Why Wild and Crazy Bitcoin May Become a Pension Portfolio Fixture
Retirement funds and other institutions are gradually warming to cryptocurrencies.
Art by Ryan Garcia
Ever-volatile Bitcoin has been on a tear lately, market data show, after yet another plunge two years ago. Thus far, most institutional investors indicate they have been leery of it. But that is changing.
A recent Fidelity Investments study found that 27% of institutional investors were in Bitcoin and other crypto denominations, up from 22% in last year. That could mean direct investments in the virtual currencies themselves, stakes in companies that trade them, or positions in venture funds that underwrite crypto startups.
Virtual currency will increasingly become a standard part of institutional portfolios, as managers overcome their qualms about its volatility, thanks to its nice returns, the study predicted. In another study, Fidelity likened Bitcoin and its ilk to emerging markets, which, after initial reluctance, pension funds and other institutions came to welcome into their portfolios.
Greater institutional investment in the cyber-stuff is coming, according to the study and interviews with financial observers. Why? A growing price, less volatility, and better law enforcement, to dispel the notion, however overblown, that cryptocurrencies are the playground of crooks, they say.
In particular, there is a slow and inexorable financial establishment acceptance of Bitcoin, which is overwhelmingly the largest cryptocurrency. Yale’s storied endowment fund, for instance, is an investor in the digital denomination. Numerous financial luminaries, such as JPMorgan’s chief, Jamie Dimon, who in late 2017 called the currency “a fraud,” now believe that Bitcoin and company have a place in institutional assets.
“The best profit-maximizing strategy is to own the fastest horse,” wrote Paul Tudor Jones, CEO of hedge fund firm Tudor Investment, in a note to clients in May. He invested around $600 million in Bitcoin for his Tudor BVI global fund, which has strong institutional support. “If I am forced to forecast, my bet will be Bitcoin.”
Counting on a surge in institutions’ interest, VanEck Securities plans to launch a Bitcoin exchange-traded fund (ETF), an easily traded vehicle that large investors are comfortable with. Attitudes will change “once we have an ETF on the market,” said Gabor Gurbacs, director of the firm’s digital assets. Up to now, the Securities and Exchange Commission (SEC) has been resistant to approving a crypto ETF.
For pensions, some argue, Bitcoin can help with the chronic problem of insufficient funding to meet obligations. “Bitcoin has the potential to save us from the current pension crisis,” argued Anthony Pompliano, founder of Morgan Creek Digital Assets, a firm that invests in blockchain technology, in a blog post.
If the California Public Employees’ Retirement System (CalPERS), which is only 70% funded, bought Bitcoin, the program could shrink its shortfall, he said. “Pension funds should add 1% to 5% to Bitcoin,” he declared. CalPERS declined to comment on the suggestion.
In reversing its position on cypto, JPMorgan, the nation’s largest bank by assets, now processes Bitcoin transactions on the lender’s platforms. The Chicago Mercantile Exchange in January started trading in Bitcoin futures contracts. PayPal last month unveiled buying and selling of virtual currencies. Amazon and Starbucks lately allow payments in Bitcoin.
Bitcoin rules the cryptocurrency realm, with by far the largest market cap, $256 billion, or 63% of the overall market, says CoinMarketCap, a price-tracking website. The next largest digital denomination, Ethereum, is a little less than a fifth of that, followed by the likes of Tether and Litecoin. In all 7,567 digital offerings exist, many of them tiny.
Voids, Volatility, and Villains
Where does this virtual currency come from? The void. For sure, that’s not an easy concept for most investors to comprehend, or feel comfortable with.
Crypto’s murky origins and abstruse method of production have delayed its acceptance in the mainstream financial world. Cryptocurrency is digital money exchanged without fees between two parties online with zero involvement from traditional banks or government regulatory oversight. No central clearinghouse exists, so transactions are done via a network of users, with the activity recorded on a public ledger called blockchain.
