'One Small Step For Managers, One Giant Leap For Bitcoin' - On The Edge Of A Paradigm Shift

Summary

• Bitcoin's recent growth is fueled by both aspects. Its ecosystem has matured, leading to more applications in real life.
• In anticipation of its wider adoption, financial institutions started delving into the crypto space, resulting in a strong inflow of capital.
• Unlike its 2017 retail frenzy, bitcoin's recent upsurge is partly driven by financial institutions' interests.

By Jianing Wu and Florian Ginez

Mainstream adoption of technology occurs when a system is robust, and its value is recognized by the public. To quantify these measures, let's talk about utility value and speculative value.

Utility value refers to the benefits that the technology provides, reflected by its demands.

Speculative value is when investors believe the technology is worth a value based on future expectations.

Both factors are essential in advancing a system's expansion-utility value is unsubstantiated if speculative value doesn't grow, and conversely, speculative value is artificial if utility value doesn't follow.

Bitcoin's recent growth is fueled by both aspects. Its ecosystem has matured, leading to more applications in real life. In anticipation of its wider adoption, financial institutions started delving into the crypto space, resulting in a strong inflow of capital.

Unlike its 2017 retail frenzy, bitcoin's recent upsurge is partly driven by financial institutions' interests.

In our first blog post of the series, we introduced corporations' purchases of bitcoin as part of their balance sheet assets. Here, we will discuss the second source of institutional demand-the investment management industry's participation.

A Shift in Narrative and Perception

Financial institutions' views of bitcoin have been evolving.

In the beginning, bitcoin was mainly regarded as electronic cash, and many saw it as a means to facilitate illicit activities. As time passed, analysis by blockchain analytics companies like Chainalysis have helped debunk the idea that bitcoin is mostly used for illicit activities-the estimated amount of laundered money accounts for 2%-5% of global GDP ($800B-$2T), while total illicit value including money laundering related to cryptocurrency accounts for 0.34% ($10B) of its transaction volume.¹

The narrative also shifted to acknowledge bitcoin as a financial asset for the potential store of value, largely per virtue of its limited supply, as well as a candidate for consideration in portfolio diversification.

The current inflationary and low-yield environment aids the financial asset narrative, as fiat money and bonds become less attractive vehicles to store value. Furthermore, companies' plans to accept bitcoin and blockchain technology's applications demonstrate one aspect of bitcoin's utility value. Bitcoin's growing influence has boosted end clients' interests to capture the potential upside of this new technology. Their interests have in turn encouraged asset managers to incorporate it into portfolios.

The Bitcoin Ecosystem Evolution

Structurally, the underlying bitcoin network has matured since its birth. The fact that bitcoin has been in place for more than a decade is a testimony of its operational validity.

Not only are the mining machines used today much more advanced, but miners and users also expanded significantly: There are now more than 76K mining nodes and 1.2M active bitcoin addresses.²

The evolution of bitcoin can also be seen through the development of its trading infrastructure. Trading volumes on the eight major exchanges have passed $11B, reaching an all-time high.³ Compared to the early days when bitcoin first started trading, the current infrastructure offers better custody solutions, more efficient pricing, higher liquidity and easier access.

• Better Custody - When someone "owns" bitcoins, what they really own are the private keys associated with their bitcoin wallets. In the past, investors either self-custodied or stored their keys in exchanges' hot wallets. These methods led to regrettable password losses and high-profile hacks. Firms have stepped in with custody solutions to provide safer and more convenient options to protect bitcoin ownership. They generally achieve this by storing private keys (or key fragments) offline-commonly referred to as cold storage. Other technologies, such as multi-party computation (MPC), have also enabled secure key storage.

• More Efficient Pricing and Higher Liquidity - Market makers such as DRW's Cumberland, Jane Street, Jump Trading and Flow Traders entered the crypto space as early as 2014. They provide liquidity, minimize slippage and reconcile prices across platforms by arbitraging the difference away. Their involvement creates a more efficient market to execute trades.

