Overview of the Bitcoin Investment Fund Landscape (Part 1)

Bitcoin exists as a self-sovereign, cryptographically verified digital asset that can be easily acquired and stored on a mobile phone. For retail investors, this convenience comes with a number of drawbacks, specifically around the risk of theft or loss. For professional asset managers such as financial advisors and institutional investors to get exposure to bitcoin, they have to satisfy a very high bar of legal and regulatory compliance. This paper and supplementary data will attempt to outline various fund structures and the current offerings.

• Investment funds simplify the process of acquisition, custody and management of digital assets.
• Various investment structures and legal constructs exist between public, private and international offerings.
• Examples of funds include Exchange Traded Funds (ETFs), OTC Traded Trusts (OTC), Exchange Traded Notes (ETNs), and Private Placements (PPs) will be discussed further.

Until the SEC approves a rule change to allow a bitcoin ETF, there will be trade-offs to that investors will need to evaluate.

Almost all investors — retail, financial advisors and institutional investors prefer pooled investment products for ease and oversight of exposure to a new asset. It is difficult and inconvenient to store bars of gold, buy 500 individual shares of stock or make a small loan to an emerging market country. For investors who are simply interested in allocating a percentage of their portfolio to digital assets such as bitcoin, there are investment funds that are available to various levels of market participants. If we compare bitcoin to gold as this paper does in reference to the launch of an ETF, investors primarily just want asset price exposure, not always physical ownership. We may be witnessing this today as bitcoin custody flows away from digital asset exchanges and into derivative markets that provide leverage and decreases counterparty risk since less bitcoin is required to be in the exchange’s custody.

Over the last five years of my career — exclusively dedicated to digital assets, I have seen a general pattern that younger, more tech-forward individuals are more eager, educated and accepting of bitcoin. I teach a graduate level class at Pepperdine University titled Digital Assets Finance. My students were far more informed and excited about bitcoin than I expected. Research from Charles Schwab clearly shows that millennials are allocating to bitcoin in higher amounts than stocks like Netflix or Microsoft. This data doesn’t even count the 30 million uses who have traded $150 billion on Coinbase, the largest digital asset exchange in the United States.

Of the 420,000 financial advisors in the United States and Canada managing $31 trillion according research by McKinsey, only 25% of them are under the age of 44.

Bitcoin Investment Thesis

Uncorrelated Asset. Modern Portfolio Theory is a widely used analysis of how investors should expect a level of return based on a corresponding level of risk, charted out across an efficient frontier. Assets that fall below this theoretical portfolio allocation line fail to provide enough return for a level of risk. Bitcoin is one of the few assets that has historically been above that line, offering a higher amount of return based on the same level of risk of other assets. This concept is also captured in the Sharpe Ratio, that measures returns in excess of a risk-free unit of risk. According to a study by Bitwise Asset Management, adding only 5% of bitcoin to a traditional 60% equity / 40% bonds portfolio results in a Sharpe Ratio of 0.71, compared to only 0.31 without bitcoin over the last six years.

Digital Gold. Gold has been a popular investment for thousands of years due to its durable store of value. The fascination with gold has existed since the Egyptians first used gold bars as money as early as 4000 BCE. Investors often flock to gold during stressful periods of “flight to safety” to protect against inflation and preserve wealth. Gold and bitcoin are similar in the borderless transfer, not controlled by any one government and limited supply. Whereas bitcoin shows more promise into the future with internet based transfer rails, near unlimited divisibility and low storage costs.

Institutional Capital

There is no shortage of top Wall Street investors only recently speaking out about their investment thesis for bitcoin:
Paul Tudor Jones wrote a letter to investors in May 2020 outlining a “growing role for Bitcoin” in his inflation hedges along with treasuries, currencies and commodities. 30% of the letter was dedicated to his investment thesis in bitcoin.

Renaissance Technologies, a $75 billion quant hedge fund led by mathematician James Simons, submitted an SEC filing in March 2020 that would allow the flagship Medallion Fund to get exposure to bitcoin.

Chris Wood, the Global Head of Equity Strategy for Jefferies, a top investment bank, told investors in April 2020 to buy bitcoin in as a “hedge against central bank manipulated fiat money.”

JP Morgan authored a 74-page research paper in February 2020 saying, “The crypto market continues to mature, and cryptocurrency trading participation by institutional investors is now significant.”

Fidelity Digital Assets recently published a survey concluding in March 2020 of 800 institutions found nearly 80% of institutional investors see the appeal of digital assets.

This is Part One of this series. Click here for Part Two on the Bitcoin Investment Fund Landscape.