Adding to the disquieting obscurity: A mysterious person or group, who went by the name of Satoshi Nakamoto, created the currency in 2009. This shadowy personage released open-source software that allowed the virtual currency to be “mined” from cyberspace, with a limited amount allowed. Every four years, that amount is reset. Mining is a mind-boggling endeavor, involving massive computing power and human technological prowess. The undertaking is like a tech Easter egg hunt.
All very esoteric. Widely heard objections to Bitcoin and the others are that nothing backs them. Corporate earnings undergird stocks. Washington’s taxing power supports Treasury bonds. Even gold, which Bitcoin often is compared to, has a physical presence.
To crypto advocates, a better comparison for the digital currency is to artwork, which has no value other than what buyers and curators assign to it. The raw materials of a Picasso masterpiece, paint and a canvas, cost very little. VanEck, in a research paper, said that art as a valuable asset “is a phenomenon of the past few centuries. Artwork did not have a monetary value in early societies.” Those Picassos, Rembrandts, and Michelangelos certainly do today. Given time, in the firm’s view, crypto may well follow their lead.
One contrast is that art doesn’t have crypto’s volatility. Swings of 2% to 5% in a day have been common. For those with iron nerves, years-long patience has been rewarded. A decade ago, Bitcoin changed hands for around $100. By the start of 2017, after much oscillation, it had wobbled up to $921, then took off big-time, hitting its peak of $19,116 in mid-December of that year.
Bitcoin’s Wild Ride
Price per unit ($USD)
$20,000
Market peak
Dec. 17, 2017
Month-ending value
Oct. 30, 2020
$15,000
$10,000
$5,000
Most recent market low point
Dec. 15, 2018
$0
6/17
12/17
6/18
12/18
6/19
12/19
6/20
$20,000
Market peak
Dec. 17, 2017
Month-ending value
Oct. 30, 2020
$15,000
$10,000
$5,000
Most recent market low point
Dec. 15, 2018
$0
6/17
12/17
6/18
12/18
6/19
12/19
6/20
$20,000
Market peak
Dec. 17, 2017
$15,000
Month-ending value
Oct. 30, 2020
$10,000
$5,000
Most recent market low point
Dec. 15, 2018
$0
6/17
12/17
6/18
12/18
6/19
12/19
6/20
$20,000
Market peak
Dec. 17, 2017
Month-ending value
Oct. 30, 2020
$15,000
$10,000
$5,000
Most recent market low point
Dec. 15, 2018
$0
6/17
12/17
6/18
12/18
6/19
12/19
6/20
Source: Coindesk
Next, oops. Bitcoin in 2018 crashed noisily, losing 85% of its value. There are various explanations for why the skid happened. Blame the Chicago Merc, says Matt Hougan, CIO of Bitwise Asset Management, which has a $100 million private fund full of Bitcoin, Ethereum, and eight others. As the year began, the Merc launched Bitcoin futures. “All of a sudden, you could short it,” Hougan said.
Nonetheless, after that nadir, Bitcoin regained its footing and has quadrupled since. The currency did tumble 52% during the February-March market-wide panic over the coronavirus, more severe than the S&P 500’s drop. Its recovery mirrors that of equities, with the difference that Bitcoin had a better October, up a stunning 28.5%, than did the benchmark stock index, which dipped 3.3%.
With more and more Bitcoin users, and an expected onset of investors who want to simply buy and hold the stuff a la gold, Bitcoin volatility should settle down, Hougan predicted. “In the early days, you’d see movements of 10% or more,” he recalled. “Today, that’s very rare.”
An additional reason to expect more calm in the crypto terrain is the “stablecoin” movement—where a cryptocurrency is pegged to traditional fiat money such as the US dollar or the Japanese yen. Tether and Paxos have offered such products in recent years. This variant should address concerns over “Bitcoin’s super volatile nature,” said Ken Nakamura, who heads the nascent stablecoin business at GMO Internet Group. His unit is awaiting US regulatory approval to bring out its own merchandise.
