Institutional Investment in Digital Assets Creates Requirement for Enterprise-Grade Self-Custody Solutions: Report

As Chainalysis discussed recently, the collapse of FTX and resulting market action prompted large net outflows “from centralized exchanges, as many users shifted their funds to personal wallets, also commonly referred to as ‘unhosted wallets’.”

Chainalysis found that while the trend wasn’t “as pronounced as some suggested and likely did not signal a mass exodus from centralized exchanges (CEXes), more users were opting for self-custody and turning to DeFi protocols to carry out activities like trading, lending, and borrowing.”

Increased flows from CEXes to personal wallets “are almost always one consequence of extreme market volatility or price declines, but what separated this latest instance from previous ones was that this time, institutional money led the charge.”

Whether they be individuals with large holdings, crypto native investors, or traditional finance players, analysis of transaction sizes “suggests these large holders are leading the way now in movements of funds from centralized services to personal wallets.”

This brings up new questions of “how the industry can best equip institutional investors to custody their own cryptocurrency and use DeFi safely.”

As noted in a blog post by Chainalysis, users usually “move crypto from CEXes to personal wallets when the market is turbulent, including new institutional users.”

As mentioned in the update, the movement of funds from a CEX to a personal wallet “can mean many things.”

Many would suggest “that it signals users are worried about their CEX’s solvency and are moving their funds to a personal wallet they control directly to ensure they don’t lose access to their funds. This is probably true in many cases.” In others, users may only “be moving the funds to a personal wallet to then move them to another CEX, or to a DeFi protocol — both of these options would enable them to continue trading or carry out other transactions, such as contributing to a lending pool.”

Regardless of the specific motivations, “the behavior holds true: Most spikes in CEX-to-personal-wallet flows are sparked by market volatility.”

But what has changed is “the makeup of the users leading these crisis-driven withdrawals to personal wallets.”

Overall, institutional funds “have made up a bigger share of movements from centralized exchanges to personal wallets over time.”

As noted in the update from Chainalysis, as institutional adoption has risen, “these investors have taken on a more and more prominent role in the movement of funds from CEXes to personal wallets.”

This also “begs the question of what institutional investors do with the funds they move from CEXes to personal wallets.” Again, many of them “are likely just holding the funds there, or transporting them to a new CEX.”

On-chain data also “suggests many are using the funds to interact with DeFi protocols, which typically allow users to connect via personal wallets and carry out many of the same financial functions a centralized cryptocurrency service would — trade, invest, borrow, lend — without the user ever having to give up custody of their funds.”

As mentioned in the update, DeFi protocols “have also historically seen surges in transaction volume in the same time periods of increased CEX-to-personal-wallet flows we discuss above, suggesting a significant portion of those funds withdrawn to personal wallets are soon after used for DeFi transactions.”

Given the growing role of institutional money in these large-scale withdrawal events, we can conclude “that institutional investors are playing a key role in the migration of funds from the CeFi to DeFi ecosystem.”

Chainalysis concluded:

“In summary, growing institutional adoption of cryptocurrency means that the common pattern of funds moving out of centralized services and into personal wallets and DeFi in response to market volatility is now being led by deep-pocketed institutional investors.”

For more details on this update, check here.

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