Digital Assets - The latest craze or here to stay?

Diving into Digital Assets

As a young, future-conscious firm that prides itself on keeping a finger on the pulse of industry-wide trends, we have hand-picked several relevant topics & disruptive themes to explore in a series of ongoing posts, surveys, and research updates. These topics include the rise of the digital asset class, growing ESG concerns & controversy, millennial investors and the great wealth transfer, and more...

Cryptocurrency: a topic that annoys some, excites others, and above all – a topic that can no longer be ignored.‍

Bitcoin will soon be welcomed into the teenage years, celebrating its 13th birthday on the 3rd of January 2022. At one point representing the entirety of the crypto market, it has now been relegated to merely being the largest player in a growing, diverse market that crested the $1 trillion mark for the first time in January of this year.  

2020 proved to be a breakout year for this emerging digital asset class, with headlines dominated by several high-profile corporate purchases of Bitcoin. Notable corporate buyers include Tesla, Microstrategy and Square, amongst others. This was followed by a dramatic runup in the Bitcoin price, which blew through the previous peak of around $19,500 in late 2017 to a level that currently sits comfortably above the $50,000 mark.

The broader cryptocurrency markets have seen a similarly meteoric rise since the beginning of last year, with the total market capitalization exploding from approximately $200 billion in early 2020 to just over $2.8 trillion as of 12 November 2021. Having survived its fair share of ups and downs over a mind-numbingly volatile history, the signals are increasingly clear that this is a market that is here to stay, and is now starting to be rewarded with serious attention and interest as a legitimate investment proposition.

Since 2019, Fidelity Digital Assets publishes an annual survey of institutional investors around the world to track opinions and preferences vis-a-vis crypto markets, providing a fascinating overview of the evolving perspectives on digital assets - what makes them interesting, who is investing in them, and what is holding many back from dipping their toes into these historically turbulent waters?  

This article provides a concise overview of the current state of the market, guided at each step by a selection of choice findings from Fidelity’s 2021 survey, and lays the groundwork for upcoming posts that will dive deeper into some of the more pressing topics.

If you’re interested in the investment propositions underlying the most popular cryptocurrencies, or a deep-dive into Bitcoin and its ESG-related concerns (and much more), make sure to subscribe and follow us on LinkedIn to stay in the loop!

Shifting World, Shifting Narratives

A chaotic global macroeconomic environment characterized by unprecedented monetary policy measures may have caused many to more seriously consider the investment thesis offered by cryptocurrencies – going beyond mere technological innovation and delivering a store of value, or at the very least an uncorrelated asset that could find a meaningful place in a diversified portfolio.

A primarily technological discussion driven by the idea of displacing middlemen in financial services with blockchain technology is now evolving into a proposition that positions cryptocurrencies as legitimate stores of value and alternative investments, a sentiment echoed by Peter Jubber – managing Director of Fidelity Digital Assets – in a recent interview with the founder of Deloittes's Blockchain Practice, Rob Massey. Initially the domain of cypherpunks, technological enthusiasts, and speculators with an elevated tolerance for risk and volatility; the continued durability, success and innovation of Bitcoin, Ethereum and other cryptocurrencies has over time led to a maturing narrative and investment thesis that is now beginning to attract a much broader class of investors. 

Underscoring this, Fidelity's Digital Asset survey also noted that beyond the high potential upside and the appeal as an innovative technology play, the third most appealing factor for institutional investors was the uncorrelated nature of digital assets.

Swelling Demand for Investment Products, Lagged by Growing Offering

If 2020 was the breakout year for Bitcoin as a corporate treasury asset, this year is on track to becoming the breakout year for Bitcoin and cryptocurrency-backed investment products launching (and thriving) on traditional, regulated markets. These products provide a secure avenue for investors to gain exposure to cryptocurrencies via traditional brokerage accounts, accompanied by the potential tax benefits and regulatory protections that come with traditional investment products. The secondary appeal for this class of products lies in the abstraction of complexity and risks associated with directly buying cryptocurrencies on crypto exchanges. Interested institutions and investors that purchase these investment products delegate the responsibilities of buying crypto (and the learning curve associated with learning how to navigate the various blockchains, exchanges and wallets involved in this process) and holding crypto (accompanied by the stress of security and safe custody of various wallet private keys and passwords) to the specialized companies offering these products.

The Grayscale Bitcoin Investment Trust was launched in 2013 as one of the first products offering an avenue for institutions and individual US accredited investors to gain exposure to Bitcoin. The pioneering investment product has seen its assets under management swell from just over $7.5 billion last November to over $43 billion as of early November this year, buoyed by a combination of strong price action and continued inflows of capital. More recently, Grayscale has also released a broader offering of similar products for other leading cryptocurrencies. Due to the structuring of the product as a trust, however, investors still have to deal with an extended 6-month lock-up period upon purchasing shares of this product, often paying significant premiums over the underlying Bitcoin price in the process, on top of a relatively steep 2% annual management fee.  

