How do Institutional Investors fit into Crypto investing?
A single investor bought $344 million of Bitcoin within a 3 day window from February 9th to 12th at average price of $8,400. The investor then waited 3 more days as momentum started to fade and then bought 41,000 more Bitcoin at average price of $9,400 to bring up their purchasing past $800 million dollars. With bitcoin having a total market cap of less than $200 billion, trade orders of this magnitude doesn’t move the market as it once did. However, the price fluctuated between Sub $8k to more than $9k, back below $8k and then back up to $8,975 in that initial 3 day window¹. By Feb 15th, the price was as high as $10,300. This price action is common place at this stage of Blockchain technology — it is simple supply and demand. If you want to buy tens of millions of an asset, the price will move against you and maneuvering the volatility is something you have to stomach. This is not controversial.
Bitcoin’s Blockchain can handle these block trades and has been battle tested for over 8 years without being hacked. The Bitcoin enthusiasts can handle this market cap, and this price action fuels the HODLers will. However, most everyone else may not handle Bitcoin and other Cryptocurrencies’ volatility so well. Regardless of investors’ comfort with these dynamics, more evidence is piling up proving that 1) Blockchain technology is a game changing technology, 2) Crypto Assets are creating a new asset class, and 3) Crypto Assets are a new source of alpha that are well-steeped to these prices, volatility and new performance metrics. This is also not controversial.
Here is the controversial part: There is over $3.5 trillion dollars being invested into traditional Hedge Funds from a single type of investor². Should this pool of investment reallocate 5% of that money to Crypto projects, this would bring an additional $175 billion to fund the Web 3.0 that Blockchain visionaries have been building.
This pool of money investments come from Institutional Investors. These aren’t banks. They aren’t central authorities. They are university endowments, pension plans, and charitable foundations that have deep pockets, long-time horizons and are always looking for new asset classes as sources of alpha. But Institutional Investors can’t invest in Cryptocurrencies right now. And Crypto projects could really benefit from them.
This controversy exposes a roadblock as the Crypto Assets field matures. Bitcoin is a payment system that is math-based, immutable and with no central institution that controls the price. Ethereum is a technology that hosts a variety of utilities that serve financial functions for its users through smart contracts. Litecoin, Cardano, Zcash are increasingly prevalent Crypto technologies that also want to further the evolution of our monetary system towards a more citizen-based utility as opposed to a central government tool. These are all technologies that help evolve our finance system. They benefit from more people using them, more investors providing funding for innovative projects, and more stability from their institutional legitimacy.
The immediate roadblock that stands in front of Crypto projects is that there is a resource-allocation problem. Three of the reasons for the roadblock are:
- Talent — the mathematicians, computer programmers, and cryptography specialists that are already in high demand are now being stretched thin into different crypto projects. The economics of developers being incentivized and allowed to work on half a dozen projects at once is laid out in this post. It will take years to fill in this skills gap and due to the technical nature of a lot of Crypto projects, their success is a direct output of technologists ability to collaborate, test and build.
- Security — the threat vectors for small teams trying to launch a crypto project are many and one of the strongest signals that can be sent to potential investors. Without pointing out any particular projects, there have been a handful of ICOs that have been subscribed to, only to have their mailing listed hacked and then scam emails sent. While there may be simple safeguards to protect Crypto teams against this, many of the most respected figures in Crypto have had their Twitter accounts hacked due to security tools that are out of their control. One scam email or tweet can scare off potential partners/investors in a project and contribute to the overall narrative that Crypto is an unsafe investment.
- Whales — without consistent, proper lock up terms and a dedicated, educated community, even the best Crypto projects are susceptible to Pump and Dump schemes unbeknownst to them. Partially due to anonymity, Crypto holders are able to quickly act in a vote of confidence and this can lead to abrupt changes of funding for their projects. While generally positive, the downside of this can be generally characterized by the concept of whales in Crypto projects. Due to the size of their large positions, their holding and selling of a token can leave other holders and project members at their whims.
