A few years ago, I asked a friend at a major Wall Street trading desk if her colleagues ever talked about cryptocurrencies. She responded that one person would occasionally bring up Bitcoin, then the room would clear out.
This was during Wall Street’s “Bitcoin is stupid” period, which fell between the initial, “I don’t understand it” era and the more recent “it’s a bubble” phase. Since the advent of the first cryptocurrency nine years ago, professional money managers have almost universally dismissed it as a potential investment. Although many have come around on the power of the underlying technology, cryptocurrencies have often been ignored or ridiculed.
Last year, as the price gains of cryptocurrencies like Bitcoin and Ether were generating daily headlines, some fund managers went on the attack, calling the sector a pyramid scheme. Although they probably really felt that way, they might have also been a little jealous. Wall Street money managers are not used to standing on the sidelines while amateurs get rich off something the pros don’t really understand, or worst yet, own.
For the crypto faithful on the other hand, it’s always been a question of when, not if, the rest of the world catches on. Their faith (despite the volatility) has put them on the right side of a powerful investment thesis, one best phrased as a question:
What happens when institutional money managers, who collectively control most of the world’s investment capital, enter a new asset class for the first time?
The answer lies in basic math. Institutions control so much money that they own half a trillion dollars’ worth of Apple alone, and that’s just one stock within a single asset class. If all the hedge funds and family offices out there decided to commit a fraction of that capital to a diversified portfolio of cryptocurrencies, they may double the size of the sector.
I’ve been making that argument to friends who work in institutional finance for years, but they’ve always brushed me off, and for good reason.
Contrary to what an outsider might think, people who manage other people’s money don’t base their decisions on how to maximize returns. Their first consideration is whether they could justify their actions should something go wrong.
This is a smart way for individual managers to make investment decisions, even if the combined effect is a lot of groupthink and the familiar cycle of booms and busts. Traders who lost money in mortgages in 2007 still have a job today because most of their colleagues also blew up in that trade.
That attitude is one reason no career-minded professional has wanted to be the first to dip toes into crypto. Or the second, or the 12th. Not if they wanted to have a long career. But with each passing month, as more people talk about Bitcoin and more conferences are held where more products aimed at institutions are introduced, the barrier to entry gets a little lower.
Every chain reaction starts small and needs the help of at least one catalyst. The adoption of the crypto-asset class by institutional investors has recently enjoyed several, the biggest of which is the introduction of infrastructure that solves the crypto-custodian problem.
Since blockchain technology gives cryptocurrencies certain physical properties, storage is a significant issue. An institution that invests in stocks doesn’t have to worry about a hacker infiltrating their servers to steal shares, but in crypto, that kind of thing happens all the time. Several solutions to this problem have been introduced by reputable crypto companies in recent months, including hardware products that help institutions secure their own cryptocurrencies and a storage service where a third party does it for them.
Then there are the recently introduced Bitcoin futures at the Chicago Mercantile Exchange and the Chicago Board Options Exchange. These products allow institutions to gain exposure to crypto markets while bypassing the storage issue altogether. As an added bonus, their creation signaled a much-needed nod of approval from financial regulators, as did Goldman Sachs’ decision to help clients trade them.
None of this means that the world’s pension funds and endowments are about to dive in. But for the bullish thesis to work, they don’t have to. Just the fact that they will start to consider the option is a major change. Throw in a sputtering stock market and a stalled bull market in bonds, and the argument becomes even more compelling.
On Wall Street, the only sin worse than being the first in a bad trade is being the last in a good one, or what crypto enthusiasts colloquially call FOMO — or fear of missing out. That fear drives a lot of investment booms, and nobody knows that better than the biggest stewards of institutional money: hedge funds.
Twenty years ago, most people had never even heard of “alternative assets.” Then the dot-com bubble burst, leading the Federal Reserve to slash interest rates, and it was no longer possible for pension funds and endowments to hit their annual return targets with only stocks and bonds. Within a few years, everyone was talking about the importance of allocating some capital to so-called absolute-return strategies, and the hedge fund boom was born.
We are still years away from when institutional investors will fully embrace crypto as an asset class, but 2018 is shaping up to be the year of the tipping point.