Over the last 3 years, major financial institutions, publicly traded companies, Ivy League Endowments and legendary investors have invested in the crypto-markets [1], [2], [3]. What are their investment theses and what can we learn from their portfolio allocations?

The economic consequences of Bitcoin are hard to unpack. The Bitcoin network can be thought of as a currency, an asset, a protocol or an economic phenomenon [4]. Each perspective can deliver insights into the true valuation of crypto assets. In any case, no agreed upon methodology exists for their valuation. So what do these investors think drives the value? Let's review the main ideas:

Efficiency and Creativity

Wire transfers take days to settle. It's not that Banks don't have fast infrastructure, it's that they must compare isolated centralized databases. If the transfer started in a small Malaysian rural bank on a Friday, how many parties need to synchronize and agree before it can be spent in a bank in Barbados? Today, with Bitcoin, it would cost 20 cents and take an hour at most. No fees needed for the routing banks, the SWIFT network, regulators or comptrollers. All their jobs are done by the Bitcoin network.

Not only are payments faster, but some payments would simply not happen through traditional banks: For instance if countries or banks don't trust each other, if the amount is too small or if it's done on a Sunday. What volume of settlements will decentralized blockchains take from the banks? And more importantly, what completely new transactions will they unlock? [5].

Rights & Contracts

Just as it was hard to predict the future of the Internet in the 1990s, the future of finance may be radically different. Two ingredients are driving this change. The first one is digital property rights. Blockchains like Bitcoin, Ethereum, Cardano or Solana allow one to prove ownership of digital objects. A skillful copy of a Picasso may look the same but would not have the same value. A paper trail and an expert appraisal would identify the original. Equally, it's simple to make digital copies of documents, images or games. Blockchain technology allows one to prove ownership of the original and to transfer this ownership instantly around the world. The second, and perhaps the most important aspect is the programmability of money. But what does programmable money mean? The CFA institute puts it succinctly:

Cryptoasset-powered blockchains allow users to program money with certain rules and conditions, as you would program any software.

These programs, also called "Smart Contracts" can create rules like the following:

  1. Jane transfers X to John, only if Julia agrees (an escrow account)
  2. Jane transfers X to John after 10 deposits and 2 years have elapsed (a trust)
  3. InsurFly transfers X to John, if his flight has been canceled. (Automated insurance)
    Smart contracts allow much more complex capabilities and have given rise to automated trading platforms, borrowing and lending, portfolio management, lotteries, and so on. These capabilities may replace or enhance jobs currently done by notaries, escrow agents, lawyers, accountants, portfolio managers and banks. If successful, what economic value could this technology unlock?

Just Getting Started

With this context in mind, are BTC or ETH cheap or expensive? People have attempted various valuation techniques. If Bitcoin replaces gold as a deflationary store of value, 21M bitcoins would be worth $11Tn, or approximately $500k each. Other attempts have been made guessing the future velocity of money [6], or tying to guess how many banking services could be replaced [5]. Bullish predictions range from $50k to $1M per bitcoin. Bearish ones assumed it would drop to zero. If you believe crypto will play a role in payments, gold-like assets, or in banking, then one thing is certain: It is just getting started.

There are 40 million Bitcoin wallets with a balance, but over 1 billion people without a bank account [8]. The picture is similar for Ethereum, with around 60 million wallets.
Investment funds are buying crypto as an inflation hedge to diversify their portfolios. Here too there is plenty of growth ahead. A recent survey found that 21% of hedge funds are investing an average of 3% of their AuM in digital assets. 86% of those hedge funds intend to deploy more capital into crypto in 2021 [1].

Finally, a movement called decentralized finance (known as DeFi) took off a year ago. Its mission is to make new versions of financial services on the blockchain. This includes lending, trading, borrowing, capital raising, insurance. This year $160 bn flowed into the industry and are currently held and traded by smart contracts. $160 bn is of course dwarfed by the financial markets and banking services [5]. There too there is a lot of room to grow.

Utility and Growth

We have reviewed the major investment theses that are driving investment into crypto assets. If those ideas about crypto are correct there is plenty of growth ahead. But what about the risks involved? Isn’t volatility a problem? And how do investors choose the right time and coin? More insights coming soon!

Essential References

[1] 2021, AIMA, PWC, Elwood, 3rd Annual Global Crypto Hedge Fund Report
[2] 2018, Rakesh Sharma, If Crypto is Dead, Why Is Yale's Endowment Fund Investing In It?, Investopedia | 2018, Jon Victor, Harvard, Stanford, MIT Endowments Invest in Crypto Funds, The Information | 2020, Alex Konrad, Harvard and Stanford along for the ride, Forbes
[3] 2021, Harry Robertson, Legendary investor George Soros is trading bitcoin, Business Insider | 2021, Alex McShane, Legendary Investor Bill Miller Has Been Buying Bitcoin Since $200, Nasdaq.com | 2021, Luke Conway, Paul Tudor Jones: I Like Bitcoin as a Portfolio Diversifier, The Street
[4] 2021, Matt Hougan, David Lawant, Cryptoassets: The Guide to Bitcoin, Blockchain, and Cryptocurrency for Investment Professionals, CFA Institute
[5] 2021, Arthur Hayes, Yes I read the whitepaper, Bitmex Blog.
[6] 2021, Accessed Sept. 2021, https://lightning.network/
[7] 2017, Chris Burniske, Jack Tatar, Cryptoassets: The Innovative Investor's Guide to Bitcoin and Beyond, McGraw-Hill - ISBN: 9781260026689
[8] 2018, Bitcoin Addresses, Chainalysis | 2021, N-unique addresses, Blockchain.com | 2021, global findex report Worldbank, (mostly 2017 data)