Bringing the Cryptocurrency Revolution to the Mainstream
As anonymous software programmers and engineers mine for their next bitcoin or ether, Ivy League business school grads decline job offers on Wall Street to join fledgling crypto funds. And, while Libertarians rejoice at the possible disintermediation of big government and financial institutions, new “crypto-millionaires” are seemingly being minted every day. When it comes to the blockchain and crypto, there appears to be a growing consensus that we are embarking upon unprecedented times. The promise of these technologies is nothing short of revolutionary, with the potential to permanently transform how we transact on a global basis.
The common refrain is that crypto investing may be the most important wealth creation opportunity of our lifetimes. Exaggeration or not, it is a new and very important asset class, and interestingly, one where individual (“retail”) investors are the early adopters, paving the way for institutional capital. A far cry from the exclusivity of venture, private equity, and hedge funds, crypto investing is available for the masses; it is as “open source” as the blockchain it is built on.
Unfortunately, access and ease are not necessarily equal. The crypto market, while rapidly evolving, is still very nascent and so is the infrastructure supporting it. For the “newbie” investor who is eager to take the plunge into crypto, the experience can be surprisingly complex and intimidating.
Trading on the exchanges requires an extensive approval process, which is not only time-consuming, but can raise legitimate concerns around identity theft. Delays in account approvals are common, and the process for moving dollars, euro, or other paper currencies (“fiat”) onto the exchanges can be quite cumbersome. Exchanges impose both size and frequency limits on transfers, and the overall process can take up to several days, if not longer. The customer service process is not exactly “high-touch”, offering essentially no options for person-to-person inquiries in the event of problems. For those who want to forego the exchange route, a small number of over-the counter trading firms have emerged. However, in most cases, the account minimums are high and the assets need to be held separately as OTC counter-parties do not provide custody.
On the few exchanges where fiat is accepted (i.e., Coinbase, Kraken, and Gemini), the options for investing in crypto are very limited. Coinbase, for instance, only supports Bitcoin, Ethereum, Litecoin, and Bitcoin Cash. While these assets comprise a very large proportion of the industry’s overall market value, investing in any other cryptocurrencies and creating a more diverse portfolio requires crypto-based transfers to other exchanges, such as Binance or Bittrex.
Regardless of which exchange the investor chooses, he or she is faced with the all-important issue of custody and security. While maintaining assets on the exchange may be the easiest option, it is clearly not without substantial risk. The famous and precipitous collapse of the Mt. Gox exchange in 2014 (and the theft of hundreds of thousands of Bitcoins) is still a stark reminder of what is possible in the absence of appropriate safeguarding measures. Off-exchange custody is clearly the more secure route, but this creates yet another learning curve for the investor (e.g., hot/warm/cold storage, multi-signature wallets, public/private keys, authentication factors, etc.).
To a certain extent, some of this complexity can be outsourced by investing in newly launched, crypto-focused hedge funds. Yet, with this simplicity comes other complications, such as exorbitant fees and the pitfalls of active management. Many of these hedge funds are charging 20–30% annual fees on profits generated, and some are as high as 40%.
The active vs. passive management debate is as hotly contested in the crypto space as it is in traditional investing circles, and maybe even more so. It seems implausible that active strategies can provide any consistent excess returns (“alpha”) over passively-managed approaches, especially when considering the magnitude of recent market performance and the high fees being charged. Furthermore, active managers can likely do very little in protecting investors from extreme market volatility, as there is generally little dispersion between individual assets. There is always room for talented managers who can successfully select the winners from the losers, but the proverbial bar is even higher here. The research process is extraordinarily complex, depending heavily on evaluations of the product itself, its code and security elements, the relevant developer community, trading activity, institutional interest, and regulatory considerations. Even if the investor is fortunate enough to identify an outperforming manager, the question remains whether meaningful alpha can be generated over the long-term and on an after-fee basis.
Without question, the investor experience in the rapidly evolving crypto market needs to be substantially improved. Deficits range across the spectrum of access, customer service, fees, custody, security, asset diversification, and portfolio management. While the analog to Fidelity, Schwab, or Vanguard has not yet emerged, the opportunity indisputably exists for a full-service investment management platform to “fill the gap” and bring cryptocurrency investing to the mainstream.
Steven Baum is a Co-Founder and the Chief Operating Officer of IronChain Capital. Prior to joining the firm in January 2018, Mr. Baum served as President and Chief Operating Officer of JMB Capital Partners (and related entities) from 2013 to 2017. Mr. Baum was a Partner and the Chief Operating Officer at Ivory Investment Management from 2006 to 2012, and co-founded Pierce Street Capital Management in 2002, where he served as Managing Partner and Chief Operating Officer until 2006. Mr. Baum served as Vice President in the investment banking group at Montgomery Securities from 1997 to 1999 and subsequently as Principal at Thomas Weisel Partners from 1999 to 2001. From 1993 to 1997, Mr. Baum was the Executive Director of Broadband Strategy and Planning at Pacific Telesis Group (now part of AT&T). Mr. Baum joined Pacific Telesis Group from Sony Pictures Entertainment, where he served as the Director of Strategic Planning and Analysis from 1991 to 1993. Mr. Baum started his career at Morgan Stanley in 1989, working as a financial analyst on mergers and acquisitions in the firm’s media and communications group from 1989 to 1991. Mr. Baum received a B.A. in Economics, with honors, from the University of California at Berkeley in 1989.
