Crypto’s New Face Doesn’t Change Its Risks to Retirement Security

After the collapse of FTX’s cryptocurrency exchange in late 2022, many critics predicted the death of the crypto ecosystem.

The reports of cryptocurrency’s death have been greatly exaggerated. And thanks to a new exchange backed by notable institutional investors, crypto could be gaining a deeply concerning new foothold in the retirement security vehicles for millions of American families: pension funds.

In June 2023, Charles Schwab, Fidelity Digital Assets, Citadel Securities, Sequoia Capital, and a variety of other high-profile founding partners, announced they were teaming up to invest in EDX Markets. On the surface, this new exchange would seem to alleviate some of the foundational problems that FTX posed. Its founding partners having demonstrated histories of responsible liquidity management marks at least one departure from the failures of FTX.

But that doesn’t mean mainstream financial entities’ crypto investments are sound or above scrutiny. Rather, the crypto space is getting a reputational makeover that could pose its own distinct threat to financial stability: crypto investments that seem secure because of big-name brands but are just as volatile and potentially dangerous. The fact that these institutions are so large—as of June 2023, Fidelity has $4.23 trillion in assets under management, and Charles Schwab has $7.05 trillion as of December 2022—could lend credibility to the crypto ecosystem they are trying to introduce to their customers.

Despite crypto’s extreme volatility, if not outright inviability, over the past two years, institutional investors are continuing to seek it out—both directly through holding the actual tokens and indirectly through investing in crypto infrastructure firms such as Coinbase. As market returns on pension funds have stagnated over the past few years, some institutional investors have begun dipping their toes into cryptocurrencies, in search of the big returns they promise their clients. Such movement in the industry was even addressed in a Chartered Financial Analyst (CFA) Institute report, which emphasized that the hype around crypto should cause institutional investors to hesitate before investing. Though these investments seem to be precursory, rather than deep, any exposure to crypto can cause potential downside. Due to the sensitive nature of retirement investing, it would be reckless to expose these funds to these risks.

Part of the reason institutional investors have had so much success in expanding into crypto markets is because mainstream, financially minded media outlets have given such investments validity, covering crypto market activity just as they would cover equities or bonds. This has given crypto a veneer of respectability as a new blue-chip asset for portfolio managers to hold, like stocks or bonds. For example, even amid collapses in the stablecoin Terra in May 2022, Fairfax County Retirement Systems, a $6.8 billion pension fund, invested in cryptocurrencies and other adjacent products, making a sizable return. They even went as far as to invest in yield-farming, a crypto product, which became notable because of the extraordinary amount of risk associated with it.

Decisions like this from pension funds, which should be some of the safest investment vehicles, should ring alarm bells. If cryptocurrencies are seen as a reasonable investment opportunity for institutional investors to make a lot of money, then they could be inclined to continue this trend.

Threats to retirement funds would be devastating for all of the contributors who have dedicated pension funds. Because pension funds have historically been a benefit promised to public-sector workers, compromised retirement financing could be particularly catastrophic for the women and people of color who traditionally hold those jobs. As such, loss of these pension funds would continue to entrench existing inequities within the broader financial system. Examples of these inequities include the dysfunctional wealth gaps that have left Latino families with 20 percent and Black families with 12 percent of the wealth of white families. For Black and brown families, this loss of retirement funds could be devastating. The goal of institutional investors is to gain outsized returns for their trustees, but by exposing their most vulnerable stakeholders to systemic risks of relatively unregulated and complicated markets, millions of Americans risk losing their well-earned retirement security.

Though large returns on crypto investments seem appealing, there are enormous risks to investing in such a volatile asset. Even indirect exposure to cryptocurrencies presents unique risks. For example, while an institutional investor such as a pension fund manager may not directly buy Bitcoin or Ethereum keys, buying a blue-chip stock like Coinbase could expose them to unforeseen crypto risk, due to correlations between the assets.

Letting institutional investors place risky bets with clients’ money without clear accountability or robust regulation could lead to a financial disaster. This type of gamble is reminiscent of elements of the Great Recession, when it was assumed that the exposure to risky investments was contained within the trading desks of large banks; but as it turned out, these risks had also spread to many other components of the financial system.

Similar spillover could happen with crypto if institutional investors continue to explore it without proper guardrails in place. In fact, large pension funds have started admitting as much. Both the California Public Employees’ Retirement System and New York State Common Retirement Fund have acknowledged that they could have some degree of indirect exposure to crypto assets.

What’s possibly more troubling is that they might not know—or at least be willing to admit—how much crypto they hold. This should be concerning to pension holders. In any investment, it is vital to understand exactly what types of assets investors are holding in order for them to make the right investment decisions. Without institutional investors understanding exactly how much crypto they hold, this type of exposure risk could leave millions at risk of losing their primary source of retirement funds.

The potential severity of this situation calls for, at the very least, much stronger regulation around transparency and accountability. Stricter accountability rules could consider pension funds to conduct systemic risk audits. These audits could be performed to ensure that hidden risks that endanger the broader financial system, and the exposures that pensions have to these risks, can be revealed through diligent research. Moreover, greater transparency rules would allow investors themselves to have a better understanding of the risks they are taking, which could make it easier to evaluate what investments could help diversify their portfolio. And, it could allow trustees to hold their investors accountable for actions they are taking on their behalf.

American families rely on a limited number of financial tools to secure their retirement. Those Americans who do have the security of a pension fund should not have to worry that, through no fault of their own, their money has been exposed to crypto, endangering the solvency of their entire retirement. But without sufficient guardrails in place, and until institutional investors take direct and indirect crypto exposure risk seriously, that is exactly what’s at stake.