• Easier Access - Institutional investors now have more tools to obtain bitcoin exposure. Bitcoin futures have grown significantly over the years. We are also witnessing the expansion of Europe's bitcoin ETP market, as well as the birth of North America's bitcoin ETF market. Moreover, exchanges such as Coinbase and Gemini are building trading systems that resemble equity systems to bring the traditional securities experience to the crypto world.

Bitcoin's network expansion has eased institutional investors' concerns about legitimacy. The development in bitcoin's trading infrastructure has paved the way for the entrance of institutional investors.

How Can Investors Get Access to Bitcoin?

Investment managers, either directly or through their affiliates, are taking steps to provide bitcoin exposure to end clients. Some of the measures include establishing crypto trading operations, offering custody services, financing transactions and allocating to bitcoin in their investment funds.

• Direct physical holding of bitcoins, often through custodians.

• Investment through bitcoin exchange-traded products (ETPs/ETFs), which eliminates the burden of managing keys and custody for the investor while providing physical exposure.

• Synthetic exposure through regulated futures like the CME instrument, offering the usual advantages that come with any other commodity futures contract (settlement, ease of shorting, leverage, etc.).

• Indirect investment through equities, such as cryptocurrency mining companies or companies that hold bitcoin in their corporate treasury.

Institutional Money Entering the Futures Market

Regulated bitcoin futures debuted in December 2017 on the Chicago Mercantile Exchange (CME). Since then, a lot of new buyers have been entering the market via futures. They include family offices, asset managers and hedge funds.

Because most participants from this channel adhere to strict compliance rules and are prohibited from trading unregulated futures on retail platforms, bitcoin futures' open interests and volume on regulated exchanges are important indicators for institutional activities.

Recently, we have witnessed a strong pickup in institutional demand, reflected by significant rises in open interest (over $2B) and trading volume (close to $2.8B) on the CME Bitcoin futures.

Figure 1: Bitcoin Futures on CME

Bitcoin Trusts and ETPs Bringing Strong Inflows

Bitcoin trusts, private funds and ETPs have also taken in significant money in recent months. Since January 2020, bitcoin ETPs took in nearly $900M in inflows.

The flow has been dominated by European products, and the North American funds are on the rise with the recent launch of Canadian ETFs. OTC-traded trusts, which are currently trading in the U.S. and have existed for a longer period of time, have taken in an even greater sum of money.

Figure 2: Cumulative Net Flows into Global Bitcoin Funds

In February 2021, bitcoin ETFs gained regulatory approval in Canada and began trading on the Toronto Stock Exchange. In just one month, the combined AUMs of such ETFs rose to more than $580M USD. Other jurisdictions, including the U.S., may follow by allowing bitcoin-focused ETFs and/or allocating greater exposure to bitcoin futures in U.S.-registered ETFs.

As we've discussed in other blog posts, we believe ETPs and ETFs can provide effective access to bitcoin for investors. The flows into these vehicles indicate continued retail and institutional interest in the asset class.

Conclusion

It is important to recognize that bitcoin's ecosystem is not yet fully developed, but it is equally important to acknowledge that its landscape is changing rapidly.

As bitcoin grows organically and realizes its utility value, we believe its speculative value will be gradually substantiated. At this moment, we are witnessing the beginning of a new paradigm, shifting away from a quasi-exclusive retail asset to a more widely accepted financial instrument.

¹Chainalysis 2021 Crypto Crime Report, https://www.unodc.org/unodc/en/money-laundering/overview.html
²Colin Harper, "Are You Running a Bitcoin Node?" Coindesk.com, 1/29/21. https://www.coindesk.com/are-you-running-a-bitcoin-node
³The eight exchanges refer to Bitfinex, Coinbase, Kraken, Bitstamp, bitFlyer, Gemini, itBit and Poloniex. https://www.coindesk.com/bitcoin-active-addresses-trading-volumes-all-time-highs

Important Risks Related to this Article

Please note WisdomTree Asset Management, Inc., does not offer any bitcoin products.

