Institutional Money is Coming to Bitcoin
Manuel Trojovsky, Dec. 23, 2020
“The herd is coming“. This reference to the inevitable arrival of institutional money to cryptocurrencies, popularized by Galaxy Digital’s Mike Novogratz, was repeated like a mantra in 2017. Back then, the notion that yield-starved investors were about to enter the cryptocurrency space rather sooner than later seemed like a no-brainer.
Except that the herd wasn’t coming. There was no stampede, no frenzy, no surge. Not in 2017, not in 2018, and not in 2019. Warren Buffet once called Bitcoin a “mirage”. In retrospect, people wondered whether he might have been right. It became clear that similar to the dot-com boom at the turn of the millennium, expectations ran way ahead of technology. True, there was the occasional hint of institutional interest, such as the CBOE and CME bitcoin futures launch, or the massive Harvard and Yale endowments venturing into crypto funds – two funds that have always been at the forefront of innovative venture capital investments. But the bulk of institutional investors remained skeptic and ultimately stayed on the sidelines. In addition, the Bitcoin obituaries and sensational opinion pieces had already been written. It became clear that the 2017/2018 bull market was by and large a retail-driven phenomenon. In short, “cryptowinter” had come. Institutional adoption seemed decades away.
It was simply too early. Unchained Capital’s Parker Lewis had a hunch on what adoption might look like. In “Gradually, Then Suddenly” – widely regarded as one of the best educational series on Bitcoin for debunking common misconceptions - he writes that the process of “how people come to understand bitcoin” is typically a slow one. This is no different for large institutional investors. In hindsight, the explanations were too simplistic, the weight of expectation was too great, the institutional infrastructure was underdeveloped and regulations too ambiguous. All this also underscored the importance of not focusing too narrowly on sentiment.
Meanwhile, startups and developers continued to build out crypto infrastructure, albeit largely unnoticed, paving the way for the current wave of adoption. Gone was the distraction by short-term price volatility and exaggerated valuations, at least for now. There was a palpable sense of optimism about the community’s ability to make the protocols more resilient and more user-friendly. Bitcoin was alive and well, despite being declared dead at least 386 times by the press since 2010.
Things changed in 2020 amid the global pandemic and the largest monetary expansion in the modern era. With many countries plunging into a severe recession, governments across the world responded with corporate bailouts and even direct cash handouts to companies and consumers, which in turn resulted in large fiscal deficits and more rapidly growing public debt. As always, central banks came to the rescue to safeguard the government emergency measures by committing to unprecedented quantitative easing. This involves the purchase of government bonds through newly created money. Lots of money. Unsurprisingly, this resulted in negative bond yields and record highs of central bank balance sheets. While central banks were printing money, Bitcoin experienced “quantitative tightening” through its third “halving”. On May 11, the number of bitcoin entering circulation roughly every 10 minutes, known as the “block subsidy”, dropped by half, to 6.25 bitcoin from 12.5 bitcoin. Although this event had probably been priced in for a long time given that it was encoded in the protocol from the beginning, it reminded investors of bitcoin’s scarcity. Its total supply is capped at 21 million, of which 90% will have been created by December 2021.
Since then, many institutional investors have changed his minds about the cryptocurrency and put their money where their mouth is. Macro investor Paul Tudor Jones acknowledged that the looming monetary inflation caused him “to revisit Bitcoin as an investable asset”. Stanley Druckenmiller, who also expects inflation to rise over the next five or six years, considers it to "work better" than gold. And mutual fund legend Bill Miller said that “supply is growing at around 2.5% a year, and the demand is growing faster than that”.
Large investment banks such as JP Morgan, Deutsche Bank and Citi also chimed in with bullish statements. Before long, BlackRock’s Larry Fink also made the case for Bitcoin and Rick Rieder, the company’s Chief Investment Officer, even went so far as to say that it “could take the place of gold to a large extent”.
