If there is to be a second act for crypto, it will not happen at the hands of its evangelists. For the asset class to be taken seriously, 2019 needs to be the year it is discovered by institutional investors – and they will take a great deal of convincing.
Institutional investors, who manage money on behalf of others, have been hesitant to enter the cryptocurrency market because of volatility, the lack of regulation and mandates that specify they cannot invest outside of a defined asset class such as equities or bonds.
If there is one thing in crypto’s favour in 2019, it is that it is generally not correlated with global equity market movements. In an environment of global market volatility due to trade wars, Brexit and an unpredictable United States, bitcoin wants to fashion itself as a store of value. Gold bulls are untroubled.
Adrian Przelozny is the chief executive and founder of Independent Reserve, an Australian digital currency exchange that allows members to trade in seven cryptocurrencies, including bitcoin.
“The year 2018 started with a massive boom in retail interest,” Przelozny says. “Since then the retail interest has dropped off, prices dropped and the interest from mums and dads probably isn’t what it was earlier this year.”
However, he said about 8000 SMSF investors were now active on Independent Reserve, most having created their accounts in the past year.
Przelozny believes the volatility of bitcoin will decrease.
Apollo Capital chief investment officer Henrik Andersson said 2019 should see more institutional investors enter the cryptocurrency space. Apollo Capital is a wholesale fund that invests in crypto assets, an asset class that uses blockchain and cryptography in a variety of applications.
“I think during the coming year we will see a gradual adoption from institutions,” Andersson says. “We have the first US university endowments investing in funds.”
Yale invested some of its endowment in a crypto fund called Paradigm, Bloomberg reported in October.
Fidelity Investments, one of the world’s largest asset managers, has also entered the crypto space, launching a business called Fidelity Digital Assets in the second half of 2018. It aims to create a platform to support and execute trades and to store bitcoin securely.
Andersson says a major advantage for institutional investors is the fact crypto assets are not correlated to regular markets, making them a good investment in turbulent times.
“It’s still very small – the total market cap of crypto assets is around $110 billion, bitcoin is around half of that. In the next three to five years, if we see another financial crisis, then crypto assets will probably benefit,” he says.
Every Capital director Tom Surman says the “everyman’s market” for crypto has ended and the institutional phase has begun.
“It’s my belief that massive retail offerings and institutional investors are probably the only groups that can meaningfully move the needle on the crypto market cap from here on,” he says.
“It’s likely that any big regulatory decisions which encourage institutional investors will have a pretty significant effect, not just because of the capital coming in directly from those large investors, but because of the confidence it will give to retail investors too.”
Despite this positivity, a research note from JP Morgan released in December said the opposite story was playing out. “Participation by financial institutions in bitcoin trading appears to be fading,” the analysts said.
For institutional investors, regulation is a key issue holding bitcoin back.
Tribeca Investment Partners portfolio manager Jun Bei Liu says stricter rules are needed to attract more institutional investment.
While acknowledging the sector has matured “quite quickly in the last two years”, she says “clarity of regulation across different markets is still to come”.
“We do need regulation; we need transparency really to see that as a mature, investable class,” Liu says.
It is perhaps ironic the main factor holding bitcoin back is third-party regulation, considering the currency was invented to bypass financial institutions.
HOW DOES BITCOIN WORK?
Bitcoin, credited to the anonymous “Satoshi Nakamoto”, is a manifestation of a vision of an electronic cash system where online payments can be sent between parties without the need for a financial institution.
Institutions such as central banks are integral to a nation’s financial system because they keep track of how much currency is in the market and guarantee the validity of that currency.
Nakamoto wanted to bypass this but because any digital currency is in essence a file on a computer – it can be copied and replicated. This makes digital currency particularly vulnerable to being spent more than once.
To solve the “double spend” problem, Nakamoto used blockchain, a cryptographic technology that began to be described in 1991. A blockchain at its core is a long list of records.
In the context of bitcoin, the blockchain is a public ledger that creates a block every 10 minutes, recording all transactions of the currency in that period. Each block contains a “hash”, like a serial number, of the previous block. Therefore, every block is linked to the preceding and following block.
Because the blockchain ledger is available to everyone on the bitcoin network, in order for a newly created block to be verified it has to be accepted by a majority. Thus, to fabricate a block, one would have to control more than 50 per cent of the network to allow it to be approved, which would be extremely difficult.
Bitcoins can be bought on exchanges and stored in an online wallet, or the currency can be “mined” by solving the complex algorithm that adds a block to the chain. The miner is rewarded with a set number of coins, currently 12.5 bitcoins.
However, the block reward is expected to be halved, to 6.25 coins, in about May 2020. This mechanism usually results in a price run-up before the change, as supply of new bitcoins contracts. The number of bitcoins is limited to 21 million, with about 3.5 million yet to be mined.