Institutional Crypto: taking a risk or converting cryptocurrencies into a “legitimate” investment?

Cryptocurrencies

Antony Zafeirakis

Antony Zafeirakis is currently studying History, Politics and Economics at UCL. He is particularly interested in financial events that influence the global markets, especially when combined with analysis of external factors such as governmental interference and political parameters. On his free time, Antony is a competitive debater and a huge football fan.

3rd June 2021

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Following Morgan Stanley’s decision to offer clients access to Bitcoin funds, Goldman Sachs announced their plans to begin offering investment options for Bitcoin and other cryptocurrencies within the next three months. More specifically, the investment avenues will range from derivatives and traditional investment vehicles to physical Bitcoin and will be operated by the private wealth management division of Goldman Sachs. This automatically implies that access to crypto investing avenues will only be feasible for the wealthiest clients of the bank, those with a minimum of $25 million to invest. 

 

What is a cryptocurrency?

 

Cryptocurrencies are an alternative form of payment that can be used for the online exchange of goods and services. They are digital assets that serve as a means of exchange. The key difference with common currencies is the technology they are based on. More specifically, cryptos work through the use of a technology named blockchain, which is a decentralised technology spread across multiple users in various places of the world that manages, keeps track and records transactions. Exactly because of its decentralised nature, cryptos are not issued by central authorities and theoretically the blockchain technology renders cryptos immune to government interference. Some of the most known cryptos are Bitcoin, Ethereum, Ripple XRP and Dogecoin. 

 

The Context of Bitcoin and “Institutional Crypto”

 

In mid-March (2021) Bitcoin’s price skyrocketed into a record of $60,000, following a previous record of $50,000 in February (2021). It is estimated that prices have increased by 70% so far this year, while the total value of the cryptocurrency is around $1 trillion (Forbes, 2021). Capitalising the increasing trend, major firms and institutions have interfered into the market. In addition to Morgan Stanley and Goldman Sachs, a recent example is that of Tesla. Although the company is not currently investing in Bitcoin, primarily due to environmental reasons, it had previously invested $1.5 billion while at the same time had announced their plans to accept it as a payment (CNBC, 2021).  

 

However, Goldman Sachs’ decision to offer Bitcoin was not solely driven by the fear of competitors gaining a competitive advantage by entering the market before them. The consumer demand was also an influential factor. More specifically, the new head of digital assets for Goldman Sachs – Mary Rich – recently stated that: “There’s a contingent of clients who are looking to this asset as a hedge against inflation, and the macro backdrop over the past year has certainly played into that” (CNN,2021). The concern about rising inflation, in combination with the fear of a potentially “weaker” US dollar, have increased investors’ perception of Bitcoin as a profitable alternative investment.  The main reason why investors perceive it as a hedge against inflation is that they expect their value to raise more than the annual expected rate of inflation. Nevertheless, absence of regulation and elements of volatility remain a stigma for the crypto market. 

 

But what makes Bitcoin so attractive to large Institutions?

 

The increasing value of Bitcoin is not its only element of attraction. There are two exclusive benefits of Bitcoin in comparison to other regular commodities major financial institutions have engaged with for years. The first one is that its financial nature is much closer to that of gold, meaning that Bitcoin’s futures have shown a tendency towards a contango structure, unlike other commodities who tend to have a backwardation structure (FT,2021). A contango structure implies that the forward price (the agreed upon price of an asset in a forward contract) of a futures contract is higher than the spot (current) price. In addition, Bitcoin is relatively easy to store and physically hold, unlike other commodities such as iron ore, coal and grain. Hence the speculation about increasing its price is not the only concern of bankers and investors as the above allow for lock-in yield strategy. This strategy consists in investors and institutional managers’ ability to attempt a “realization of previously unrealised gains accrued in a security by closing all or a portion of the holdings” (Investopedia, 2021)

 

What does Institutional Bitcoin mean for the market?

