On the frontline of crypto trading, Anton Chashchin, the Managing Partner of Bitfrost, presents his insights into the rising institutional adoption of cryptocurrencies and the buyers flying under the radar of the Elon Musk-focused headlines.
This year, many investors have experienced déjà vu of 2017 with the amount of hype about cryptocurrencies. Elon Musk, Twitter bots and the media have all seemingly joined forces to push crypto into the stratosphere of buzzy trends.
Commentators are split as to whether there is anything behind the hype, or if it is a bubble waiting to burst. With memories of the cold crypto winter of early 2018 and the ongoing warnings from the Bank of England, it is no wonder that many are still on the fence.
But this time, it is different. While 2017 was largely defined by more fickle trend-driven retail investors, institutions have since entered the game, and they are in it for the long haul. Recent research from Deloitte found that 76% of financial leaders believe that digital assets will replace fiat in the next 5 to 10 years.
With this recognition, large players are buying in bigger amounts than ever before. Many large companies, and even some governments, are now using cryptocurrencies and more are expected to jump in, with Nickel Digital Asset Manager finding that 62% of firms plan to buy Bitcoin within the next year.
These decisions are not on a whim either, with lengthy board meetings and risk assessments preceding every buy. By buying and selling long-term, they are helping to create more scarcity, and thus more demand, catalysing a positive loop that will see the value of Bitcoin continue on a healthy growth trajectory. This institutional era marks a more mature age for Bitcoin.
Pull Factors
So, what is drawing institutions to crypto? Broadly speaking, institutional actors share three main reasons for entering the crypto market.
First, price does not matter. From start-ups to billion-dollar funds, if an institution’s goal is to have 1%, 10%, 20% or even 50% of their portfolio converted to crypto, they can do it, whatever the price might be. This makes it appealing to a wider range of businesses.
Second, crypto is attractive from a long-term strategic perspective. Institutions drawn to holding have noticed the potential in crypto. Many institutions have lockup policies, corporate institutional money or use Bitcoin as a hedge against long-term inflation trends. As such, we are now witnessing a concurrent rise of institutional investment and holding behaviour, creating more buy pressure down the line.
Third, it is self-perpetuating. Institutional trading creates larger volumes, and larger volumes attract new institutions. As Bitcoin silently breaks certain evaluation thresholds, we will see increasing interest from traditionally conservative entities.
While they share certain primary motivations, there is a growing range of institutions exploring the benefits of crypto. The following are some of those moving into the space.
Estate Planning and Trusts
With crypto now firmly in the mainstream consciousness, there is a slightly older demographic becoming interested in reaping the benefits, which is pulling in more sophisticated investment vehicles. As most still do not know how to set up their own Bitcoin investments, they are asking their estate planners to buy on their behalf for family trusts. In response to beneficiary demand, more and more trusts are converting parts of their holdings into Bitcoin. This is now becoming an increasingly competitive part of many estate planning trusts’ client offerings.
More adept crypto investors are turning to trusts as a way to legally avoid increasing taxation in the space. Depending on the setup, Trusts can provide significant tax benefits, the transfer of Bitcoin or another cryptocurrency to such a trust is not taxable. Just like crypto-backed loans, this also allows beneficiaries to reduce taxes on their capital gains, drawing in more traditional investors who have discovered these upsides.
Additionally, many investors are concerned by the lack of anonymity that Bitcoin provides in light of newly applicable KYC/AML regulations. Anyone with sufficient impetus could easily find out where an individual investor spends their money. Living trusts protect the assets of their beneficiaries by adding an additional level of privacy, attributing asset’s ownership to the trustee, instead of disclosing the real owner.
Family Offices
With crypto-aware millennials rising through the ranks of more institutional asset management style family offices, Bitcoin is an increasingly popular portfolio component.
