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The Case for Bitcoin Investing for Institutions

December 6, 2024

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Bitcoin is no longer just a speculative investment for retail investors. It has established itself as a viable option for institutional investors as well. 

Read on to learn about Bitcoin’s role in an institutional investment portfolio.

Bitcoin: A New Digital Investment Asset

In 2009, Satoshi Nakamoto introduced Bitcoin with the goal of enabling peer-to-peer transactions. 

Bitcoin’s underlying blockchain is decentralized, meaning that any information recorded on it is maintained by a network of nodes distributed across the globe instead of a centralized server. 

Therefore, Bitcoin has no single point of failure due to its decentralized nature.

Besides removing intermediaries from the transaction process and providing decentralization, Bitcoin is also the most secure blockchain to date, with an uptime of 99.9% in ten years. 

These advantages and the limited supply of its digital currency, BTC, have drawn ample investor attention. As a result, the crypto asset has become a popular investment for retail as well as increasingly for institutional investors.

However, this wasn’t always the case. 

Initially, Bitcoin was a niche digital currency popular among tech-savvy people who wanted to gain more control over their own money. 

But as the digital asset’s value rose, it attracted retail investors who embraced the idea of HODLing to refrain from selling when Bitcoin’s price fell. This investment strategy paid off for these early investors as each time the price dropped, it bounced back and surpassed the previous all-time high. 

As Bitcoin’s price continued climbing and making mainstream headlines, it caught the attention of several public companies, such as MicroStrategy and Tesla, inspiring them to add it to their balance sheets. 

Numerous asset management companies also got on board and began creating Bitcoin-based investment products for their clients.  

The Growth of Institutional Interest in Bitcoin

According to a survey by EY Parthenon, institutional interest in Bitcoin remains strong and isn’t going away. 

Institutions recognize the diversification value of digital assets and are exploring other use cases. In other words, institutional interest in Bitcoin is maturing.

Evidence of this is seen in the spot Bitcoin ETFs by BlackRock, VanEck, Invesco, 21Shares & Ark, WisdomTree, Fidelity, BitWise, Valkyrie, and several others. Earlier this year, the SEC approved a wave of pending applications for Bitcoin ETFs, further propelling the growth of institutional interest. 

Moreover, financial institutions like Morgan Stanley, BNY Mellon, Charles Schwab, and Goldman Sachs have also shown interest in digital assets in various ways. For instance, Charles Schwab launched a crypto thematic ETF in 2022, while BNY Mellon introduced a digital asset custody platform the same year.

Institutional investors are also backing Bitcoin companies as they attempt to build experience in this new industry and capture growth opportunities. For example, digital exchange EDX Markets is supported by Charles Schwab, Citadel Securities, Sequoia Capital, and Virtu Financial.

Bitcoin’s Role in an Institutional Investment Portfolio 

Based on EY Parthenon’s survey, institutional investors believe in the long-term value of digital assets and blockchain technology. 

They acknowledge that digital assets like Bitcoin have immense value in diversifying investment portfolios and hold the potential for asymmetric returns

Institutional investors consider Bitcoin a potential diversifier because of its low correlation to traditional asset classes of less than 0.5. 

While this correlation may change from time to time due to macroeconomic drivers and other factors, Bitcoin’s long-term correlation to traditional asset classes is low, as shown in this table that discloses the 10-year correlation between Bitcoin and key assets (as of December 2023). 

Source: Lazy Portfolio ETF

Bitcoin’s low correlation to other assets can improve an investor’s risk-return profile. Data shows that a small BTC allocation can significantly enhance the cumulative return of any portfolio with minimal effect on its overall volatility.

Research by the University of Twente showed that diversifying an institutional investment portfolio with Bitcoin returned a 1.6 Sharpe ratio, which makes BTC a good diversification instrument when judged against the benchmark of a 1.04 ratio. 

The Sharpe ratio compares the returns of an investment asset against its risk. According to an analysis by CoinShares, adding Bitcoin to a portfolio improved Sharpe ratios.

Judging from the cumulative fund flows between BTC and gold, there was an indication that investors were reallocating their gold positions into BTC. Over the past 1-year, Gold ETPs have registered outflows of over $20 billion, while bitcoin has registered over $16 billion in inflows.

Source: CoinShares

Over a 6-year period, the analysis (dubbed: a little bitcoin goes a long way) yielded that the most significant improvement in the Sharpe ratio was achieved where the allocation of Bitcoin was up to 10% of the portfolio. 

The chart below shows how the allocation of BTC to a portfolio impacts the ratio.

Source: CoinShares

Bitcoin has also considerably outperformed traditional assets, illustrating how essential its contribution can potentially be when added to an investment portfolio.

Bitcoin’s 5-year percentage returns have also been impressive in comparison to traditional assets, as shown in the table below.

Sources: CoinMarketCap, S&P, Google Finance, DailyFX

Bitcoin has been endorsed as a hedge against inflation, and for good reason. As inflation was rising during the onset of COVID-19 in 2020, BTC’s price climbed, cementing its position as a suitable alternative asset. 

A research paper that examined Bitcoin’s price against five-year inflation expectations between July 21, 2010, and December 31, 2020, found that Bitcoin’s price increased significantly after a positive inflation shock.

While Bitcoin can hedge against inflation, timing is crucial. 

For example, experts hold that BTC would have been a good hedge if purchased before the Federal Reserve implemented quantitative easing in March 2020 to boost the money supply and minimize interest rates. As the M2 money supply started climbing the year after, inflation also peaked, closing the window for investors to use Bitcoin as a hedge.

Source: Ecoinometrics

Risk Management Considerations

Although Bitcoin can benefit institutional investors in several ways, it is worth considering and mitigating the risks to maximize returns. 

Here are the possible risks connected with a Bitcoin investment:

Volatility

While BTC is highly volatile, dropping volumes have heightened price sensitivity which has made institutional activity such as buying or selling BTC to cause large price swings. Low trading volumes also reduce the amount of liquidity that’s available for investors to enter or exit positions, a situation that often results in slippage or leaves traders trapped, particularly if they hold large positions.

Although Bitcoin’s price fluctuations are declining, investors can mitigate this risk with dollar cost averaging. This strategy allows investors to average out the buying price while not having to think about timing the market.

Other strategies for mitigating volatility risk include setting a stop-loss order and using hedging techniques like options contracts and short selling.

Regulatory Concerns

Despite believing in the long-term value of Bitcoin, institutional investors are adopting a prudent stance due to prevailing regulatory uncertainties. Fortunately, the newly elected U.S. President, Donald Trump, promised to create crypto-friendly regulations that will help businesses and investors in this space. 

What’s more, on January 10, 2024, the SEC announced the approval of Bitcoin spot ETFs from multiple financial firms. The watershed moment led to a momentary decline in BTC’s price despite its upward trend in the months preceding the spot ETF approval. 

The launch of Bitcoin ETFs makes the asset more accessible to retail investors, especially those who are risk-averse, which could play a crucial role in Bitcoin’s global adoption. 

Future Outlook

From a technological perspective, the Bitcoin landscape is changing for the better, thanks to Layer 2 scaling protocols and other projects like Ordinals that are building directly on the blockchain. This technological advancement is, in turn, increasing Bitcoin’s utility and boosting adoption.

The global regulatory environment is also progressing with the release of new crypto laws in different jurisdictions. Also, international oversight bodies like the FSB and IOSCO have published crypto regulatory recommendations for their member states. 

Finally, boosted by a crypto-friendlier U.S., Bitcoin finally hit $100,000 in December 2024, helping to cement the digital currency’s position as an institutional investment asset. 

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