3 Challenges Shaping the Future of Crypto
Portfolio > Alternative Investments > Cryptocurrencies
By Dinah Wisenberg Brin

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.
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.
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Hume noted that prosecutors recently charged a former employee of leading nonfungible token platform OpenSea with wire fraud and money laundering in connection with an alleged insider trading scheme. Federal prosecutors called it the “first ever digital asset insider trading scheme.” Hume considers it a test case.
“Since there’s no framework for digital assets it’s regulation by enforcement, which means lifting existing frameworks from other asset types and attempting to apply them to digital assets — difficult to do, legally speaking. Right now the SEC is still testing out these cases but it’s uncharted territory, and the outcome of the OpenSea case is still unsettled,” she said.
In their crypto report, Hume and Pagan wrote that the firm anticipates a higher volume of regulatory developments in the next several years that will determine the adoption rates of cryptocurrency as a form of payment.
Ensuring scalability is a key technological challenge facing the crypto industry in the medium term, Hume noted.
While many crypto tokens and platforms have succeeded as proof of concept, “they haven’t necessarily been able to execute at scale,” she said. Hume cited high transaction fees for engaging with the underlying blockchain technology, which can grow over time as more people do so.
Ethereum plans to switch to a different proof-of-stake blockchain this year, which should lower the computing power needed to validate a transaction, Hume noted. It’s unclear how that change will affect its gas fees, “but scalability concerns will continue to compound as digital assets grow in prominence,” the recent Morningstar report predicted.
There’s also much to be resolved on how digital currencies can compete with Visa and Mastercard on transaction speed, according to Hume, who called the issue a medium-term technological challenge. 
The payment processing giants far outpace Bitcoin and Ethereum, the two biggest cryptocurrency players, in handling transactions with merchants, according to Morningstar, which notes that blockchain transactions require validation from volunteers, limiting the speed at which asset exchanges are added to the network’s ledger. The industry will need to improve in this area to achieve widespread adoption, said Hume. “It’s a pretty significant challenge,” she said.
Sometime in the next five to 10 years, cryptocurrencies likely will integrate with incumbent financial players rather than replace them, although it could happen sooner, according to Hume.
“We expect it to unfold over the long term,” she said. “It’s our view that over time that cryptocurrencies will kind of converge with existing players rather than unseat them,” perhaps being featured in partnerships with longstanding players to establish a foothold in the financial services industry.
Incumbent financial firms have recognized Bitcoin as an asset to offer as part of their services, Hume noted.
She also cited cryptocurrency exchange Coinbase’s debit card partnership with Visa, which converts customers’ crypto into their home fiat currency in transactions, although she noted it “kind of defeats the whole purpose” of engaging with crypto — the decentralization idea. That partnership, though, is “an example of a partnership between a crypto-native firm and an incumbent that we expect to see more of — if the digital asset community hopes to have some staying power,” she said.
Morningstar noted in a recent paper that the Visa-Coinbase partnership reached $2.5 billion in transactions in the fiscal first quarter this year.
“Cryptocurrency returns have no parallels to traditional risk factors across the stock and bond universes, and the contours of the market’s returns in aggregate fly in the face of normal market dynamics,” the Morningstar analysts wrote. Cryptocurrencies’ decentralized infrastructure “sets up meaningful barriers against real-world use cases,” they said. 
“Rather than a swift takeover, we expect that integration with existing systems across financial services and other sectors will likely determine future adoption rates in the space.”
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