How Institutions Can Get Access to Crypto Exposure
By: David Olsson, Global Head of Institutional Distribution at BlockFi
Institutions face a dilemma when they have decided to invest in Bitcoin and other cryptocurrencies. If one thought that the first bridge to cross - accepting that Bitcoin is an asset class that has value in diversifying a portfolio - was difficult, the intricacies of getting exposure to Bitcoin can be just as daunting for some. I lay out some of the instruments here, and the pros and cons associated with each of them.
The easiest way to get exposure with the least amount of infrastructure is to invest into a fund vehicle. Funds allow institutional investors to hand the keys to a manager and rely on an institutional grade wrapper to invest and monitor. Once upon a time (about a year ago), there was little choice besides Grayscale’s vehicle. Today, there are many. Stateside, the most commonly used vehicle at the moment is a U.S. grantor trust that trades in the secondary market and enables accredited investors to purchase shares of the fund at NAV in a daily private placement. Generally, after a 6-month lockup period, the shares can be sold to retail investors on the secondary market. Grantor trusts have the ability to allow redemptions, but this is commonly turned off during the period when they trade the secondary market, making them more of a hybrid fund. BlockFi, Osprey, Arca, Grayscale, and Bitwise currently offer these types of vehicles. Note that none of these have been approved to be listed on an exchange or to become an Exchange Traded Fund (“ETF”). We think that this is a likely evolution in the next year in the U.S. given the number of high quality managers who have filed, including Fidelity, Van Eck, and Skybridge.
In Europe, other closed end type vehicles also exist, Coinshares has a Bitcoin (BITC) and Ethereum ETP listed on Nasdaq OMX, which enables investors to purchase shares via their investment platform or broker. For a centrally-cleared ETP, investors can look at HanETF’s BTCE listed on Deutsche Bourse. There are also open ended funds like NYDIG’s Bitcoin Strategy Fund and Skybridge’s Bitcoin Fund, which offers daily subscriptions, with quarterly 30 days’ notice redemptions.
Looking to the future, ETFs are on the horizon, with Canadian firm Purpose Investments recently issuing the first Bitcoin ETF back in late February. In its first two days of trading, it had collected over $400m in AUM, and today it is about to break $1billion AUM. ETFs are a game changer, breaking down the barriers institutions face when trying to enter Bitcoin. Fundamentally, ETFs will bring more stability to Bitcoin, as we see an increase in liquidity, circulation and users. However, institutional investors, particularly in Europe, are focused on the ESG credentials of the funds into which they invest. Large corporate pensions and endowments in the U.S. are starting to ask for similar investments. Given the publicity surrounding the energy consumption of Proof-of-Work for Bitcoin, we think that there may be some ESG-friendly solutions at some point in the market. Perhaps institutions will start questioning whether a Bitcoin is mined with coal-fired power or hydro-electricity. This might result in some ETFs trading at a premium to others based on how the Bitcoin is sourced; was it mined sustainably using renewable energy? These types of questions will become more and more relevant as institutions look to align Bitcoin to their mandate.
The more intrepid (and cost focused) investors, or those who may want more control over their holdings, may desire to invest in Bitcoin directly through a custodian. Most of these investors would look at using a qualified custodian with a SOC 2 audit. The SOC 2 is an audit designed to identify if the clients and organisations data is securely managed. Each audit is unique to each organisation but must pass five trust principles: 1. Security (protection of unauthorized access) 2. Availability (monitoring and disaster recovery) 3. Processing Integrity (delivering the correct data) 4. Confidentiality (restricting access to specific data) 5. Privacy (following the AICPA’s generally accepted privacy principles (GAPP). Gemini was the first digital asset custodian to complete a SOC 2, carried out by Deloitte & Touche LLP. Coinbase also recently completed a SOC 2 with Grant Thorton, and BlockFi is underway with its own SOC 2 audit.1
If you’ve chosen the direct route of buying your Bitcoin, you will need an OTC Trading desk partner who can execute your purchases through a market, limit order or a number of algos, including the popular TWAP. Algorithms space out your purchases to limit market impact. As more institutions invest, we may see some of the same focus on TCA (Transaction Cost Analysis) that we see in the traditional markets. BlockFi and Coinbase, for example, provide OTC trading desk services along with other market participants.
Non custodial secure payment networks
Silvergate, Signet, and BCB offer secure payments of fiat between counterparties. This can be particularly useful when trading needs to be done out-of-hours or over the weekend when traditional banking wires are dark. The three networks allow 24/7 movement of fiat to settle trades. On the digital asset side, firms like Fireblocks and Curv operate secure, non-custodial networks to move crypto round-the-clock from point-to-point.
Some investors with PPMs restricting owning physical Bitcoin or other crypto, may want synthetic access. CME futures offer access to the asset class (Bitcoin and Ethereum so far) without the overhead of custody and with deep liquidity; as of March 1st, there were about $2.7bln open interest across the two cryptocurrencies. However, these often trade at a premium to spot Bitcoin and Ethereum.
Some trading desks can also provide non-deliverable forwards (NDFs) which are similar to futures but trade bilaterally OTC between a dealer and a customer. The advantage may be that the client can achieve cross-margining if they have other positions (i.e., higher leverage), or a cheaper financing rate than that implied by futures. On the flip side, the counterparty risk may be higher.
Historically, the kind of architecture available for institutions was scant, but during the “nuclear winter” of 2017-2020, the industry was busy building for the hopeful return of mass adoption in that space.
Indeed, mass adoption has come, as evidenced by the number of large corporates and hedge funds investing, and the infrastructure for institutions has never been so robust. There are mature regulated Bitcoin and Ethereum products, as well a number of qualified custodians. There has never been so much confidence in digital assets as a viable part of an institutional investment mandate.
About the Author
The content expressed in this article by David Olsson was prepared or accomplished in his personal capacity. The opinions expressed in this article are David Olsson's own and do not reflect the view of BlockFi or its affiliates.