Another selling point for Bitcoin is that it has a very small correlation to stocks, not to mention other asset classes. That lack of correlation, its fans say, aids the case for including it in a diversified portfolio. According to a VanEck study, Bitcoin’s correlation to the S&P 500 is a low 0.15 (1.0 is a perfect match).
One hurdle that Bitcoin and the rest have to surmount is their reputation for criminal clandestine payments. The anonymous, decentralized asset category is perfect for hanky-panky.
The volume of illicit crypto transactions topped 1% last year, more than doubling 2018’s incidence, by the reckoning of Chainalysis, a blockchain research firm. That may not sound like a lot, yet losses are in the many millions. Scams keep cropping up, such as a fraudulent crypto mining and trading company called AirBit Club. Five men were indicted in connection with the alleged Ponzi ring in August.
On the bright side, a Chainalysis report contended, crypto crime does leave an electronic trail that tech-adept sleuths can follow. “Cryptocurrency is inherently transparent,” the study noted, and that should allow proper investigations and apprehension of crooks. The US Department of Justice is gearing up its efforts to combat crypto crime.
Vindication, or At Least a Start
Bitcoin’s newfound acceptance on Wall Street in remarkable. JPM’s about-face on crypto is a case in point. Consider what CEO Dimon had to say about Bitcoin three years ago: “It’s worse than tulip bulbs. It won’t end well. Someone is going to get killed. … It’s just not a real thing, eventually it will be closed.”
Well, times sure have changed. JPM has accepted two well-known Bitcoin exchanges, Coinbase and Gemini Trust, as banking customers. Dimon later said he regretted his remarks about Bitcoin. At the same time, Bitcoin futures have seen an enormous 40% increase from a year ago, on the CME Group’s floor. Some 850 new accounts have opened in 2020, double the pace in 2019.
What’s more, Fidelity announced it was opening a fund, called Wise Origin Bitcoin Index, for wealthy (minimum investment: $100,000) investors, including family offices and other institutions. In 2018, the fund giant started acting as a custodian for crypto transactions.
Endowments are the institutions that have delved the most into this area. In 2018, CIO David Swensen of Yale (total assets: $31.2 billion) invested an undisclosed sum in two separate crypto venture funds, Andreessen Horowitz and Paradigm. Harvard’s endowment ($40.9 billion) is backing Blockstack, a company that seeks to hold a $50 million digital-token offering. The size of Harvard’s investment is a reported $11.5 million. Neither Ivy school would comment.
At this stage, for pension funds, direct investments into Bitcoin and its ilk are scarce. Their exposure is mostly indirect, concentrated in venture capital partnerships, which invest in crypto and blockchain company startups. The Fairfax County Retirement System last year invested a reported $40 million in the Morgan Creek Digital fund. Most of the Virginia county’s stake with Morgan Creek is in blockchain companies, with just 15% of it in the currencies themselves.
Bitcoin’s overall price growth has helped it gain credibility among investors. Fidelity issued a study last month finding that adding Bitcoin to a hypothetical portfolio at a 3% share of assets, over the past five years, would have boosted its returns by 3 percentage points annually. When tech firm MicroStrategy disclosed in August that it had invested $250 million in Bitcoin, the stock jumped 9% that day.
Meanwhile, acceptance among the American public is growing. Some 18% of US adults have bought cryptocurrency in 2019, and the heaviest users are millennials, 35%, a survey by research firm YouGov finds.
Bitcoin aficionados are fond of comparing their favorite commodity to gold. The entities both have a limited supply, generate no income, and are often used as stores of value, to be locked away, instead of being traded. VanEck’s Gurbacs pointed out that the gold price also has shot up gloriously in recent years.
Over the past two decades, gold appreciated seven-fold. Since 2000, the S&P 500 has climbed 2.5 times. “Bitcoin,” Gurbacs said, has “the potential to follow gold’s trajectory.”
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