The Future of Institutional Digital Asset Management Has Arrived
It’s not often as an investor or an operator that you have the opportunity to build something measured in the trillions. The institutional adoption of digital assets represents that scale of an opportunity.
If investors allocate just 200bps of the $73tn of professionally managed assets in the world to Bitcoin, Ethereum, and other “crypto majors,” the institutionally-held digital asset class will cross $1.5tn¹.
We have hit an inflection point in the building blocks required for institutional participation in the digital asset class. As the attributes of digital assets become fully appreciated, we expect that over the next decade:
- Financial institutions and fund complexes will develop and distribute digital asset products
- Foundations, endowments, RIAs, and sovereigns will look to digital assets as a store of value and macro hedge
- Hedge funds and family offices will find much coveted yield opportunities and structured cash-on-cash returns
- Public and private corporates will look to hold a portion of their Treasury reserves in digital assets as a currency / inflation hedge
While this will not be a “winner take all” market opportunity, the winners that emerge in the institutional digital asset management space will exhibit the following characteristics as exemplified by NYDIG, a fully-licensed and regulated New York-based digital asset manager and qualified custodian:
- Highly tailored digital asset solutions enabling institutional clients to build into positions and construct offensive & defensive strategies
- Seasoned management team and operators with deep capital markets expertise
- White-glove approach to customer service
- Foundationally secure base custody layer and designed to meet the highest regulatory, compliance, and reporting standards
- Full-stack technology solution that has been built from the ground-up
- Strong balance sheet to provide leverage and flexibility to its clients
- A brand synonymous with institutional-grade quality
The Macro Picture
As a result of the $2.2tn CARES Act (Coronavirus Aid, Relief, and Economic Security Act), the United States will run a record $3.8tn national deficit (13.8% of GDP) for fiscal year 2020. Total US national debt has now ballooned to $26.7tn (135% of GDP).
Even prior to the stimulus measures precipitated by COVID-19, total US public debt as a % of GDP reached 110% at the end of 2019 — up from just 30% in the early 1980s, and a level not seen since the recovery period following World War II. The non-partisan Congressional Budget Office estimates that projected budget deficits over the coming decades will drive US public debt levels to an unprecedented 195% of GDP².
The Federal Reserve has done its fair share, accordioning its balance sheet to ensure economic growth marched on during the recovery in the wake of the Great Recession. Just when it seemed like there was finally an opening to decrease its balance sheet and scale back its long-standing asset purchase program, the Coronavirus hit. The Fed balance sheet was once again put to work, and now stands at $7.1tn.
Bitcoin, born out of the Great Recession of 2009 and thriving during the many subsequent monetary quantitative easing cycles that resulted, has seen its price closely track the growth of the Fed balance sheet over the past decade.
Looking around the world, the global debt picture is not much healthier. The top four Central Banks globally (US Fed, European Central Bank, Bank of Japan, and the Bank of England) now have amassed $20tn of debt. Moreover, while negative interest rates may be a new feature to the US macro equation, they long ago solidified their toehold in Europe when in June 2014 the ECB lowered its deposit rate to -0.1% to stimulate the European economy.
Just this past month, the Fed released its own much anticipated dot plot for the future of interest rates and its adjusted inflation targets. Until 2023, the Fed expects nominal interest rates to remain at 0%. In the biggest change to its policy, the Fed for the first time articulated that it will allow its target for inflation to float above 2% — a solid indication that not only are negative real interest rates here to stay in the US, but that price inflation may also be on the horizon³.
As seen below, Bitcoin’s historic price has exhibited a strong inverse correlation with real interest rates (ie the lower / more negative real interest rates, the higher the price of Bitcoin).
Institutional asset owners and allocators are becoming increasingly jaded by an equity market that seemingly hits new all-time highs everyday, while 13.3m Americans remain out of work due to the COVID-19 pandemic. The equity market’s outperformance feels incongruous with the macro reality. While most can’t pinpoint exactly how, or when, the repercussions of endless money printing will come — be it the loss of US dollar reserve status, or something even more nefarious such as a Treasury default — having a long term hedge in place seems both prudent and rational.
Bitcoin - A Better Hedge than Gold
Based on the current and future macro picture outlined above, the case for a non-sovereign currency with hard money properties is building strong. Fiscal spending and global monetary quantitative easing have taken control of any currency that can be “eased,” i.e. the supply increased at will, most specifically the formerly almighty US dollar. Consequently, since the onset of the pandemic and the resulting stimulus package, we have seen an increase in the price and a race to assets that are governed by the laws of scarcity and limited supply — equities, gold, single family residential, and Bitcoin itself.
Institutional investors have long looked to gold and other commodities as a reliable store of value and inflation hedge. Total gold market capitalization stands at $9tn today. At a current market cap of $200bn, the total market capitalization of Bitcoin is just 2% of that of gold.
But, in comparison to gold, Bitcoin is much more portable, easier to store, infinitely divisible, and much more easily verifiable.