By safely allocating just 1% to Bitcoin, an Office can safely expect between 1 and 5% return without any significant risk. By comparison, an asset taking up as much as 30% of their portfolio might only achieve an equivalent level of return on the day-to-day. The better the Bitcoin allocation performs over time compared with the rest of their portfolio, the more family offices are likely to invest.
Unlike trusts, where protection is a top priority, family offices quite simply want to make more money and avoid inflation. Therefore, the attraction to Bitcoin, which, like gold, is a protective asset due to its scarcity, is plain, particularly for those with sufficient knowledge and connections.
In fact, Bitcoin is increasingly seen as having an edge on gold. While gold has real-world obligations limiting its worth, Bitcoin is unconstrained. Its room for growth is theoretically exponential. Therefore, Bank of England Governor, Andrew Bailey’s recent criticism of crypto as having "no intrinsic value" could ironically be seen as complementary
These arguments paired with a hostile and high-risk post-covid investment environment have led to a rise in family offices holding Bitcoin.
Buy-Side Funds
Far from fearing the hype, buy-side funds are taking advantage of it to attract more investors, typically adopting the most modern top-performing assets into their portfolios. Thus, their strategy is fairly PR-heavy.
Once more investors are on-side, they can then buy more Bitcoin. With more Bitcoin, they can make more commission. The scarcity of Bitcoin works well in tandem with their growth goals.
The most famous example of funds selling securities as shares of the fund that has some crypto assets on its balance would be the US-based Grayscale Bitcoin Trust (OTC:GBTC), but there are dozens of them operating in Europe within small closed communities.
Liquidity Start-ups
Liquidity start-ups encompass a wide range of institutions, anyone who would be a virtual asset service provider. If you are starting any company that wants to include any kind of Bitcoin-based offering, be it a fintech, fund or exchange, you need to buy it in order to sell it.
In cases where we are talking about BTC/USD exchange or arbitrage, essentially buying something cheap and selling it at a better price, both base and quote assets are needed to run a business. As operations are scaled, more is required.
These types of companies are very susceptible to market opportunities. While many closed their crypto trading desks in 2019 because of a lack of arbitrage opportunities and low trading volumes, 2021 is seeing many get back to business with more vigour than ever.
As more liquidity start-ups pop up every day all over the world, initial liquidity will become increasingly essential, as will liquidity partners. And, with better liquidity provided globally, a growing number of institutions will look to leverage Bitcoin in the way that suits them.
First-Time Crypto Buyers
Just like in the retail world, many buyers of Bitcoin are doing so for the first time. These can be corporations or asset management firms and, for many of them, Bitcoin is the go-to crypto option given its liquidity, widespread adoption, established regulations, the general trust and awareness surrounding it.
First-time crypto buyers generally approach crypto, not because they have fallen in love with Bitcoin, but rather because they have fallen out of love with banks for their holding fees and lack of privacy, among other things.
These entities turn to crypto to extract different benefits, ranging from portfolio diversification to inflation protection, to security from theft or reducing transaction fees. Some are approaching it with a risk-averse mentality, working with countries with licenses only, preferencing premium service and compliance, or using it to cautiously optimise taxes. Others enjoy a higher risk, a higher return approach.
Whereas in the retail space, buying crypto is usually a speculative investment, institutions generally have more responsibility so the overarching strategy shared by first-timers is to learn. Even though they may not trust crypto 100% yet, it is often a pilot project as opposed to a get rich quick scheme.
They want to know what benefits they could extract from holding cryptocurrencies, such as favourable international transactions. For this to be possible, their CFOs, accountants, lawyers and managers have to learn how to invoice, receive, store, send, liquidate and tax cryptocurrencies before any full-scale shift.
A “Positive Cycle” for the Crypto Industry
Institutional adoption creates a positive cycle for the industry. Wider adoption invites sophisticated regulatory initiatives and frameworks, which is evidence of a stable and maturing market.
In short, more institutional investment means more stability, which means more institutional investment. Hype aside, it is an ongoing cycle that could genuinely see Bitcoin take off in a way we have not yet seen.
