Authored by: Scott Canning, CFA & Erik A. Swords
If the scope of disruptive projects emerging from the crypto asset space is analogous to an iceberg, we hold the view that Bitcoin amounts to only what is above the surface. Having repeatedly taken out all-time highs in parabolic fashion, it is no surprise that the most capitalized cryptocurrency dominates headlines related to the fast-growing category. Viewing the meteoric rise of Bitcoin's price as the early validation of a new asset class, what might be some longer-term implications?
- Bitcoin has successfully proven that decentralized systems are viable in ecosystems that require trust, providing a peer-to-peer mechanism that puts centralized institutions on notice. We are devoting rigorous thought to identify industries that may be overly reliant on inefficient data infrastructure, as well as operating models that provide trusted intermediation, for example, settling and clearing.
- Initial blockchain implementations are imperfect; however, scaling solutions are evolving rapidly and a rift between winners and losers will emerge as the markets become more efficient. While Bitcoin is winning the cryptocurrency price race at the moment, we think less well-known but more flexible blockchain platforms like Ethereum transact more efficiently and have clearer roadmaps to further improve scalability.
- Institutions have indicated interest in allocating to these digital assets, but funds will remain largely sidelined until we see progress on three key fronts:
- Custody solutions: While crypto assets never leave the blockchain, accessing an account requires the paired private key. Managing the security of these keys is the most sensitive constraint given that they are the only inputs required to execute transactions. There are widely available solutions for retail investors to store keys, but scaling this for larger institutional clients creates obvious operational risks.
- Derivatives: Institutional investors require the ability to short, hedge and dynamically manage positions. While nascent, options contracts currently exist on Bitcoin and futures went live just this month.
- Regulatory: In the U.S., regulators have taken a hands-off approach so far, fostering rapid innovation as well as speculation. Domestically, we expect this regulation-light environment to remain given the current administration; however, there will likely be heightened oversight within the initial coin offering (ICO) space.
We have been following the development and implications of blockchain since 2015 and shared our initial thinking in a series of papers, the earliest of which discussed Bitcoin and cryptocurrencies (Bitcoin: The New Smart Money). We actively seek to research trends that have the potential to meaningfully remake the investment landscape. One such theme is blockchain technology, and crypto assets represent the earliest investable exposure.