Bitcoin operates as a decentralized, peer-to-peer financial exchange and value storage that is used like money. Bitcoin operates without central authority or banks and is not backed by any government. Bitcoin generally experiences very high volatility. Bitcoin is also not legal tender. Federal, state or foreign governments may restrict the use and exchange of cryptocurrency, and regulation in the U.S. is still developing. Bitcoin exchanges may stop operating or permanently shut down due to fraud, technical glitches, hackers or malware.

This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This material should not be relied upon as research or investment advice regarding any security in particular. The user of this information assumes the entire risk of any use made of the information provided herein. Unless expressly stated otherwise, the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.

Jianing Wu, Senior Analyst, Research

Jianing Wu joined WisdomTree as a Research Analyst in October 2018. She is responsible for analyzing market trends and helping support WisdomTree’s research efforts. Previously, Jianing completed internships and projects at Geode Capital, Starwint Capital, and Invesco Great Wall Fund Management with a focus in quantitative research. Jianing received her M.S in Finance from the Massachusetts Institute of Technology. She graduated with honors from Boston College with degrees in Mathematics and Philosophy.

Florian Ginez, Associate Director, Quantitative Research

Florian Ginez is an Associate Director, Quantitative Research for WisdomTree in Europe. He is responsible for market analysis, formulating investment and hedging strategies, trade ideas, as well as the development of products collateral and automating research processes. He also works closely with WisdomTree’s Quantitative Group on data analytics. Florian joined WisdomTree in 2016 after he started his career as an Assistant Portfolio Manager at Amaïka Asset Management in Paris, researching factor investing. Florian holds a Master’s degree from Neoma Business School.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Comments

[jackrandolf]

Read "The Age of Cryptocurrency" for a balanced discussion, and bear in mind that book was written 5 years ago.

[BayArea2016]

Timely and correct. It isn't to late for those who haven't pulled the trigger. Know this ... the lowest price forward for bitcoin 5 years from now is around $600K.

[jdah411]

Very impressive. Thanks so much!

[manfac]

This article was interestingly written using the concept of crypto specifically Bitcoin .
By definition Bitcoin represents a safe and secure means for value .

Bitcoin Value is brought from the economic term of Utility and the capitalistic term of Speculative .

Beyond the terminology those aspects of Bitcoin are surging demand in the Market.

Will Bitcoin deepen to the level that Fiat has never really overcome it's inflationary instability ?

[PaFromFL]

The nail that sticks up, gets hammered down. As cryptocurrency gets more popular and profitable, entrenched governments will see it as a threat to their power and monopoly on money. I expect that governments will ban cryptocurrency using the pretense of a war against drug lords, human trafficking, tax cheaters, energy waste, etc.. Power to the people sounds nice, but ask Bernie Sanders and Donald Trump how that works out in the long run. Money can be made (literally) until the hammer comes down, but it always pays to keep an eye on the authorities (remember the stock sales by congressmen before the pandemic announcement?).

[ngtenor]

@PaFromFL They can't ban it. If they could, they would have done it already. The problem is that the technology is going to generate so much economic activity, and this puts governments in a real bind. I'm not talking about crypto as a store of value (which everyone seems to be fixated about on this website) but as a UTILITY.
Crypto is already being used to eliminate advertising and retail coupon fraud and monitor the rollout of vaccines. Soon, it will eliminate pharmaceutical fraud, enable fair elections, ensure the fair trading of carbon credits... the use-cases are endless. Crypto is even being used to prevent Syrians from being bombed by their own government!
You can read more about what's coming here:
seekingalpha.com/...

[ephud]

@ngtenor

You are talking about blockchain, not crypto which is based on blockchain.

[ngtenor]

@ephud With Proof of Stake, one can't exist without the other.

[Fero.]

Where is the utility of BTC? All I see in this article is speculation based on expected store of value. This or that is buying BTC. What are they going to do with it if they are never going to sell it? How is it going to provide anything to anybody unless he sells it for more at a later stage? That's what I want to know.