 

The first and arguably one of the most important effects of Institutional Bitcoin and generally crypto, is the diminished governmental barriers that exist in the status quo. As more and more financial institutions and firms accept cryptos, it is becoming harder for governments to deny and disregard the vital role that cryptocurrencies play in financial markets. However, the need for governmental intervention is a highly controversial factor of the “crypto equation”. Despite the flexibility that bankers and investors enjoy from the highly unregulated market of Bitcoin, several risks are hidden below the table. Examples of those risks are ability for money laundering, and inability for governmental bodies to assure consumer protection due to the high volatility that inherently exists in the crypto market. 

 

An additional implication of institutional crypto has to do with its volatile nature. We must admit that the market is characterised by high volatilities that are often caused by over-purchasing of cryptos or other irrational actions coming from investors that have limited resources and capabilities to adequately research the market. The involvement of financial institutions can potentially bring additional expertise and rationalisation in the market that can limit to a certain extent the irrationality of the status quo. More specifically, financial institutions will contribute to the research of the market, allow for greater information and also better advise as for the crypto transaction that individuals can make. In case this turns out to be true, companies that have or plan to accept it as a payment can also benefit as less risk and volatility in the market also means less risk for their future profits coming from crypto payments. 

 

Goldman Sachs’ decision to engage with Bitcoin is definitely a big step towards a more institutionalised crypto market, and wider adoption of crypto. It definitely drives greater attention from the general public and increases its perception as a legitimate investment option rather than a speculative asset. However, the question of governmental barriers and intervention is more imminent than ever. Its financial nature might be threatened by it but the increasing influence of crypto into the financial market and consequently the economy has incentivised governmental bodies to act. The future actions of all the above stakeholders are really interesting and intriguing as they will greatly affect the process of crypto abandoning its “immature” state.

 

References and Suggestion for Further Reading
  1. What Does Institutional Adoption Of Crypto Mean For 2021 And Beyond?. [online] Available at: <https://www.nasdaq.com/articles/what-does-institutional-adoption-of-crypto-mean-for-2021-and-beyond-2020-12-14> [Accessed 7 April 2021].

BBC News. 2021. Bitcoin hits new record of $50,000. [online] Available at: <https://www.bbc.com/news/business-56084499> [Accessed 7 April 2021].

Downey, L., 2019. Lock In Profits Definition. [online] Investopedia. Available at: <https://www.investopedia.com/terms/l/lock_in_profits.asp> [Accessed 7 April 2021].

Group, Bay Area News. “Smart Strategy: ‘Lock in Yield’.” East Bay Times, East Bay Times, 17 Aug. 2016, www.eastbaytimes.com/2007/03/30/smart-strategy-lock-in-yield/. 

Hale, K., 2021. Goldman Sachs Cryptocurrency Endorsement Boosts Wealth Management. [online] Forbes. Available at: <https://www.forbes.com/sites/korihale/2021/04/05/goldman-sachs-cryptocurrency-endorsement-boosts-wealth-management/?sh=30e163d361cb> [Accessed 7 April 2021].

Kaminska, I., 2021. What does institutional bitcoin mean?. [online] Ft.com. Available at: <https://www.ft.com/content/bed3e1ed-1379-44f7-b216-f388a172f45b> [Accessed 7 April 2021].

Ramishah Maruf, C., 2021. Goldman Sachs reportedly jumps on the bitcoin bandwagon. [online] CNN. Available at: <https://edition.cnn.com/2021/03/31/investing/goldman-sachs-bitcoin-investing/index.html> [Accessed 7 April 2021].

Son, H., 2021. Morgan Stanley becomes the first big U.S. bank to offer its wealthy clients access to bitcoin funds. [online] Available at: <https://www.cnbc.com/2021/03/17/bitcoin-morgan-stanley-is-the-first-big-us-bank-to-offer-wealthy-clients-access-to-bitcoin-funds.html> [Accessed 7 April 2021].

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