The Evolution of Institutional Investors’ Exposure to Cryptocurrencies and Blockchain Technologies

Exploring the different ways institutions are gaining exposure to cryptocurrencies and how these exposures are likely to play out over time. While cryptocurrencies have been in a drawdown of late, these declines are coming after huge rallies ; Bitcoin and Ether remain 4 times and 10 times respectively more valuable than they were barely 18 months ago. These run-ups took place during a time of unprecedented liquidity, as trillions of dollars of central banks ’ money printing made its room to households via fiscal policies. Over this period, the fluidity of cryptocurrencies significantly increased as many newfangled players entered the markets, and newfangled exchanges, instruments, and service providers to support digital asset invest have continued to mature. Although these remain small markets relative to the most liquid markets in the world, we believe crypto markets are now large enough to allow for positions in sizes relevant to institutional investors. Looking ahead, we are following how flows into cryptocurrencies evolve in an environment of much less liquid ( and even real tighten ). While any asset will have its ups and downs, we are closely tracking whether institutional investors begin to adopt the asset class into their portfolios. At a high level, we see institutional investors as still being at the very early stages of developing exposures, but adoption looks likely to pick up in the coming years. The pace of adoption so far has been rapid, specially in smaller institutions ( for example, family offices ), such that it bears watching closely. We see institutional investors beginning to access these markets in a few distinct ways for unlike purposes :

  1. Outright exposure to cryptocurrencies: This is the most relevant to watch, since it could grow significantly in size and impact the overall risk and asset allocation of large institutions. The most liquid and common cryptocurrency for outright direct exposure is Bitcoin, which is a potential “digital gold” asset. There is also growing interest and liquidity in Ethereum, a blockchain-based computing platform, whose native currency, Ether, is required as “fuel” to power the decentralized apps on its network—akin to a “digital oil.” Exposure by smaller institutions (e.g., family offices) has grown rapidly. For the largest institutional investors, exposure is much lower but rising, with adoption still held back in part by significant operational and regulatory concerns.
  2. Exposure to arbitrage and money-making opportunities: The size of potential opportunities in any pool of liquidity can be measured by how often it trades and how high its volatility is. The crypto ecosystem has quickly emerged as a sizable pool of liquidity from this perspective, so we are seeing players step in to trade it. In turn, it is slowly becoming a part of institutional investors’ alpha risk budget as they begin to gain access to these opportunities through their holdings of hedge funds expanding into this area as well as some new crypto-specific funds.
  3. Exposure to technological growth via venture capital or equities: A large number of new businesses utilizing blockchain tech are being formed, and institutional investors are increasingly investing in them through venture capital or the few listed public equities in the space. This is generally an easy way to gain exposure, as it fits neatly into existing investment mandates and competencies. That said, venture and a few specific public equity names can only be a relatively small part of large institutions’ asset allocations.

Below, we size each of these activities. We begin with our assessment of the size of the commercialize.

Size of the Market and Paths to Exposure

Below, we give a grating sense of the allocation plowshare that Bitcoin and Ether could have in a fluent institutional portfolio relative to other assets. In assessing liquidity, we take into bill market capital, trading action, and other relevant characteristics. We have normalized each grocery store proportional to US equities, the single most liquid and accessible market in the world. Cryptocurrencies are still far from being huge markets, but Bitcoin and Ether are now large and liquid enough that institutional investors could access them in relevant size. For example, we think that Bitcoin is about 1.4 % vitamin a liquid as US equities ; this would entail holding a much smaller capital position in the fluent desegregate, but its high volatility means that a relatively little allotment in dollar terms would still give meaningful exposure on a risk-adjusted footing. As a resultant role, our approximate calculate would be that an institutional investor could build a liquid cryptocurrency allotment that is comparable in risk exposure to gold or inflation-linked bonds .
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However, cryptocurrencies are still operationally difficult for large institutional investors to access. Holding cryptocurrencies outright requires the development of new operational pathways and approvals for institutional investors. Spot bitcoin ( and related derivatives ) traded via crypto exchanges or nonprescription ( OTC ) with specialist brokers are the most fluid instruments. however, these come with risks around hands and newer counterparties and require apparatus of new functional and performance capabilities. In line, futures-based ETFs and Bitcoin CME futures are available through existing institutional pathways but represent a small parcel of the sum fluidity. The CME futures besides frequently trade at a bounty to spot and have an associated basis gamble ( that has frequently ranged well above 10 % annualized ). As a publicly traded security, the Grayscale Bitcoin Trust is an easily accessible and well-regulated product. however, it is a closed-end fund that is not redeemable for actual bitcoin, creating material footing gamble, and it is presently trading at a goodly deduction to NAV. It besides charges 2 % annual management fees, high for a passive product. There are besides other like fund products that passively track Bitcoin, Ether, or a broader basket of crypto, but these all involve meaningful fees and/or have limited fluidity. As such, unless the SEC approves a blot bitcoin ETF, handiness for big institutional investors will remain restrain by the development of hands and counterparty services .
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Our Rough Assessment of the Size of Direct Exposure by Institutional Investors