[dpfor3]

@Fero. There is no utility in it other than speculation. How would buying Bitcoin improve my life? Truth is, it wouldn’t unless the price appreciated and I could sell it to buy things that actually could improve my life. It’ll collapse at some point because the store of value doesn’t hold up either, as every new Crypto bastardizes the value of every other Crypto. Precious metals are the only true store of value as they can’t be replicated.

[Jamjack]

Total portfolio weighting is about 1% and my cost basis is very low now and appreciated value is still very high in the Grayscale so I don't know what to say to the naysayers....However, history teaches us a lot. There can and will be bubbles, but to say fiat paper government currency is the only reliable medium of exchange and to dismiss these crypto currencies like Bitcoin is not very smart and indeed goes against the lessons of history. I do get a little irritated with those who think we all need to know all the technical information on how it works, the creation and the function including mining aspects in order to make a wise and informed decision on crypto currencies. How many people know advanced monetary theory and federal reserve policy and money supply (sure it helps) in order to make informed investment decisions and depend on the paper dollar to buy and sell goods. Could we might just be looking at an alternative global currency not tied to any one country.

[Fero.]

@Jamjack , thanks for confirming what I wrote. It has no use to you except giving you warm feelings from looking at large unrealized capital gains. Just remember unrealized gains are just that, till you make them realized by selling. They can vanish faster than they materialized.

[richjoy403]

Thanks for the well-balanced article.

Compared to the size of the portfolios I manage, their BTC positions are relatively small, as would be expected of any other speculative investment.

Rich-untrack:12hrs

[petsitter210]

Bitcoin is mainstream. Love it or hate it, crypto is here to stay. Once the lightening network is in full swing, we'll be counting satoshis, not fiat.

[Fero.]

@petsitter210 , the gold standard failed for a reason. It is being used nowhere. How can anybody expect a pseudo gold standard to be accepted anywhere is beyond me. You hate fiat you can still settle your bills in gold if you find a counterparty that accepts it. Same with BTC. But that feature does not make it money and never will in the future. Because no fiat will be ever tied to BTC. Like they are not tied to gold anymore. A volatile commodity at best.

[ababich1]

I have studied btc and can find no reason to buy it. It is at best a confidence game. If you have confidence you buy it. That confidence however is built on a very weak foundation and very fragile.

[Kochie OneTime]

@ababich1 you studied Btc and found it’s at best a confidence game? I’d say it’s at best would be it’s an open, global financial network. It’s already solving real world problems, like fees on remittances. It’s openness and interoperability mean anyone can create and compete freely and this creativity and competition are both wildly additive to the value of the network. No private company could afford to hire as many people building it’s network as are currently working on Btc and peripheral layers now and at any given moment. The scarcity of Bitcoin the asset makes it valuable as a store of value. But the exponentially growing network is what can really shape the future. Check out what innovation and adoption curves look like over time. Best to at least keep learning than to write off completely IMO.

[SelfEmployedSepRothandRentals]

It might be similar to the "Information Superhighway"

[ababich1]

@Kochie OneTime
All interesting points but still built on confidence not a hard assets. A store of value...hardly. Real estate with which to grow food, manufacturing, things that matter in ones life represent a store of value. Even if it gains confidence, Its use will be challanged by various governments. The fees to trade through the exchanges are costly ...no free lunch.

[Matts_Bytes]

No one, including fund managers, should invest in this type of asset without first *Understanding how it actually Works* !

You'll notice such details are conveniently missing from this article

I am a lifelong technologist, I believe there is great potential to crypto technologies, but you won't harvest it by owning an outdated coin that can't be mined anymore and is impractical for transactions (EDIT to clarify, your personal mining is effectively ZERO compared to miners of previous years [exponential difficulty increase] and the current professional ASIC miners).

Do your homework, and seek more nuanced opinions.

[ephud]

@Matts_Bytes

"you won't harvest it by owning an outdated coin that can't be mined anymore"

Can't be mined anymore? I'm mining it now.