Having cemented its spot as the market leader in this space, Grayscale is facing increasing competition from a number of new entrants. The first US Bitcoin ETF was launched on October 19 of this year in the form of Proshares' BITO Bitcoin ETF, opening the floodgates for retail investors to enjoy the same benefits that were previously afforded to only accredited investors. The fund secured a record-breaking debut, with close to $1 billion in volume in its first day of trading (second only to a BlackRock low-carbon fund in total first-day volume), with close to $1.4 billion in Assets under Management less than a month later in mid-November. Despite its advances in opening up this market toward retail investors, accompanied by a lower expense ratio versus the Grayscale Bitcoin Trust, the fund has still been a recipient of notable criticism. Its structure as a futures-based Bitcoin fund that holds Bitcoin futures contracts instead of Bitcoin directly can result in discrepancies between the performance of the fund and the underlying Bitcoin price it is intended to track, leaving ample room for improvement for future competitors in this space. 

Further north in the Canadian markets, investors were graced with access to the world's first physically traded Bitcoin ETF in February, with the Purpose Bitcoin ETF gathering more than $1 billion in Assets underManagement within the first 6 months of trading, and across the Atlantic, financial firm Jacobi Asset Management has received the regulatory permissions needed to launch the first European Bitcoin ETF and open up this line of products to the European markets.

Even with demand running hot and clear points of improvement for the current range of available investment vehicles, newer and improved products are not likely to start entering the market at more than a trickle due to the lengthy process required to obtain the regulatory green-light for listing, thus it may take time for some of the mentioned inefficiencies and fees to be slowly whittled down.

Old & New Concerns

Despite growing interest, acceptance, and accessibility, the cryptocurrency space still hasn’t fully outgrown the challenges that come with being a young and emerging asset class. The primary concerns for institutional investors outlined in Fidelity's Digital AssetSurvey revolve around volatility in price, the difficulty in modelling or assessing underlying value, as well as fears surrounding regulatory acceptance or classification for cryptocurrencies.

Volatility is likely to remain a feature of this market for the foreseeable future– even with the impressive growth witnessed in recent years it remains a market dominated by retail actors in a space that is still valued at a small fraction of more traditional investment markets.

The concerns around a lack of fundamentals to gauge appropriate value may perhaps be alleviated overtime as investors become more familiarized with the space and increase their understanding of certain frameworks emerging in the space such as Bitcoin's stock to flow valuation model or Metcalfe's law applied to the number of active Ethereum addresses, or analyses of the Total Value Locked across various decentralized finance protocols. If some of these concepts seem confusing andforeign at first glance, don’t fret dear readers, the chances are high that a future post will delve into the value propositions and analyses for cryptocurrencies in the near future.

Finally, even with the announcement of China banning all cryptocurrency transactions in September, investors can at least be reassured by US Federal Reserve Chair Jerome Powell's statement that he has 'no intention' of banning cryptocurrencies in the UnitedStates, even as the SEC Chairman Gary Gensler maintains that the SEC will be keeping a close eye on the industry. Further afield in Europe, the European Commission introduced the Markets in Crypto Assets (MiCA) proposal as part of the EU's comprehensive Digital Finance Strategy. These proposed regulations would seek to provide protective guardrails for the operations of cryptocurrency markets within the EU, with the reassurance from the EC that it has tried to be fair 'where possible', and that 'the requirements imposed on crypto asset service providers are proportionate to the risks created by the services provided'.

And as a final note of concern, Bitcoin has also drawn increasing scrutiny for the sizable sums of energy required to mine the currency and secure the network, drawing questions marks as to the environmental-friendliness of the premiere cryptocurrency at a time where ESG factors are playing an increasingly important role in the investment frameworks of institutional investors.

Conclusions, and Looking Forward

A heuristic known as the Lindy Effect, popularized by statistician and author NassimTaleb, describes the idea that the older something is, the longer it is likely to be around in the future (and thus the more likely it is to survive ‘the test of time’). Despite a turbulent history marked by euphoric highs, crushing lows, regulatory challenges and much more, the broader cryptocurrency markets have been able to withstand and eventually overcome every challenge threatening their extinction, or more accurately perhaps their relegation to the realm of obscure and forgotten techno-financial experiments.

The 2021 Fidelity Digital Asset Survey highlights that the unprecedented macroeconomic conditions following the onset of the Coronavirus pandemic have been a catalyst for many investors to more seriously explore the investment proposition of digital assets. The outstanding success of cryptocurrency investment products witnessed over the last year is a testament to a growing demand for a class of products that allows investors, retail and institutional alike, to gain exposure to this emerging alternative asset class while abstracting away the complexities and risks of dealing with various blockchain protocols and preserving the regulatory protections offered by more traditional investment products. Interest and demand remain elevated, even as new products enter the market at a slow trickle, gated by the arduous process of obtaining the appropriate regulatory seals of approval.

 With each passing year, the Lindy Effect grows stronger for the digital asset space, while the barriers to investment seem to be – slowly, but surely – falling away one by one…

As this nascent asset class continues to establish itself as a mature & investable alternative investment, be sure to follow our feed to stay on top of the latest developments in the space and gain a fuller understanding of investor needs, concerns, and the available instruments offered by reputable industry players.