Back in the days of the first tech boom, a wild phenomenon occurred. The heads of all the biggest funds would watch their competitors put money into a company and would do the exact same, purely out of the fear of missing out. They couldn’t handle the fact that if they didn’t put their money in and that stock went to the moon, they might end up out of a job.
As we have gone through the first big wave of the crypto and blockchain boom, one has to ask: how are asset managers going to handle things this time? Will it be the same mistake, or have the mechanism evolved to the point that will save these investors from themselves?
The Asset Manager’s Goal
From the outside, every asset manager’s goal looks the same: make lots of money. They are tasked with taking some money and turning it into more money. Pretty simple, right? But in reality, the business is much more complicated than that.
The first thing asset managers seek is “alpha”, which is a premium return above the market. They need to beat the market to prove they are adding value to their investors’ portfolio, otherwise those investors could just index into the market.
But alpha is hard to find. So a secondary goal pops up: “beta”. Beta is the level of correlation with the market. The higher the beta, the more it reacts in line with changes in the market as a whole. The lower beta investments are the ones whose stocks move in an almost completely unrelated manner to what the market is doing. One example of a low beta investment is gold. It almost moves counter to the market, since it is viewed as a hedge to the economy as a whole.
What is Bitcoin to An Asset Manager?
Asset managers can look at Bitcoin and see one of two things. They can view it as a potential source of alpha, or they can see it as having extremely low beta. It really depends on the manager, but unless they have a very high understanding of the crypto space, they won’t invest in it for alpha alone. Crypto hedge funds are the ones more likely to try and gain specific knowledge and make money focusing on certain coins within the industry.
A more broad-minded asset manager would view crypto as a hedge to the overall market, just in case something happens. This doesn’t just mean Bitcoin is a bet against gold, the Fed, or the USD. It is more of an “insurance policy” in case something like that were to ever happen.
The Big Difference
The fact is that VC’s and angels roll in very different circles from hedge funds because of the knowledge required to get “alpha”. Investing may require some hubris and risk-taking, but you lose your shirt in the long-run if you don’t defer to experts in certain fields. The amount of a time investment it would take for an asset manager to be comfortable choosing individual coins isn’t justified by the small amount of money they would make on it. Crypto, after all, would always remain a tiny proportion of their portfolio. This is exactly why you won’t see any big hedge funds getting into crypto investing in a huge way any time soon.
The heads of these funds have a massive amount of power. They can move a lot of money and change the fates of companies (and maybe industries) based on the way they invest. Yet they are never confused about the fact they are dealing with other people’s money and must protect and manage this money with extreme prudence. The money is a liability as well as an asset. The more money they get given by investors, they are expected to deliver even more back.
As a result, this generally leads to a few “needs” in terms of an investment. First of all, hedge funds end up much less likely to deal with companies which may face a solvency crisis. Any company that could disappear has to large a potential loss and isn’t worth the risk. There is also the factor of retaining full control over an asset, being able to sell it when needed, and not getting sued by their investors.
What is Holding Them Back?
Bitcoin comes in pretty weak on all those fronts. As the oldest of the cryptocurrencies, it has the most likelihood of staying around longer, but there are still limited chances on that. It isn’t hard to imagine how skeptical this would leave an asset manager.
You might be asking yourself what could possibly be stopping these asset managers from investing in cryptocurrencies in the same way that you are. And the answer is simple: it is a lot easier to buy $100 of Bitcoin than $1,000,000 of Bitcoin. Institutions generally love vehicles like ETFs for putting their money in, but all of the current options, such as Grayscale’s Bitcoin Investment Trust, are open-ended funds that trade at a massive (50-100%) premium to net asset value. This creates a massive disconnect that makes it infeasible for investors to currently invest in the market.
Once an ETF is approved by the SEC, this premium is likely to disappear. You can do two things with that. First, you can short any existing ETFs in any way possible, or you can go long Bitcoin in preparation for an eventual spike in the price when an ETF reaches approval. The real question is: when will an ETF finally be approved for trading?
Other Bitcoin Issues
Custody is a key issue, because these funds would almost have to develop their own wallet solution in order to store the crypto. The alternatives are all too risky. Liquidity is also fairly limited on the scope a fund would require. Bitcoin trades the most on a daily basis, yet it would be unlikely you could move even $1MM of Bitcoin without manipulating the market.
Not all investors are comfortable with Bitcoin, and they always have the option of suing for fraud if Bitcoin drops a ton, since it isn’t recognized as an unregistered security. Although it was recently ruled that Bitcoin was a commodity, this is a huge potential risk.
Most of all, there are no currently no optimal solutions for institutions that would like to put their money in crypto. Coinbase and Gemini are hardly a great option, due to the opacity of their vertical integration, and over-the-counter trading costs are high (2-5%). Additionally, many investors are worried about dealing with “tainted coins” that have used in money laundering and may be difficult to sell in the future. For all of these reasons, asset managers are less likely to put money in Bitcoin right now.
For all of these reasons, it doesn’t yet make sense for hedge funds to buy much crypto. Their bets need to be larger to move the needle, and the liquidity, custody and legal requirements exclude Bitcoin quite easily. In the end, this creates a great opportunity for retail investors, since right now the scale doesn’t make sense unless you’re a dedicated crypto fund. One day the aforementioned problems will be solved, and the asset managers will join, and retail investors may look forward to a large bump then.
The Current Thesis
We have been in a period of relative peace for the last several decades, and as a result, capital preservation has become a larger focus for investors. Fortunes have been made, and now it is time to make safe haven bets such as gold or offshore banking. Bitcoin represents a new way of investing in a safe haven.
So even though some pundits will say Bitcoin is a “moonshot” and people are throwing their money away investing in it, you will often find the richest investors putting a small percentage of their money in crypto… just in case. Perhaps this will offer you an alternative pitch when discussing your crypto hypotheses with friends and family.
Disclaimer: The author owns bitcoin, Ethereum and other cryptocurrencies. He holds investment positions in the coins, but does not engage in short-term or day-trading.
Featured image courtesy of Shutterstock.