Institutional Investors Move into Cryptocurrencies – Good News for Investors?
Every investor has probably asked themselves the question: should I be investing in bitcoin and other cryptocurrencies? Unfortunately, this column will not provide the answer. But what we will do is provide key insights into the cryptocurrency landscape, to help investors with their own due diligence process.
Below, we cite three important – though seldom discussed – factors investors should consider.
Factor #1: Institutional Uptake
Several of the world’s foremost financial institutions are starting to invest and build exposure to cryptocurrency. As many will remember from the 2008 Global Financial Crisis, however, Wall Street isn’t always right. But it is a meaningful data point that major institutions are confident enough to get involved.
Morgan Stanley is positioning to offer wealth management clients access to bitcoin funds; JP Morgan is creating debt products linked to the performance of a basket of cryptocurrencies, much like ETFs function; Goldman Sachs is activating a cryptocurrency trading desk where it plans to deal bitcoin futures and other derivatives for clients, all in response to rising client demand for investment access to bitcoin; Bank of New York Mellon plans to serve as a custodian for clients’ bitcoin, where it will facilitate holding, reporting, and transferring the cryptocurrency much like it would stocks or other asset classes in a portfolio.
These represent a handful of major Wall Street firms adding access and exposure to cryptocurrency. But there are also a few major companies adding bitcoin specifically to balance sheets. The fintech payments company, Square, owns some of $450 million worth of bitcoin, while Tesla went even further and invested $1.5 billion. As far as payments are concerned, PayPal already allows customers to buy, sell, and hold bitcoin using online ‘wallets,’ and Mastercard is rolling out a pilot program to allow certain merchants to accept bitcoin payments.1
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Institutional and corporate uptake is meaningful, but investors should also remember that these companies not only can afford to take losses, but they are also in some cases merely facilitating the use and investment in bitcoin and other cryptocurrencies. In other words, they are redirecting the risk to the investor and consumer.
Factor #2: The Regulatory Environment
As cryptocurrency has grown in prominence, acceptance, functionality, and value, governments have grappled with ways to regulate it. There is a myriad of logistical challenges in overseeing a new financial system predicated on anonymity, and that’s before taking into account crypto investors’ concerns that regulation would cripple, or even destroy, vital elements of the currency and impede its ability to grow.
Nevertheless, talks broaching the regulatory subject have heated up. There have been hearings to discuss the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission’s (CFTC) roles in overseeing cryptocurrency markets in the US. Many are concerned about the ability to misuse or abuse cryptocurrency, particularly through illegal activity, like money laundering. There is also concern about market speculation, which appears evident today.
Regulatory discussions are ongoing, and it appears the desire to regulate cryptocurrency exchanges is a key part of a broader effort focused on protecting and educating investors – who may assume cryptocurrency markets are regulated like traditional ones. Plans are underway for interagency cooperation between the SEC, CFTC, states, and federal regulators to teach consumers about unregulated trading platforms.3
A big question for investors going forward is what shape regulation will take, and how that may affect the trajectory of cryptocurrencies as an asset class. Typically, regulations equal headwinds.
Factor #3: Uncertainty
Bitcoin has no well-defined intrinsic value since it is not gaining traction as a currency. Bitcoin has blockchain, which is a groundbreaking technology with extraordinary potential, but blockchain doesn’t generate earnings for bitcoin. Bitcoin has no real tangibles, and the intangibles are murky and hard to value. Why is $50,000 or $100,000 the right price for one unit of a digital currency with no earnings?
Skeptics see a fad whose value is being assigned by pure speculation. Enthusiasts see blockchain functionality, institutional uptake, finite supply, brand, and retail investor demand as undervalued intangibles. At the end of the day, in our view, no one knows anything about price.
The head of Goldman Sachs Global Investment Research, Steve Strongin, has cautioned in the past that most digital currencies, which lack intrinsic value, will likely trade to zero before being replaced by a small group of competitors. Strongin’s research is not saying that all cryptocurrency will fail – he is more pointing out that we may see a “few-winners-take-most” market.
Strongin believes that most modern digital coins have too many challenges to succeed – security issues, high maintenance costs, and slow transaction times that present significant obstacles to consistency and staying power. Strongin alludes to parallels with the 1990s dotcom bubble – when it burst, it cleared detritus from the landscape, leaving survivors like Google and Amazon. Strongin remains bullish on the improvement of blockchain, and he envisions important practical applications, like improving financial ledgers, to become mainstream at some point down the road.4
Bottom Line for Investors
Bitcoin and other major cryptocurrencies are tiptoeing into the mainstream, and many investors are wondering if it is a worthy investment. The true answer, in our view, is that no one can say for sure. Bitcoin has no intrinsic value, and while blockchain is a promising technology that could have breakthrough implications, it does not generate earnings for bitcoin. Again, no one really knows anything about price.
Investors should strongly consider their goals and financial situation before considering investing in bitcoin and/or other cryptocurrencies, and understand where cryptocurrency falls on the risk/reward spectrum. You may not need it to achieve your long-term goals.
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4 Pitchbook. February 27, 2018
5 Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.
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