[TimBandito]

@Matts_Bytes

An "outdated coin" whose adoption is increasing daily...Unless you're referring to the USD "coin", which can't be "mined" due to the fact it was removed from the gold standard in the 70s...How is the USD's currency devaluation favoring anyone?

[Matts_Bytes]

@TimBandito I heard tulips were adopted pretty heavily at one point too.

At least those could change hands easily...

[Pompano Frog]

Dear Reader..

I have experienced so many of these bubbles over the years that you can't believe a new set of fools will fall for a slight change of name and be given the same old elaborate details which mean nothing. This certainly demonstrates that these ETF aggregators are pure marketing organizations who hire young MBA's to do their simplistic analysis to some topic to make it appear that there is some thinking behind all of this investment structure. I assure you there is not.

"Institutions," and I use the word loosely are buying bitcoin for accounts because their clients are asking for about it. These "institutional investors" will buy anything their clients want. They are marketing machines.

Musk didn't buy Bitcoin because of his belief in it. It is because he is smart enough to realize the unknowledgeable who buy Bitcoin also are the same buyers who participate in all of his other equity raises.

The existence of Bitcoin allows for free capital flows around the world. It makes tax avoidance for the wealthy easier. It makes drug money easier to move. It makes it easier to move money out of poor countries.

China has an economic plan. It is not an accident that China has had enormous per capita income growth over the last 30 years. The center of that economic plan is to maintain a dramatically undervalued currency for as long as possible. This is what made Japan. China has designed a tax system to encourage a huge savings rate. That savings rate is funneled through large Chinese financial institutions which carry out their lending activities under the guidance of China's Ministry of Finance.

The first order of business for that lending direction is to offset the positive trade flows with overseas capital flows and/or lending. This is done to maintain a low appreciation rate for the Yuan. China cannot afford capital flows that cannot be controlled. At some point China will use the full force of the State to do something about this. You don't want to be on the other side of this.

This market is unstable to begin with. It will only take one global institutional investor to realize they have to much committed to U.S. equities to start this thing moving in the other direction. Since most investors are using a mental or real momentum model it could unravel very quickly.

S&P 4019, Nasdaq 13480, GBTC 50.87, ARKK 120.85, SPAK 26.92, IPO 63.46

[NoahKaufmanMD]

@Pompano Frog My god you’re out of touch.

[TimBandito]

@Pompano Frog
"Musk didn't buy Bitcoin because of his belief in it. It is because he is smart enough to realize the unknowledgeable who buy Bitcoin also are the same buyers who participate in all of his other equity raises."

Did Musk tell you this?

[Positive777]

@Pompano Frog

I wouldn't talk for the richest man on the planet if I were you. I woukd think that none of know what he is thinking.

Crypto is here to stay and defi most definitely. Those that broke the system cannot fix it. And they might damage the value of btc by heavy regulation but they will never destroy it. It is transnational.

The only thing that could would be a 51% attack or quantum computing, for which workarounds will be found in due course out of necessity..

The world is changing...

[Kagami427]

Certainly. Many long awaited key governmental and banking decisions have been made just in the past few days. I'm sure many have heard of or seen the Citibank projection for over $300,000 (318K?) by the end of '21. I don't know that it will go quite that fast but I do think another double by the end of the year is possible for sure. We've seen a lot of positive things or catalysts for price appreciation happen all at once.

Federal banks can now hold Bitcoin and other crypto assets/tokens (I believe its both, but tax can get complicated...) on behalf of the bank's customers legally as of just a few days ago now. There is sufficient demand from investors to get involved so the banks have listened to the customers demands or requests as Government has since given the okay ( the okay to collect taxes :-] ) to do so and its certainly a decision that's evolved over time through various important avenues. Of late, it hasn't been hard to see the real positive impact that blockchain technology and the cryptocurrencies or tokens that represent that technology (in many cases,) have on the world. The new technology certainly has the potential to make just about everything (almost,) better in any and/or every way you or your employed engineer can personally think up. Applications are endless. We are already starting to see the asset class have real impact on the world even in these very early days, IMO.

Agreed! Nice article!