Suddenly, the herd was within sight. And institutional capital started to pour in. The Grayscale Bitcoin Trust (GBTC) - the largest publicly traded Bitcoin vehicle with holdings of roughly $12 billion and a quasi-ETF - grew from 261,000 bitcoin to almost 570,000 in December 2020. Fueled by demand from institutional investors like Guggenheim Partners, it now accounts for about 3% of total bitcoin supply.
The increased probability that Bitcoin is heading for “digital gold” appears to be sufficiently high for many traditional investors to justify such a bet and to allocate a small portion of their assets to bitcoin with a long-term investment horizon. Large pools of capital are now actively seeking exposure to bitcoin and other cryptocurrencies.
Corporate Treasuries have also broken new ground by allocating considerable funds to bitcoin. After spending $475M to buy bitcoin as a treasury reserve asset, MicroStrategy issued a $650M convertible note that was heavily oversubscribed for the sole purpose of buying more bitcoin. Some of its largest shareholders such as Russell Investment, Renaissance Tech and The Citron Fund have all increased their positions in the company. The latter fund even issued a statement arguing that MicroStrategy is “the best way to own Bitcoin” in the stock market. Equally important, Massachusetts Mutual Life Insurance Co., bought $100 million of bitcoin for its $235 billion general investment account. The Fortune 500 company’s allocation to bitcoin is a particularly noteworthy milestone. The insurance industry is not only conservative and cautious, but an allocation to bitcoin cannot simply be pushed through by a single founder or majority shareholder as in the case of MicroStrategy and Square.
At about $400 billion, bitcoin’s market capitalization remains small relative to other asset classes. By comparison, its market size accounts for just 3.5% of the total value of gold in circulation (roughly $12 trillion), let alone its tiny fraction of the global stock market (roughly $100 trillion). If large institutional investors were to enter the space, bitcoin still would not be able to absorb all that capital. Chances are that even small allocations from those behemoths to the tune of 1% or smaller are likely to overwhelm the market. Hence, the smaller, more nimble and risk-seeking investors were the first to hop on the bitcoin trade.
Critics still deny Bitcoin its status as an asset class. Economists continue to point out that it is not legal tender in any jurisdiction. Deliberately or not, they ignore its role as a store of value in inflationary regimes across the world and the alternatives it provides for people trying to protect their savings. They hold the view that sentiment and speculation continue to be the catalyst behind the recent price rally while fundamentals play just a minor part, or barely exist. Others have attributed its bull market mainly to exogenous factors, such as the specter of inflation and negative yields in the face of excessive money printing.
Conversely, the role of endogenous factors, i.e. those within the crypto ecosystem, are often underappreciated or entirely overlooked when it comes to changing institutional interest and adoption. When comparing today’s market structure with that during the previous bitcoin bull runs, it becomes clear that financial infrastructure has matured notably. Today, the growth and quality of financial infrastructure has undoubtedly paved the way for more adoption. Investors have benefitted from increased specialization in the space and the unbundling of custody, retail, trading and brokerage functions in the form of new startups, ultimately resulting in more high-quality services. At the same time, the cryptoasset infrastructure is now much more intertwined with the traditional financial system and already meets many regulatory requirements. For example, large investors can now store their bitcoin with institutional-grade custodians such as Fidelity. While US banks steered clear of cryptocurrencies prior to 2020, they now have more clarity thanks to an interpretive letter by the Office of the Comptroller of the Currency (OCC) stating that banks have the authority to provide custody services for customers with respect to cryptocurrency and other digital assets
Of course, retail investors will continue to play a role, not least since PayPal will soon offer a large chunk of its 361 million active users to buy cryptocurrencies. Likewise, Coinbase has filed with the SEC to go public which will allow investors to get exposure to crypto via the stock market. Yet, this time is different in that institutional investors have started to diversify their portfolios by accumulating bitcoin.
Watch out for the herd.