Institutional Investment in Bitcoin

Fortress Investment Group was first in 2013. Which buy-side firm will be next?

Fortress Investment Group became the first large Wall Street firm to declare an investment in Bitcoin during late 2013. But in the investment business you not only need the correct thesis — you must have the right timing too. Fortress later rolled its holdings of the digital asset into a $150m hedge fund run by Pantera Capital Management to target venture capital investments in the fast growing space.

The early price chart looks similar to a typical bubble pattern. Credit: Google Finance Website.

Looking at a chart helps to visualize the chain of events. Fortress bought ~$20 Million worth of bitcoin in late 2013. They later marked down the investment to ~$13 Million, roughly a 35% loss, in March of 2014 when the deal happened. A quick look back to the price reveals Fortress purchased at an average price of around $990, which later dropped to nearly $640 at the time of the deal with Pantera.

Much has happened in the bitcoin space since the early days of 2009–2013. Since then there’s been a large amount of interest in blockchain technology and smart contracts to drive innovation in the enterprise software space. But a lot has been happening in the pure-play bitcoin space as well. For one, the price has become more stable, at least up until the recent Bitfinex theft. Next, bitcoin just experienced its second “halving” of the block size reward and there’s been renewed interest from high net-worth investors at family offices and hedge funds. Ark Invest, a firm focused on investing in digital disruption, recently released a report citing the benefits of adding bitcoin to a portfolio — the main one being negative correlation to other asset classes.

In 2015, the BIT (Bitcoin Investment Trust) launched as the first investment vehicle to gain exposure to the digital currency. The BIT is managed by Grayscale, a subsidiary of Digital Currency Group. It is a private, open-ended trust that is invested exclusively in bitcoin and derives its value solely from the price of bitcoin. It has price quotes, but is traded OTC (over-the-counter) and sometimes trades out of sync with the underlying price.

Total Bitcoin in Circulation (Will be 21 Million once all mined; currently ~15.7 Million). Credit: Website.

Just recently, Tyler and Cameron Winklevoss got closer to offering the first Securities and Exchange Commission (SEC) regulated bitcoin investment product. They filed paperwork to list on the BATS exchange after two years trying to get the ETF (exchange traded fund) listed under the “COIN” symbol on NASDAQ.

There are several exchanges to buy digital currency in the us including Coinbase, Gemini, and ItBit. But, some have argued the exchange volume doesn’t represent true market based supply/demand since large buyers don’t use exchanges to acquire bitcoin — an phenomenon recently explained by Vinny Lingham.

Several firms cater to large investors that don’t want to buy through an exchange. A few of these include Genesis Trading, also a subsidiary of Digital Currency group, ItBit, Noble Markets, and Binary Financial. OTC markets will be crucial to assure large asset managers can take positions without moving the price as the market cap still remains small.

Institutional investors looking for a reason to invest might look for insight from the commodity market. Many industry analysts have compared bitcoin to digital gold. The perception of gold’s ability to store value is arguably based on two things — scarcity and the historical precedence as an accepted form of money — two things bitcoin has.

There’s been a handful of high profile investors loading up on the precious metal as the Fed has increased its balance sheet. Investors like John Paulson, and others waving the inflationary warning flag, have been wrong up until recently when the price of gold moved up following volatility from the “Brexit” — once again proving timing is everything.

Some large investors use an ETF such as GLD to get exposure, which tracks the price of gold. Others like David Einhorn of Greenlight Capital have purchased physical gold bricks, storing them in a warehouse. This has big implications for a fund holding bitcoin: will firms opt to hold their own private keys as opposed to having a third-party secure keys or through exposure via an ETF?

Federal Reserve Balance Sheet. Credit: Federal Reserve Bank Website as of July 20, 2016.

Central banks around the world will soon reach the extent to which quantitative easing adds value. Global rates have gone into negative territory as fear has spread through markets markets. Even the U.S. 10-year Treasury yield hit all-time low of 1.34% and questions remain about where it goes from here.

When comparing the ~$8 trillion market cap for gold to the bitcoin, each “coin” would cost almost ~$400,000, once all 21 Million bitcoins have been mined. Currently, bitcoin has hovering around a ~$9-$10 Billion dollar market cap, dwarfing the demand for gold.

It begs the question: which large asset manager will be next to announce a position in an upcoming bitcoin ETF or in bitcoin itself? As we come to an interesting end-point in unprecedented monetary expansion, bitcoin might start looking attractive as a store of value in an ever-evolving digital world.

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