Institutionalisation of digital assets: history doesn’t repeat, it rhymes

Institutionalisation of digital assets: history doesn’t repeat, it rhymes

Digital assets did not actually start with mass adoption, however, this industry has now embarked on the very important path of institutionalisation. 

Prior to 2017, investors who wanted to invest in crypto had no obvious choice – they just invested in Bitcoin. Today investors have an exciting opportunity to bet on the asset classes, create a portfolio, diversify it, as one of the main investing principles states, and actively manage it as things change in the market. 

Furthermore, there has been an exponential growth in crypto market capitalisation from the start of 2017: from $17.7 billion into 2018 to $800 billion back down to $270+ billion as of today. Still it represents only 0.05% of capital markets and other asset classes. Even if crypto market cap doesn’t grow, the percent relative to itself should increase significantly, but most likely both will grow significantly in value.

Along with the market cap and the number of applications for cryptocurrencies and blockchain technology in general, grows the interest from financial institutions and “big fish” who tend to make waves on the traditional market.

According to the latest research by Coinshares, covering the market situation of H1 2019, spikes in growing retail interest in Bitcoin “was largely driven by the long-awaited entrance of institutional money.”

Definitely the hottest race we’ve witnessed this summer was the highly anticipated launch of physically settled Bitcoin (BTC) futures platform Bakkt, outrun by LedgerX. Their platform is now open to all US-based investors with a government issued ID and is not limited to institutional clients or high-net-worth individuals. 

Currently, there are three main platforms that are competing to gain the attention of investors, with LedgerX, the ICE-backed Bakkt, and the TD Ameritrade-backed ErisX, all launching similar products. This is going to be a huge catalyst for institutional participation in the crypto market. 

We’ve been all very excited earlier this year, when Fidelity released its surprising research on institutional demand for digital assets, with myriads of catchy headlines hitting the Internet: “Institutional Investors Will Flood the Crypto Market within the Next 5 Years!”

Catchy or not, the report literally called for a new era for the industry’s development and it’s convergence with institutional money. Let me highlight the report:

  • Financial advisors (74%) and family offices (80%) view the characteristics of digital assets most favorably
  • 46% or investors find digital assets’ low correlation to other assets among its most appealing characteristics.

To me a low correlation with all other asset classes turned out to be one of the most intriguing aspects, because almost all asset classes correlate to one when markets fall. This eventually makes it a viable candidate for institutional investors.

Evolution is the key – why even investing in digital asset fund industry

First of all, because this sector is naturally growing.

The pace of digital hedge fund launches really began accelerating amidst galloping appreciation in cryptocurrency prices.

To give you some flavor of some top funds, here is a list, in alpha order:

  • Marc Andreessen raised $300 million for its first Crypto Focused Fund, a16z. Also, in 2019 Andreessen Horowitz has revealed that it is transitioning from being a venture capital firm to a registered investment advisor (RIA), to be able to put as much as $1 billion into cryptocurrencies or other digital assets.
  • Fenbushi is a Chinese venture hedge fund founded in 2015. Early player in the VC space involved in deals like TenX.
  • Galaxy Digital Asset Fund, run by famous Mike Novogratz, former CIO of Fortress Hedge Fund.
  • Digital Capital Management fund is run by Tim Enneking, one of the industry pioneers – he was the founder and investment manager for the Crypto Currency Fund, one of the world’s first private funds focused on cryptocurrencies.

My professional background involves 30 years of working in the investment industry, with experience in VC, HF, principal trading, asset management, investment advisory and crypto investing. I have had the fortunate opportunity to observe the evolution of the hedge fund industry being involved since the early 90’s. Arguably, the first time that hedge funds reached the public consciousness, at least in Europe, was in 1992 — when Soros broke the Bank of England. You could start a hedge in the early 90’s with less than $5 million. However, the bar for a successful one day launch today is set at as much as $200 million. 

According to the PwC report, in the digital fund industry, quant funds represent about 37% of the market, fundamental take 19%, and discretionary take 44%. The median crypto hedge fund AUM has grown to $4.3 million at the end of Q1 2019 as compared to $1.2 million in January 2018.

Second reason is professional management. The above mentioned report states that together with institutions many more traditional asset management professionals switch markets and join digital hedge funds.

“While the size of the average crypto hedge fund team is 7 to 8 people, the cumulative average investment management experience is 24 years. This may indicate that an increasing number of experienced investment professionals are moving into the crypto asset space. Having an investment team with ‘traditional’ asset management experience will likely give not only investors, but also regulators, greater comfort as they seek to absorb the regulation of digital assets into existing frameworks or create bespoke frameworks.”

The involvement of experienced fund managers is not only natural, but highly necessary, as there are many challenges facing organizations as they institutionalize crypto.

Lessons learned from traditional business models are still applicable, but funds and companies will need to adapt these, being in crypto shoes. 

There is a need for a comprehensive framework, and a robust due diligence to differentiate good funds from weak funds. 

Plus, institutions have a different set of requirements than retail investors or their client networks. Large players usually require an infrastructure that is focused on strong governance, compliance, due diligence and a certain level of transparency. Building the infrastructure that is needed will help promote trust and accelerate the adoption of digital assets by investors and institutional clients.

We are now in the beginning phase of institutionalising the digital hedge fund industry. There will be multiple phases, but ultimately this industry will address the security, the market, and the difficulty of the crypto industry. Why I am optimistic?

Because history doesn’t repeat. It rhymes.

Author: Juwan Lee