Cryptocurrency & Decentralization: The Road to Societal Transformation, Part 3
The road leading to the creation of cryptocurrency was constructed over millennia. Since the first stones were laid in the time of hunter-gatherers, it has taken twists and turns, from the use of shells, beads and gold coins to the printing of money and the creation of the Federal Reserve. Today we are on the cusp of a major societal transformation that is due in part to this evolution.
In this four-part series, Totle will discuss four crucial ways that cryptocurrency and decentralization are poised to rock the foundations of nation states and alter the world we live in.
Part 3: A New Asset Class
As the 2018 bear market continues to take hold, many crypto investors are drawing parallels between the current slump and the sharp downturn that began at the end of 2013. In the eyes of many crypto experts, the catalyst for the crash of November 2013 was the implosion of Mt. Gox. At that time hackers made off with 740,000 Bitcoins, valued at around $525 million, as a result of the Japan-based company’s lax security practices. But since that unfortunate attack, the decentralized financial infrastructure, regulatory clarity and investment vehicles giving investors an entry point into the crypto markets have evolved at a rapid pace. In the span of just five years, cryptocurrencies have gone from being a risky, fringe endeavor to a legitimate alternative asset class being considered by traditional asset allocators.
How to Classify Cryptocurrency?
When Satoshi released his Bitcoin source code to the world 10 years ago, he firmly defined his creation as “peer-to-peer electronic cash.” However, the debate over how to correctly classify Bitcoin has raged ever since. The Commodity Futures Trading Commission (CFTC) sees it as a commodity while the Internal Revenue Service (IRS) considers it property and the Securities and Exchange Commission (SEC) has decided to approach it on a case-by-case basis.
In a seminal 2017 paper, Chris Burniske and Adam White made the case for classifying Bitcoin as a separate asset class due to its differentiated risk-reward profile and lack of correlation with traditional asset classes. The ensuing period has seen this narrative catch fire, as institutional asset managers begin to see the promise of including Bitcoin in a diversified portfolio.
A year and a half after Burniske and White lobbied for Bitcoin to receive recognition as an alternative asset class, investment banking giant Morgan Stanley released a research paper heralding Bitcoin as a new institutional investment class.
An Eye to Diversification
While it is still widely viewed as a speculative investment due to the experimental nature of the underlying technology, acknowledging Bitcoin as an institutional asset class will pave the way for asset allocators to include it as an alternative investment within their portfolios. Seeing as crypto markets are largely uncorrelated to traditional markets such as equities and bonds, diversifying into Bitcoin would reduce the overall risk of a single portfolio. The decentralized nature of Bitcoin also puts it out of any single government’s reach, making it attractive as a hedge against a catastrophic “black swan” event bringing down the system.
Big Money Gets Involved
David Swensen, Yale’s venerated Chief Investment Officer, gave cryptocurrencies a much-needed vote of confidence when he became the first endowment money manager to invest in the space. Specifically, Swensen invested in a16z, Andreessen Horowitz’s inaugural $300 million fund dedicated solely to crypto as well as Paradigm, a yet-unannounced fund started by Coinbase co-founder Fred Ehrsam and former Sequoia Capital partner Matt Huang. In a display of institutional FOMO, shortly after news of Yale’s investment broke, reports began to circulate that Harvard and other endowment funds had begun allocating to crypto. Family offices, which manage wealth for ultra-high-net-worth individuals (UHNWI), have also shown an increased appetite for cryptocurrency investment. According to Angelo Robles, founder and CEO of the Family Office Association, single-family offices are investing in Bitcoin as a way to diversify portfolios.
Getting in On the Action
Investors aiming to incorporate Bitcoin into their portfolios have a slew of derivative products to choose from. Launched way back in 2013, the Grayscale Bitcoin Investment Trust enables investors to track the price movement of Bitcoin without the headache of physically controlling their private keys. At the time of writing, a single share of the Trust (ticker: GBTC) is priced at $4.32 USD. With each share representing 0.00099226 Bitcoin, the GBTC trades at a 19.54% premium to actual Bitcoin. Another option is to purchase a Bitcoin futures contract on the CBOE or the CME. CME leads the pack with a third-quarter average of about 25,000BTC, equivalent to $162.5 million in daily volume. While the CBOE and CME contracts are cash-settled, the ICE exchange is slated to release a fully-collateralized futures contract that will require the actual purchase of Bitcoin. Live trading of Bakkt Bitcoin futures, after multiple delays, has no confirmed launch date at this time. Bakkt will buy and hold the underlying Bitcoin, reducing circulating supply and having a positive effect on Bitcoin’s price.
When the ETF?
Despite all these liquid, compliant avenues for entry into the crypto markets, the investment community is still waiting with bated breath for the Holy Grail that is the Bitcoin exchange-traded fund (ETF). Traders the world over pore over SEC commissioners’ quotes looking for any indication as to when the SEC will green-light this fund.
Thus far, numerous attempts to get an ETF proposal through the SEC have failed. However, the recent appointment of Elad Roisman to the post of SEC Commissioner has elicited optimism from the crypto community. Both Roisman and fellow SEC Commissioner Hester Pierce have shown a favorable disposition towards cryptocurrencies as they recognize that their responsibilities to provide investor protections is counterbalanced by the necessity of letting innovation flourish.
Just two years ago, even the most ardent cryptocurrency enthusiasts failed to include “institutional investment class” among the list of cryptocurrency use cases. Today, however, major legacy financial corporations are beginning to recognize the utility of including exposure to Bitcoin and the crypto space in general as a component of a diversified portfolio. Endowments, family offices, and investment banks are investing both in underlying infrastructure and directly in Bitcoin and other crypto assets. Crypto-custody services and regulated derivative products offer them an opportunity to enter the markets while remaining compliant and carrying out their fiduciary duties. But all eyes are on the SEC, as investors anticipate a positive ETF ruling that would truly herald the institutional era of cryptocurrencies.
Wrapping up — Part 4: Transformation Requires New Forms of Governance
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