A lot of these roadblocks can be overcome with additional funding and exposure to new financial participants. This, however, exposes a larger roadblock which investors face. Three of the reasons for their roadblock are:
- Custody — these efforts are largely underway, but still an agenda item that can lead to an ideological divide. Individuals may have the independence to store wealth in the millions on external hard wallet, but investment bodies have historically relied on custodians, banks, and external services to oversee their wealth. To what extent are larger investors partaking in Crypto investing if their assets need to ultimately being centralized. We have yet to see an industry standard and proven solution to this roadblock.
- Diversification — partaking in the few Crypto asset trusts that have the regulatory green light still limits an investor to only a handful of assets. When a university endowment wants to make a $25 million subscription to a trust, should it encompass more than 30% exposure, if not 100% to BTC? At present, the available Crypto investment vehicles are limited in scope to only a handful of currencies and this concentration risk is antithetical to the diversification that is part of the Institutional Investors’ mandate. As the Crypto project universe widens, larger investors will benefit from new vehicles that diversifies them across Crypto projects, instead of just the 5 most proven Crypto Assets.
- Auditing — as measures of safekeeping and proper evaluation, larger investors rely on auditing on the grounds of fiduciary care. This auditing process is different for Crypto Assets and is in many ways optional. We have been interested to learn the ways that auditing services are evolving to address these new set of needs and standards.
A logical retort to why these roadblocks exist is how Cryptocurrencies are being created for the individual. That was certainly true 9 years ago and this Cypher Punk ethos is (and rightfully so) very strong. The end user of Cryptocurrencies has started to evolve and asubset of the libertarian ethos is for financial systems to evolve so they are not centralized. This will be aided by larger financial players as a function of time. Three of the reasons why Institutional Investors can help Crypto projects overcome roadblocks previously presented are as follow:
- Time Horizon — They have some of the longest time horizons. Given that most of these large investors don’t have imminent liabilities, they can have allocations to a Hedge Fund Manager for a years at a time with lock up terms that prevent them from being ‘hot’ money. When they invest with a Private Equity Manager, they expect the payout to take at least 10 years. For new Crypto projects, they are usually building projects off of momentum measured in months and roadmaps that seldom go beyond 2 years. If more long term money comes into the space, investors can afford to be more patient to see Crypto projects come into fruition.
- Risk Appetite — They have some of the largest risk appetites. This has been well documented, but subsets of Institutional Investors can afford to have a larger risk appetite than other investment professionals. The alternatives space is meant to provide additional returns beyond status quo investments in the market. To capture this alpha, Institutional Investors will slide along the Risk/Return scale and not restrict 100% of their investments to normal stocks and bonds. Crypto Assets fits this bill quite well.
- Their Clientele — They have the ability to bring the fruits of Crypto Asset returns to fund pensions, university operational budgets, and charitable foundations. The straw the broke the financial system’s back may have been proved to be Global Financial Crisis of 2008. Pensioners around the world were given good reason why individuals should distrust financial systems. This distrust of the financial system fueled early Bitcoin community members to create a trustless architecture for money. As a sort of ironic form of justice, the wealth that Crypto Assets creates can be redistributed to the pensioners around the world by Institutional Investors simultaneously achieving outsized returns and funding Crypto projects on a large scale.
This value proposition of Institutional Investor funds pouring into Crypto space has already been playing out in several ways. Future topics that we will document include:
- How Private Equity has chosen viable technology companies that are serving as the Blockchain for Crypto projects
- Where new Crypto hedge funds are different than traditional ones
- What are the new tools/ financial service companies that will be helpful for Institutional Investors to be directly involved with Crypto Assets
Feel free to reach us at insights@sightlinescrypto.com if you or your company are playing any role in this process.
Sources
¹ - https://www.investopedia.com/news/anonymous-cryptocurrency-enthusiast-bought-400-million-bitcoin/
