The Tipping Point: The Coming Wave of Institutional Investors In Crypto Assets

In some periods of the financial markets evolution, we generally see small incremental changes that only become evident as to their impact in later decades. However as we have seen in the past few years, decades of change can take place in very short space of time. As the saying goes: “There are decades where nothing happens; and there are weeks where decades happen.”

As professional investors and fund managers, we need to discern between short-term gyrations caused by knee-jerk reactions to the latest data point such as CPI, geopolitical conflict or employment updates, vs. the long-term accretion of value to our investors via significant wealth creation. In the long run, assets that will deliver superior risk-adjusted returns are either able to grow their return on invested capital (ROIC) greater than their weighted average cost of capital, (WACC) or they represent a disruptive technology that monetises a new opportunity and adoption is rapid and exponential due to the network effect.

We believe that cryptocurrency and digital assets (“crypto assets”) represent both options. This is due to the three major trends that are intersecting as monetary debasement and technological adoption intersect with crypto assets unique product-market-fit, providing neutral, inclusive non-state financial settlement systems for a world increasingly frustrated by reckless governments and incompetent central banks. 

The Great Debasement Continues

We have discussed this in many of our past market commentaries how global quantitative easing will lead to a debasement of currency and a sharp increase in inflation (remember “M x V=P x Q”, always!).

The USA Money Supply M3 has grown 1,200% from $1.7trn in 1977 to $22trn 45 years later. The concerning aspect is that 47% of this increase has come in the past three years, most notably accelerating since the pandemic began in March 2020.

You cannot raise rates and reduce liquidity during stagflation, defined as “an inflationary period accompanied by rising unemployment and lack of growth in consumer demand and business activity.” This combined with tightening central bank liquidity resulted in the prolonged 1929-1932 crash that saw a -89% correction from peak to trough over 3 years.

No, unfortunately you have no other option but to inflate your way out of the debt, which results in further transfer of wealth from the middle class to the large corporates and banks. Main Street is being hollowed out by Wall Street and Silicon Valley, but unfortunately, the alternative is financial collapse of the global fiat-based capitalist system. The Great Debasement will continue shortly as the Fed reverses course, and fiat cash’s value will continue to be eroded.

The Rapid Adoption of Crypto Continues Unabated

In assessing investment opportunities, you cannot decipher where the trends are going unless you know where they initially originated and why, and more importantly – how they evolved.

The main underlying drivers of the genesis of Crypto Assets in 2008 have been strengthened – especially the need for decentralisation and an independent, alternative accounting / transacting system. BTC was created in response to the reckless excess leverage utilised and predatory lending practices of banks that sparked the 2008 “Global Financial Crisis”.

As risk was moved from bank balance sheets to sovereign balance sheets with the 2008 Bank Bailouts and 2009 TARP (Targeted Asset Relief Program) we then saw the rolling European Debt Crisis unfold in 2009 sparked by the collapse of Iceland’s Banking system. This crisis peaked in 2016 with Brexit as many European countries were unable to repay their loans and unable to roll / refinance their debt.

This calamity culminated with a new precedent being set when “Bank Bail-In’s” were used against Cypriot insured depositors in various banks, most notably Laiki, who had their deposits seized and transferred to the “creditors” such as German banks, all guaranteed by the IMF. Indeed €6bn of the €10bn IMF guarantee was paid for by Cypriot depositors. Investors in 2016 realised that both global governments and banks could no longer be trusted to manage risk and match assets and liabilities appropriately.

Over the past 15 years investors have been forced to examine alternatives that provide transportability, security, and immutability in ownership. The risk, particularly from debasement through inflation, in having your assets in any centralised ledger such as bank or in any central bank-controlled fiat currency should be obvious for any investor who wishes to preserve and control their wealth.

Convergence and Institutional Adoption

We are now at the tipping point of a very rapid surge in adoption of Crypto Assets, and this is underpinned by the factual growth in both institutions and governments as detailed further below, combined with the private sector, seeking independent alternatives.

Most Institutional investors raise concerns around risk and volatility of the crypto asset market. However, it can further be seen empirically that a simple ‘buy-and-hold’ strategy with an allocation as small as 1% of an investor’s portfolio has resulted in a 14% outperformance over the past 7 years.

In a world of continued debasement and risk of tenure, combined with soon to be unlimited QE and rapid advances in technological innovation by developers, we believe that crypto assets are very attractive substitutes to both fiat currency and fixed income with their deflationary characteristics, security of ownership and independence.

Large Increase in Institutional Crypto Asset Investment

Q3 of 2022 saw a monumental level of institutional investment into crypto assets with Shima Capital launching a $200m blockchain fund, Invesco launching a metaverse specific fund, Barclays buying a stake in self-proclaimed “institutional gate to digital asset investing” firm Copper, Felix Capital raising $600m for its fourth fund and the South Korean government investing $177 million into metaverse projects, directly.

In addition, CoinFund launched $300mn Web3 fund, crypto fund Variant is looking to invest $450m into Web3 and DeFi, Lightspeed raised $7 billion across its 3 US domiciled funds and Indian Fund, Multicoin’s third and largest fund raised $430 million and finally Binance Labs closed a Web3 $500m fund.

Whilst the market price (perception) remains negative along with the macro, the underlying news flow in crypto assets is continuously positive:

• Fidelity Weighs Bitcoin Trading on Brokerage Platform – The firm has more than 34 million brokerage accounts.

• Schwab, Citadel Securities, Fidelity, Other Wall Street Firms Start Crypto Exchange EDX

• Norwegian central bank uses Ethereum to build national digital currency

• KKR dives into Avalanche blockchain to tokenize and ‘democratize’ financial services

• Two Sigma Ventures Raises $400mn for Two Funds, Plans Crypto Investments – The firm invests about 15% of its capital to crypto and Web3 projects

• Nasdaq is preparing to launch an institutional crypto custody service

• Ethereum activates The Merge as it successfully shifts to proof of stake

• SEC to open digital asset office as it cranks up regulatory scrutiny of cryptocurrencies

• Investment Management Giant Franklin Templeton to Offer Digital Asset Strategies to Wealth Managers

• India’s Central Bank RBI Starts Digital Currency Pilot With 4 Banks

• Coinbase shares soar on deal to provide crypto services for BlackRock clients

• European Central Bank recruits Amazon, 4 other firms to test digital euro

• Brevan Howard Scores Largest Crypto Hedge Fund Launch Ever with US$1bn for Flagship Crypto Hedge Fund

We continue to believe that crypto assets provide the best long-term opportunity of all asset classes and will outperform significantly as and when the chaotic global macro-economic conditions moderate.

In the short term, institutions are underestimating long-term fiat currency debasement risk and technological adoption trends while overstating crypto asset risks, which can easily be managed with correct sizing of the investment – between 3-5% as an allocation. Furthermore, we can see that on-chain metrics explain network adoption (demand) and are evidence that both the number of wallets and market participants are increasing, despite this bear market in all risk assets. Ultimately, people see the promise in crypto assets for a more equitable economy, and we as investors want to invest in that opportunity.

Mark Witten is CIO of Portal Asset Management