrency to learn and experiment without expecting a big return, she said, adding that investors should draw a clear, apples-and-oranges line between crypto and traditional investing. “I would go so far as to say it may not make sense to expect a return from crypto at all — there are plenty of tokens that will die out and fail.”

For each potential step in this emerging asset class’s development, “I see one key hurdle or opportunity,” depending on how one looks at the situation, said Hume.

Near Term: Regulation

The regulatory path for cryptocurrency remains a significant uncertainty. The Securities and Exchange Commission, concerned about a lack of cryptocurrency regulation, hasn’t yet allowed mutual funds or ETFs to invest directly in Bitcoin.

In Morningstar’s recent crypto landscape report, Hume and research analyst Jeremy Pagan cited “the absence of smart, measured regulation in cryptocurrencies (as) the key barrier to future adoption,” with 55% of U.S.-based financial advisors and 39% of institutional investors globally citing regulation as a “key roadblock.” 

Current solutions for investors interested in cryptocurrency investing, aside from directly purchasing the digital tokens themselves, include mutual funds and ETFs that own Bitcoin futures or invest in companies that hold Bitcoin. These products, however, “don’t track the asset class particularly well,” Hume told ThinkAdvisor.

(Investors also can gain exposure through private trusts, like the Grayscale Bitcoin Trust, that directly hold Bitcoin.)

“We’re seeing that regulators are taking note and there are some within the digital asset native world that are actively calling for more regulation and oversight,” said Hume. She cited Sam Bankman-Fried, FTX cryptocurrency exchange founder and CEO, as one example.

Smart regulation that protects consumers could ensure confidence in the crypto market and give it a boost, she added, “or it could kill it completely, but I think at this point that’s probability unlikely.” 

The fact that the SEC and the Commodity Futures Trading Commission have not stepped in by now to prevent the proliferation of these types of assets “means they’re willing to allow these kinds of technologies to develop and iterate” before clamping down, according to Hume. If these regulators wanted to nip it in the bud, she added, “they most likely would have done it already,” before allowing entrenched players and ballooning valuations.

Hume was hesitant to speculate on the timing of crypto regulations. “It will come when regulators are prepared to do so,” she said. “But I think it is a consideration that will need to be resolved in the next three years or so if crypto is to cement itself as a permanent fixture of our financial markets.”

Giving her own view rather than Morningstar’s formal position, Hume said she would like to see more investor protections. Crypto buyers don’t enjoy the same safety measures as investors trading stocks and ETFs, such as a ban on insider trading, she said.