The Infrastructure Is Now In Place
We’ve been hearing it for over three years now — the herd is coming! A trite reference to the wall of institutional scale capital eagerly waiting on the sidelines to deploy into digital assets at just a moment’s notice. Yet, the market has remained predominately (95%+) retail-driven.
But, in the wake of the 2017 digital asset craze and complementary ICO boom and bust cycle, the digital market has been quietly preparing itself for more durable wave of adoption. A number of foundational pieces for institutional participation that weren’t in place during the last bull run are now here:
- The Bitcoin network has now been tried and tested by time for over ten years: The blockchain industry’s first mover is now supported by an established network effect of 40m active wallets, a $200bn market cap, and 100k nodes verifying transactions. The network itself has never been hacked since inception.
- “Qualified custodian” distinctions awarded: More than a handful of custodians with proven security solutions, strong financial standing, some level of digital asset insurance, clear audit procedures, and regulatory compliance have been given the SEC designation as “qualified custodians.”
- Many digital asset custodians now have “trust charters”: Top-tier digital asset custodians act more like banks, with trust charter status being secured, allowing them to serve as SEC registered advisors and fiduciaries to their clients.
- Hardened, bank-grade security practices: Improved cold storage security practices involving the usage of HSMs (hardware security module), threat monitoring, multi-sig key management, disaster recovery protocols, and continuous code reviews and audits have increased trust in digital asset custody.
- Clear regulatory guidance: Both Bitcoin and Ethereum deemed to be commodities, and not securities by the SEC and CFTC — removing regulatory ambiguity.
- Enough time series data to empirically prove portfolio diversification benefit: We now have over a decade worth of data to backtest how an institutional portfolio may have performed assuming a small allocation to digital assets.
A Case Study: US Equities
Today, institutions own 78% of the market value of U.S. broad market Russell 3000 index, and 80% of the large-cap S&P 500 index⁴. In dollars, that is approximately $21.7tn of the Russell 3000 and $18tn S&P 500 that are in institutional hands.
Yet, this was not always the case. In the early days of equity exchanges and publicly listed stocks, the majority of shares were held by ordinary “mom and pop” investors. While it took nearly eight decades for institutional ownership to reach 80%+ levels, professional allocators have dominated trading activity and market participation for the last 40 years.
Institutional participation in the crypto space will evolve similar to that of other verticals within the capital markets, specifically that of US equities and global foreign-exchange. Given today’s digital first-world, the extreme velocity at which the crypto space moves, and the fact the core supporting infrastructure is now in place, it is reasonable to believe that the “institutionalization” will happen on a more condensed timeline in digital assets than it did in US equities.
The Survey Data Says a Sea Change Is Already Upon Us
In Fidelity Digital Asset’s most recent 2020 survey of institutional investors, 27% of respondents either “currently hold” or “expect to hold” some digital assets in their portfolio⁵. That stands in stark contrast to 2017 when just 2% of institutional investors answered that they “currently hold” or “expect to hold” digital assets. Looking forward, most insightful is that by 2025 nearly 90% of institutional investors expect to have digital assets as some % of their portfolio — a number that, if true, would indicate broad institutional adoption.
Unsurprisingly, Bitcoin is the premiere digital asset of choice for institutions, comprising 72% of institutional volume. Interestingly, the majority of institutions (60%) prefer to hold the actual digital assets (via a third-party qualified custodian), rather than investing in digital assets through a fund structure or synthetic alternative.
Institutional investors and executives are much better educated today about what digital assets are, the opportunities and risks, and different security practices. There is far less career risk in dabbling in an allocation in digital assets today than there was just even a year ago.
The Early Green Shoots
While we are still in the first inning of institutional participation in the digital asset market, the last three years have provided some early green shoots.
Below are some important events worth highlighting for their significance and / or signaling power to the institutional market:
- CME & CBOE Bitcoin futures launch
- Cambridge Associates digital asset report publication
- Yale and Harvard endowments invest in crypto funds
- Paul Tudor Jones announcement of fund allocation to Bitcoin
- MicroStrategy, Square, and Stone Ridge invest corporate treasury holdings in BTC
Birthed out of the $10bn New York based asset manager, Stone Ridge, NYDIG was the result of the executive team’s early exploratory foray into the digital asset space. As early as 2015, the team went on a journey to find the best custody solution as they invested their own balance sheet and began to explore new digital asset management products to distribute through its established channels.
Much to their chagrin, they couldn’t find an institutional outfit that fit the bill. At the time, the custody and asset management solutions in the market were either extremely immature from a modern security perspective, or were operating without much proper regulatory oversight.
Today, NYDIG is the culmination of five years of work by the team — regulated as a NY State Limited Purpose Trust Charter, has secured its own BitLicense, and is independently Soc II Type 1 Certified by EY.
