The “new gold” is how the young asset class of cryptocurrencies is often described.
With miners virtually unearthing new ‘coins’ every day via a decentralised system that operates beyond the influence of government, it’s easy to see the attraction.
The “new gold” is how the young asset class of cryptocurrencies is often described. With miners virtually unearthing new ‘coins’ every day via a decentralised system that operates beyond the influence of government, it’s easy to see the attraction.
Since the start of 2020, Bitcoin has appreciated over 35 per cent, while “old” gold rose 11 per cent, and the S&P 500 index of US stocks was flat.
But the majority of institutional investors are only just starting to dip a toe into crypto waters. Just over a third of institutional investors say they are currently invested in digital assets, according to a recent survey by Fidelity Digital Assets. With six out of ten saying they believe digital assets have a place in their portfolio, crypto may be about to hit the mainstream.
“One of the biggest blocks to investment is liquidity, and the other is the legal answer. It was very unclear until two years ago if you were a regulated fund whether you were allowed to touch this stuff.” This is how Alex Batlin, CEO and founder of digital assets custodian Trustology, who previously worked at UBS and BNY Mellon, explains the lack of investment so far.
Until 2017 and early 2018, when the combined market capitalisation of all cryptocurrencies hit USD800 billion, Batlin says the crypto landscape was simply not deep enough for traditional asset managers to take an interest. It was then that Batlin says “we saw the first surge of interest from institutional players”, as banks sought after a way to safely store digital assets.
Much of that interest vanished as quickly as it had appeared, when the market subsequently nosedived, but Batlin says it was at this time that many asset managers “caught the bug”, and left their firms to launch “small institutional crypto-focused funds, managing between USD5 to 10 million”.
In the meantime, regulators have been catching up with crypto’s popularity. The BaFin regulation in Germany has allowed banks to provide crypto services for the first time, and a new update to the EU’s anti-money laundering directive has brought crypto custodians under a new license, that makes it clearer who’s participating in crypto transactions.
According to Batlin, these improvements mean the market is primed to see a second wave of interest. The coronavirus crisis has made many asset managers rethink how they are going to make money, as we enter a world of negative yields, government spending sprees, and risk increasing in debt and equity markets.
“One thing that Covid proved is that people will continue to look for assets that can’t be quantitatively eased.” Batlin says that many countries are “printing money at a pretty high rate”, which benefits the domestic society, but does nothing for the foreign investor. “Their holdings go down with the currency devaluations, which have happened twice.”
According to Batlin, “Bitcoin is gold without the physical transfers and settlement risks”, and he says that the fact that it is decentralised makes it a more resilient system than traditional banking, which relies on people to keep banking ledgers up to date.
But it’s safety-first for the institutional investors. Understandable, given the infamous cyber thefts in crypto history, like the raid on Mt Gox exchange in 2014.
Batlin says that until recently there were “no solutions that were good enough” to protect digital assets, noting that “people literally used to wear crypto keys around their necks”.
“Most people would never dream of taking personal risks to that extent, but in crypto, people were inexperienced and didn’t realise the risks they were taking.”
Trustology says it has solved these risks by combining the perks of online and offline storage for crypto keys, and the firm is also insured in case something goes wrong. Online storage makes transfers easier, but also leaves open the possibility of cyber-attacks. Trustology says it has deliberately limited its server’s capabilities, so that one has to be physically present in the data centre to modify security controls.
An uptick in institutional investor enquiries to Trustology has already begun. “A lot of large asset managers are preparing plans to launch around January or February next year,” says Batlin.
Nevertheless, it will be a while before everyone is cheering for a crypto-utopia. In late May, Goldman Sachs noted on a call with analysts that while cryptocurrencies like bitcoin “have received enormous attention,” they “are not an asset class.”
The investment bank cited bitcoin’s inherent lack of cash flow, unlike bonds, and its inability to generate earnings through exposure to global economic growth, as well as the recent price volatility.
As long as regulation, market infrastructure, and security continue to catch up with traditional investment, managers can expect to see digital assets as a real alternative.