On net, we estimate that ~1 million bitcoin (around 5% of total issued supply, ~$42 billion by current prices) are now held by institutional-level players via custodial intermediaries. CME Bitcoin futures, which have ranged between ~ $ 1-5 billion great over the past year, are modest in comparison. This includes both larger institutions and smaller institutions such as family offices, ampere well as some peculiarly high-net-worth individuals. custodial intermediaries are a popular choice for such players, as it removes the technical, security, and infrastructure hurdles associated with cryptocurrencies and allows them to have exposure to the asset immediately without relying on structure products, which have fees, or actively managing an outright put through futures .
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Going Forward, Direct Allocations by Institutions Are Likely to Rise

There has been a meaningful uptick in sake toward gaining some photograph to Bitcoin and crypto over the past class or sol, across all levels of institutional investors. When we look at what is holding institutions back, some of the barriers cited in surveys are about the nature of the asset class ( e.g., it is volatile, intemperate to value, etc. ), and others are more structural ( for example, hands issues and regulative uncertainty ). however, the surveys besides indicate that a majority of respondents are interest in digital assets, with closely 8 in 10 institutions surveyed by Fidelity responding that crypto and digital assets “ have a target in a portfolio. ” We see outright exposures to crypto from large allocators as likely to grow over meter, as institutional-quality investment products and service providers continue to develop at a fast pace and more investors and their stakeholders continue along their processes of exploring the asset class. The investment by many of the major Wall Street banks over the final year in building out fresh trade desks and infrastructure for Bitcoin and crypto is another reading of expectations that institutional adoption of crypto will grow over the longer term .
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At the tip off of the spear, a growing and meaningful share of less-constrained institutional investors, such as family offices, have already begun to allocate a small parcel of their assets to outright crypto exposure. As shown below, well over half of high-net-worth investors in Europe and Asia have access to digital assets, directly or through fiscal advisors. The number is lower in the US but still goodly. additionally, about half of US kin offices and about 30 % of kin offices in Europe and Asia already hold digital assets.

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The Growth in Crypto Arbitrage and Money-Making Opportunities for Institutional Investors

The size of likely opportunities in any pool of fluidity can be measured by how much it trades and how high its volatility is. As shown above, the crypto ecosystem has quickly emerged as a goodly pool of liquid from this position, so we are seeing players step in to trade it. Traditional hedge funds have started to tiptoe into the distance as opportunities have grown. According to PWC ’ s sketch for 2020, 21 % of traditional hedge investment company respondents had some allotment to crypto ( ~3 % of AUM on average ), with most intending to deploy more capital at some point in the future. A Fidelity surveil similarly found that about 15 % of traditional hedge funds now have a crypto allotment. The types of hedge funds that have made crypto allocations are largely either quantitative/high-frequency trade ( HFT ) funds or long-short equity funds. For quant/HFT funds, the opportunity is to extend their existing market-making and statistical arbitrage processes into markets that now have meaningful volumes but remain much more ineffective and offer much higher spreads than traditional assets. For long-short equity funds, their betrothal in Bitcoin and crypto has besides frequently been via an elongation of strategies such as factor-based investing, tail-risk hedging/asymmetric bets, or stock-picking. One strategy that is presently popular among hedge funds is the market-neutral “ cash and carry ” trade. As note above, Bitcoin CME futures frequently trade at a goodly premium to spot, driven by the miss of dollar fund within the crypto markets relative to demand by speculators for extra leverage. Buying spot bitcoin and sell CME futures has collected an ~10 % annualized return since mid-2019 ( the startle of the recent crypto bull cycle ). The charts below show the premiums over prison term and the size of the short positions by hedge funds that are probably engaging in this trade .
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up until early 2021, a similar barter was available through the Grayscale Bitcoin Trust ( GBTC ), enabled by the idiosyncrasies of the product. GBTC shares had been trading at a persistent bounty to NAV for many years, but accredited investors could subscribe in primary placements for new GBTC shares issued at NAV, with a six-month lockup before junior-grade marketplace sales were enabled. Hedge funds engaging in this strategy would borrow bitcoin to exchange for GBTC, then sell those GBTC shares for a 10-20 % agio to spot bitcoin price after six months, pocketing the dispute. however, this opportunity has unraveled since 2021, as the add of GBTC grew quickly from funds crowding in, while retail demand for GBTC shares on the secondary marketplace faded due to competition from other Bitcoin products and instruments. Crypto-specific hedge funds are besides starting to emerge, specializing in strategies primarily intended to access crypto assets directly on native platforms and, in some cases, bridge inefficiencies between crypto-linked assets in traditional finance and their comparable on-chain products. As shown below, estimates of entire AUM remain relatively minor, at about ~ $ 20 billion. many of the largest crypto-native active managers have both hedge fund and VC arms, which can often entail both overlaps and some synergies but makes it unmanageable to cleanly attribute AUM. Some of the largest crypto funds are besides immediately efficaciously “ prop shops ” that do not accept outside capital .
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Crypto hedge funds, which specialize in digital assets by and large, come in one of two flavors—those that focus on higher-risk directing strategies and those that favor more market-neutral strategies, such as high-frequency trade, market-making, and arbitrage. There are besides an increasing count of funds focusing on strategies that are more recess or idiosyncratic to crypto, such as “ farming ” yield across decentralized finance protocols ( DeFi ) or trading non-fungible tokens ( NFTs ). Crypto hedge funds can, by design, move promptly to take advantage of new alpha opportunities in the space as they arise, though the custodial and complaisance risks entailed in doing sol are improbable to be acceptable for larger institutions .