A New Type of Institutional Digital Asset Manager
NYDIG was early in recognizing that there are a wide range of reasons why institutions may be entering the digital asset market for the first time. And each one likely requires its own specific tailored solution. A family office in the US Midwest may want to earn a 15% yield through a BTC call selling overlay strategy, a NYC based macro hedge fund may want to play the BTC spot / futures basis trade, a European pension may be seeking a long-term macro hedge for its portfolio, and a Latin American multinational may be seeking a more inflation proof base currency for its cash reserves. A one-size-fits-all approach would certainly not work in a market with institutional participants who are this large and diverse.
The mission of NYDIG is to be to be the most complete provider of digital asset prime brokerage, execution, and asset management services to institutions and high net worth individuals. Its broad and deep product solutions are reflective of the market’s need and a management team with deep financial expertise across capital markets, derivatives, and asset management.
Built on a Secure, Proprietary Crypto Stack
The future of digital asset asset management must be grounded in a foundational layer of secure custody. For NYDIG, this means at all times all private keys are generated and stored completely offline, using specialized hardware and adhering to the highest cybersecurity standards.
Importantly, and differentiated from its competitors, NYDIG’s institutional clients have their own segregated and bankruptcy-remote accounts, 1 hour access time, API access, third party audit checks, and hefty insurance coverage for its digital assets in cold storage.
Every single line of code and tech has all been written in-house, giving confidence not seen in other solutions that have been cobbled together through inorganic acquisition. NYDIG supports custody for the “crypto majors” — Bitcoin, XRP, Ether, Litecoin, and Bitcoin Cash.
Ability to Attract Top Talent
From the NYDIG CEO, Robby Gutmann, on down, we’ve been constantly impressed by the caliber of talent within the NYDIG organization. Having been investing in and operating within the digital asset space at FinTech Collective since 2014, we quickly came to the conclusion that NYDIG was the most professional and polished institutional team we had interfaced with in the digital asset space.
Recent high powered hires, including Ronny Wexler (former GS Partner, Head of Equity Derivative Sales, 18 years), Tejas Shah (former GS Partner, Head of Equity Derivatives Trading, 17 years), Eric Kramer (prior GS Managing Director, 15 years), Rodney Miller (prior GS Managing Director and Chief of Staff Global Equities Division, 14 years), and Greg Cipolaro (co-founder of Digital Asset Research) demonstrates continued strong talent attraction and new books of business development for NYDIG.
The Path Forward Together
We’ve had the pleasure of getting to know the NYDIG team over the past five years and watched them execute from initial idea conception to very first dollar of revenue to beginning to deliver on the opportunity at scale. We’ve always felt a high level of philosophical alignment in our belief that it was not a predetermined conclusion that the aforementioned herd was coming, but rather that it would take the confluence of market participant readiness and digital asset product maturation.
Over the next decade, institutions will not enter the digital asset market because of the store of value thesis alone, or on the assumption that the Bitcoin price will only go up over the coming decade. A nuanced, high-touch approach will be needed to properly service institutional clients and capitalize on this transformational opportunity. We believe NYDIG is best positioned to deliver upon this vision — hence, our decision to lead NYDIG’s oversubscribed $50m growth equity round. This round brings the total outside capital raised to $100m, and we are excited and proud to join world-class investors including Bessemer, Ribbit, Starr, and Stone Ridge.
We look forward to being thought partners and evangelists in NYDIG’s global mission to deliver the future of institutional digital asset management. Onwards!
FinTech Collective backs creators with a hunger to reimagine how money flows through the world. We are a sector-focused venture capital firm, based in New York City and investing globally. The firm was founded in 2012 by serial entrepreneurs with four prior exits and one IPO in capital markets tech, payments tech and enterprise AI. Since inception, FinTech Collective has seeded 40 portfolio companies and has been active in crypto and blockchain since 2013. Blockchain and DeFi positions include Axoni (re-platforming capital markets), Dharma (banking and trading built on DeFi), Minka (real-time payment infrastructure for LatAm), Oxio (emerging markets exchange for mobile connectivity), TradeBlock (OTC data and messaging platform), UMA (decentralized financial contracts platform), Centrifuge (decentralized asset finance), and Rainbow (smart contract wallet). Recent exits include Plaid acquired by Visa, Quovo acquired by Plaid, and Reorg Research acquired by Warburg Pincus. The firm is currently investing out of FTC III, an early-stage fund with a focus on software, data, financial services, and digital assets. A weekly client newsletter is available at fintech.io/newsletter.
- Assumes a 2.00% average allocation to digital assets across institutional portfolios (2% * 73.5tn = $1.5tn). Most professional allocators are thinking about 2- 5% portfolio allocations to digital assets.
- Congressional Budget Office (September 2020). https://www.cbo.gov/publication/56598
- What The Fed’s New Stance On Inflation Means For You. (August 2020) https://www.forbes.com/sites/advisor/2020/08/27/fed-changes-inflation-stance-powell/#1494b4914686
- Pensions & Investments. (April 2017). https://www.pionline.com/article/20170425/INTERACTIVE/170429926/80-of-equity-market-cap-held-by-institutions
- Fidelity Digital Assets. (June 2020). https://www.fidelitydigitalassets.com/articles/institutional-digital-asset-survey-report