Ever since Satoshi Nakamoto wrote the Bitcoin whitepaper in 2008, it has mainly been retail investors who have shown an interest in this asset class. Institutions have kept their distance. This however seems to be changing. I argue below that since institutions control the bulk of investible assets, even minimal interest from them, as they learn to maneuver the world of cryptos, could lead to Bitcoin touching $55,862.
Why have institutions have stayed away from bitcoin for so long?
1. Regulatory Compliance - Institutions are subject to stringent compliance standards and crypto regulation has been fairly unclear. The legal and compliance departments of asset management firms are likely not supporting this asset class even if the fund managers are convinced.
2. Criminal Nexus- Governments have viewed cryptos with suspicion as its privacy protection properties have been exploited by criminals and terrorists to buy drugs and arms, among other unsavoury items. Clearly, no institution wants to give governments a reason to go digging into their books.
3. Investment infrastructure - Support like custody services for crypto assets was unavailable till recently.
A few brave firms have been unable to resist the opportunity though
=> MicroStrategy announced in September that it has purchased a total of $425mn worth of bitcoin. Fun fact- The co-founder of MicroStrategy back in 2013 had written a tweet - “#Bitcoin days are numbered. It seems like just a matter of time before it suffers the same fate as online gambling”. Clearly, bitcoin is making a believer of several skeptics.
=> Square led by Jack Dorsey, the co-founder of Twitter, announced in October that it has invested $50mn in bitcoin.
=> Mode, a UK based FinTech announced in October that it will allocate up to 10% of its cash reserves to Bitcoin. Its stock price rose 9% after the announcement.
=> Stone Ridge Holdings, a $10bn Hedge Fund announced that it had $115mn worth of bitcoin and it has built from scratch - New York Digital Investment Group (NYDIG), a crypto execution and custody service which currently has over $1bn assets in custody.
Why is institutional money getting into cryptos now?
1. Insurance against Inflation - Easy money policies of Central Banks have brought the world very close to the brink of hyperinflation. In such a situation, Bitcoin can serve as a good hedge.
For most of us, Bitcoin hit an all-time high in Dec’2017. However, for countries facing rapid inflation, Bitcoin has been touching all-time highs in the local currency in 2020. Take a look at Alistair Milne’s tweet below:
Image source - Alistair Milne
The US Fed’s money printing has led to its balance sheet growing from $870bn in Aug’17 to over $7.1tr in Oct’20. ~$3tr of this expansion has happened in the last 6 months. A study by Lawrence Summers and David Cutler indicates that the Covid Pandemic will cost the US $16tr. In this environment, it is not a stretch to think that US$ too could become a victim of high inflation, and investing in bitcoin as a hedge, along with say gold would be a prudent strategy.
Image Source - Federal Reserve
2. Backend Support - Fund management requires the support of robust backend systems- order management software, custody services, etc that meet stringent regulatory standards. Such support is now available making it easier for any asset manager convinced of the value of cryptos to invest in the same.
3. Mainstream Acceptance - Bitcoin is no longer just an esoteric store of value. It is getting mainstream acceptance. Paypal announced this month that it is allowing Bitcoin and select cryptocurrencies into its ecosystem. Customers will be able to buy, hold and sell cryptos and use the same to purchase goods from their 26 million merchant. Coinbase announced the launch of it's Visa debit card where any of the cryptocurrencies that it supports can be used to pay merchants.
4. FOMO - I suspect some institutions have been stealthily investing in this space for the last few years, but with the latest announcements, the floodgates of institutional money might have been finally unlocked. Asset managers constantly on the lookout for multi-bagger opportunities are suddenly being hit with the news that other asset managers are betting on this new asset class. Let us not underestimate the impact of the Fear Of Missing Out.
NOW FOR THE FUN STUFF - $55,000? How much of institutional funds can find its way into Bitcoin and what would that mean for Bitcoin's valuation?
According to IPE, Assets under Management globally for the Top 500 Asset Managers is at $81.1 trillion .
The total supply of bitcoin is capped at 21mn. Currently, 18.5mn bitcoins have been mined. According to a recent study by Chainanalysis 4mn bitcoins have been lost and cannot be recovered (this includes bitcoin owners who have lost their private keys, bitcoin owners who have died without sharing private keys with anyone, and the 1.1mn bitcoin owned by Satoshi Nakamoto). This means that only about 14.5mn bitcoins are in circulation.
=> If even 1% of the Global AUM is invested in bitcoin, then the value of 1 bitcoin can reach $55,862 (89tr x 1% / 14.5mn).
=> If 5% of Global AUM is invested in bitcoin (possible but unlikely in the near term), the value of 1 bitcoin can reach $279,310.
=> If 10% of Global AUM is invested in bitcoin (highly unlikely in my opinion), the value of 1 bitcoin can reach $558,621.
Remember, that with time, the numerator i.e. the AUM will continue to rise. However, the denominator i.e. total supply of bitcoin can only reach a maximum value of 21 million by the year 2140, assuming the lost bitcoin are all magically found.
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