Indirect Exposure via Venture Capital or Public Equities

many entrepreneurs are betting that blockchain technologies will become a spine of much of the global economy over meter and are building businesses using these technologies. These crop from new crypto asset exchanges to DeFi protocols that are seeking to rebuild traditional finance functionality in these new technologies to many other industries being reimagined ( for example, digital art, gambling, sociable networks, sharing-economy platforms ). For institutional investors, investing in these companies provides exposure to the likely of distribute daybook technologies—or collateral exposure to the cryptocurrencies themselves in some cases. exposure is small relative to their big balance sheets but easily to do, as they frequently already have buckets carved out for VC, and a few large IPOs in the end year or therefore create populace equities that can provide photograph. As shown below, guess fund for cryptocurrency and blockchain companies more than quadrupled to over $ 25 billion in 2021, and a number of high-profile IPOs in the space monetized large gains for early investors and created public fairness exposure opportunities. Crypto exchanges are a particularly popular growth investment for institutions, and we ’ ve seen respective large investors take stakes in FTX, Gemini, and of course the publicly listed Coinbase .
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This research composition is prepared by and is the place of Bridgewater Associates, LP and is circulated for informational and educational purposes only. There is no consideration given to the specific investment needs, objectives or tolerances of any of the recipients. additionally, Bridgewater ‘s actual investment positions may, and frequently will, deviate from its conclusions discussed herein based on any numeral of factors, such as client investment restrictions, portfolio rebalancing and transactions costs, among others. Recipients should consult their own advisors, including tax advisors, before making any investing decision. This report is not an volunteer to sell or the solicitation of an crack to buy the securities or early instruments mentioned. Bridgewater inquiry utilizes data and information from public, private and home sources, including data from actual Bridgewater trades. Sources include, the Australian Bureau of Statistics, Bloomberg Finance L.P., Capital Economics, CBRE, Inc., CEIC Data Company Ltd., Clarus Financial Technology, Conference Board of Canada, Consensus Economics Inc., Corelogic, Inc., CoStar Realty Information, Inc., CreditSights, Inc., Credit Market Analysis Ltd., Dealogic LLC, DTCC Data Repository ( U.S. ), LLC, Ecoanalitica, Energy Aspects, EPFR Global, Eurasia Group Ltd., european Money Markets Institute – EMMI, Evercore, Factset Research Systems, Inc., The Financial Times Limited, GaveKal Research Ltd., Global Financial Data, Inc., Harvard Business Review, Haver Analytics, Inc., The Investment Funds Institute of Canada, ICE Data Derivatives UK Limited, IHS Markit, Impact-Cubed, Institutional Shareholder Services, Informa ( EPFR ), Investment Company Institute, International Energy Agency ( IEA ), Investment Management Association, JP Morgan, Lipper Financial, Mergent, Inc., Metals Focus Ltd, Moody ’ south Analytics, Inc., MSCI, Inc., National Bureau of Economic Research, Organisation for Economic Cooperation and Development ( OCED ), Pensions & Investments Research Center, Qontigo GmbH, Quandl, Refinitiv RP Data Ltd, Rystad Energy, Inc., S & P Global Market Intelligence Inc., Sentix GmbH, Spears & Associates, Inc., State Street Bank and Trust Company, Sustainalytics, Totem Macro, United Nations, US Department of Commerce, Verisk-Maplecroft, Vigeo-Eiris ( V.E ), Wind Information ( HK ) Company, Wood Mackenzie Limited, World Bureau of Metal Statistics, World Economic Forum, NBER 2021 ( Igor Makarov and Antoinette Schoar ), Glassnode, and Coinbase. While we consider information from external sources to be authentic, we do not assume province for its accuracy. The views expressed herein are entirely those of Bridgewater as of the date of this report and are subject to change without detect. Bridgewater may have a significant fiscal interest in one or more of the positions and/or securities or derivatives discussed. Those creditworthy for preparing this report receive compensation based upon assorted factors, including, among other things, the timbre of their shape and firm revenues.

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