Like any emerging asset class, there's a learning curve for institutions considering getting involved, said Marcos Veremis, a Washington-based managing director at Cambridge Associates LLC. "There's a lack of education in this space because it takes a lot of time to build knowledge," he said. "A lot of institutions (don't want to take the time to learn about) an allocation that's half a percent of their portfolio."
The asset class as a whole also lacks sufficient scale and liquidity to entice most institutional investors, said John D'Agostino, a Massachusetts Institute of Technology and Columbia University lecturer and the New York-based global leader of investor management for DMS Governance, which provides governance services to investment funds.
Another major custodian, Bank of New York Mellon, is currently eyeing the market from the outside.
"Ensuring the safekeeping of private keys and cryptoassets is essential to institutional investors, though uncertainty surrounding the regulatory framework and the lack of safe, qualified custody are significant barriers preventing institutional investors from joining the crypto market in greater numbers," said Tom Casteleyn, global head of custody at BNY Mellon Asset Servicing.
In recent years, the SEC has cracked down on several bad actors conducting improper initial coin offerings, which has garnered publicity and potentially scared investors, experts said.
However, opportunities are still there for institutional investors, sources said.
Cambridge has advised institutional investors to explore opportunities in the cryptoassets and broader blockchain industry. Though cryptoassets and blockchain technology do not yet have a mainstream adoption, Mr. Veremis said the underlying technology presents the possibility of trillions of dollars of value in the form of value transfers from existing industries as well as the creation of new markets and business models. But he noted it is still very early in the development of the space and several issues need to be addressed.
"It's a new technology, a riskier subset of venture capital, that could allow for the development of numerous new exciting business models based on digital scarcity and cryptoassets," Mr. Veremis said. "It's early but could be promising."
About 22% of institutional investors already have some exposure to digital assets and about 40% said they are open to investments in digital assets over the next five years, according to a survey released in May from Fidelity. More than 400 U.S. institutional investors were surveyed, including pension funds, family offices, cryptocurrency and traditional hedge funds, financial advisers and endowments. A recent report from PricewaterhouseCoopers estimates 150 active cryptocurrency hedge funds collectively manage $1 billion currently.
With the maturation of the cryptocurrency market and the launch of Fidelity Digital Assets, Mr. Jessop expects other institutional custodians to get involved. "While there is latent demand, the fact that we exist and are offering a service that focuses on institutional needs, it's something that, quite frankly, we think has generated some additional demand."
A vital aspect of cryptocustody is who holds the digital keys to the vault where the assets are stored. Fidelity Digital Assets offers secure storage of private keys and has spent years developing a "cold and hot" wallet structure, Mr. Jessop said. In a cold wallet, private keys are kept in secure locations not connected to the internet; a hot wallet is connected to the internet.
Andrew Palmer, chief investment officer of the $52.7 billion Maryland State Retirement & Pension System, noted that cryptocustody isn't a top priority at the moment because the system doesn't invest in any cryptocurrency funds. But he said, "We'd feel more comfortable with bigger custodians getting involved."
The inertia between those bigger custodians and the cryptocurrency market is evident, said Vincent Molinari, New York-based co-founder of Templum Inc., a technology company focused on developing new market infrastructure for the digital asset sector, and CEO of Templum Markets, its blockchain-enabled, regulated marketplace for the primary sale and secondary trading of digital assets.
"I think traditional custodians will look at this as a market opportunity to capture new instruments that they don't have today, particularly while our public market issuances continue to decline," Mr. Molinari said. "I think they will look to this as new, fertile ground. And if they do, that adds comfort because they are household names within institutional communities."