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 just 18 months ago. These run-ups took target during a time of unprecedented fluidity, as trillions of dollars of cardinal banks ’ money printing made its way to households via fiscal policies. Over this menstruation, the fluidity of cryptocurrencies significantly increased as many raw players entered the markets, and newfangled exchanges, instruments, and serve 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 fluidity ( and even veridical reduce ). 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 borrowing so far has been rapid, specially in smaller institutions ( for example, kin offices ), such that it bears watching closely. We see institutional investors beginning to access these markets in a few clear-cut ways for different 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 judgment of the size of the commercialize.

Size of the Market and Paths to Exposure

Below, we give a harsh sense of the allocation contribution that Bitcoin and Ether could have in a liquid institutional portfolio relative to other assets. In assessing liquidity, we take into account market cap, trade activeness, and other relevant characteristics. We have normalized each grocery store relative to US equities, the single most liquid and accessible market in the populace. 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 exemplar, we think that Bitcoin is about 1.4 % adenine liquid as US equities ; this would entail holding a a lot smaller capital side in the liquid mix, but its high volatility means that a relatively small allotment in dollar terms would still give meaningful exposure on a risk-adjusted footing. As a solution, our rough estimate would be that an institutional investor could build a liquid cryptocurrency allotment that is comparable in risk vulnerability 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 functional pathways and approvals for institutional investors. Spot bitcoin ( and related derivatives ) traded via crypto exchanges or over-the-counter ( OTC ) with specialist brokers are the most liquid instruments. however, these come with risks around hands and newer counterparties and require frame-up of newfangled operational and execution capabilities. In contrast, futures-based ETFs and Bitcoin CME futures are available through existing institutional pathways but represent a little share of the entire liquidity. The CME futures besides often barter at a premium to point and have an associated basis hazard ( that has frequently ranged well above 10 % annualized ). As a publicly traded security system, the Grayscale Bitcoin Trust is an easily accessible and well-regulated merchandise. however, it is a closed-end fund that is not cashable for actual bitcoin, creating material basis hazard, and it is presently trading at a ample rebate to NAV. It besides charges 2 % annual management fees, high for a passive intersection. There are besides other exchangeable fund products that passively track Bitcoin, Ether, or a broader basket of crypto, but these all involve meaningful fees and/or have limited liquid. As such, unless the SEC approves a descry bitcoin ETF, handiness for big institutional investors will remain stiffen 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 small in comparison. This includes both larger institutions and smaller institutions such as family offices, american samoa well as some peculiarly high-net-worth individuals. custodial intermediaries are a popular option for such players, as it removes the technological, security, and infrastructure hurdles associated with cryptocurrencies and allows them to have exposure to the asset directly without relying on structured products, which have fees, or actively managing an instantaneously placement through futures .
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Going Forward, Direct Allocations by Institutions Are Likely to Rise

There has been a meaningful uptick in interest toward gaining some exposure to Bitcoin and crypto over the past year or so, 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 course ( e.g., it is volatile, difficult to respect, etc. ), and others are more structural ( for example, custody issues and regulative uncertainty ). however, the surveys besides indicate that a majority of respondents are interest in digital assets, with about 8 in 10 institutions surveyed by Fidelity responding that crypto and digital assets “ have a place in a portfolio. ” We see outright exposures to crypto from large allocators as probable to grow over time, as institutional-quality investing products and serve 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 stopping point year in building out new trade desks and infrastructure for Bitcoin and crypto is another indication of expectations that institutional adoption of crypto will grow over the longer term .
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At the tip of the spear, a growing and meaningful partake of less-constrained institutional investors, such as family offices, have already begun to allocate a minor dowry 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, immediately or through fiscal advisors. The number is lower in the US but still goodly. additionally, about one-half of US family offices and about 30 % of family 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 senior high school its excitability is. As shown above, the crypto ecosystem has promptly emerged as a ample pool of fluidity from this position, so we are seeing players step in to trade it. Traditional hedge funds have started to tiptoe into the space as opportunities have grown. According to PWC ’ s view for 2020, 21 % of traditional hedge fund 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 review 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 trading ( 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 engagement in Bitcoin and crypto has besides much been via an extension of strategies such as factor-based induct, tail-risk hedging/asymmetric bets, or stock-picking. One strategy that is presently democratic among hedge funds is the market-neutral “ cash and carry ” trade. As note above, Bitcoin CME futures frequently trade at a goodly agio to spot, driven by the lack of dollar fund within the crypto markets relative to demand by speculators for extra leverage. Buying blot bitcoin and sell CME futures has collected an ~10 % annualized return since mid-2019 ( the begin of the late crypto taurus hertz ). The charts below show the premiums over time and the size of the short positions by hedge funds that are likely engaging in this trade .
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up until early 2021, a alike trade was available through the Grayscale Bitcoin Trust ( GBTC ), enabled by the idiosyncrasies of the intersection. GBTC shares had been trading at a haunting agio to NAV for many years, but accredited investors could subscribe in primary placements for modern GBTC shares issued at NAV, with a six-month lockup before secondary market sales were enabled. Hedge funds engaging in this scheme would borrow bitcoin to exchange for GBTC, then sell those GBTC shares for a 10-20 % premium to spot bitcoin monetary value 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 market faded due to competition from early Bitcoin products and instruments. Crypto-specific hedge funds are besides starting to emerge, specializing in strategies chiefly intended to access crypto assets directly on native platforms and, in some cases, bridge inefficiencies between crypto-linked assets in traditional finance and their corresponding on-chain products. As shown below, estimates of sum AUM remain relatively modest, at about ~ $ 20 billion. many of the largest crypto-native active managers have both hedge fund and VC arms, which can frequently entail both overlaps and some synergies but makes it difficult to cleanly assign AUM. Some of the largest crypto funds are besides now effectively “ property 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 directional strategies and those that favor more market-neutral strategies, such as high-frequency trade, market-making, and arbitrage. There are besides an increasing issue of funds focusing on strategies that are more niche or idiosyncratic to crypto, such as “ farming ” move over across decentralized finance protocols ( DeFi ) or trading non-fungible tokens ( NFTs ). Crypto hedge funds can, by blueprint, move promptly to take advantage of fresh alpha opportunities in the space as they arise, though the custodial and conformity risks entailed in doing therefore 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 backbone of much of the ball-shaped economy over prison term and are building businesses using these technologies. These range from fresh crypto asset exchanges to DeFi protocols that are seeking to rebuild traditional finance functionality in these newfangled technologies to many early industries being reimagined ( for example, digital art, gambling, social networks, sharing-economy platforms ). For institutional investors, investing in these companies provides exposure to the potential of spread daybook technologies—or indirect exposure to the cryptocurrencies themselves in some cases. exposure is minor relative to their large balance sheets but easy to do, as they frequently already have buckets carved out for VC, and a few large IPOs in the last year or therefore produce public equities that can provide vulnerability. 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 bombastic gains for early investors and created public equity exposure opportunities. Crypto exchanges are a peculiarly 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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