The Institutional Argument for Crypto
Below is a write-up from the team at Delphi Digital, an independent research boutique providing institutional-grade research on the digital asset market. They share some of the key takeaways from one of their most recent reports examining the benefits of a small allocation to crypto through the lens of an institutional investor. Full disclosure: I currently sit on Delphi’s board of directors.
It's becoming increasingly clear the world is rapidly approaching a serious inflection point. Trust in government is at its lowest point in decades. After a decade of inflated asset prices and unprecedented central bank policy, the majority is arguably no better off than when we set out on this monetary experiment.
But times are changing. The masses are becoming increasingly aware of the stranglehold today’s corporate giants have on them. Adverse fiscal and monetary policies are being heavily scrutinized as the world grapples with increasingly unsustainable debt burdens. The popularity surge in Bitcoin and crypto is as much a product of the macro environment from which it was born as it is a technological revolution. The rise of crypto, however, has the potential to provide far more than just financial freedom; it has the potential to provide significant returns for investors as well.
Past Performance Is Not Indicative of Future Results
Risk assets have had a tremendous run the past ten years. Real estate recovered, U.S. equities dominated, and several asset classes saw double digital annual real returns. Suppressed interest rates amid lackluster inflationary pressures drove investors further out the risk curve in search of higher returns; and those who obliged were rewarded handsomely. If markets operated like childhood fantasy stories, this is where you’d insert “and they lived happily ever after” before closing your eyes for the night. Unfortunately, investing is never that simple, and history reminds us that the next decade is unlikely to mimic the last.
Setting the Institutional Stage
Let’s use pension funds as a quick example. Despite the significant gains in many financial assets over the last ten years, the funding status of many pension funds, both public and private, remain extremely vulnerable today. Public pension funds in the U.S. are approximately 72% funded, in aggregate, according to The Center for Retirement Research at Boston College (CCR), down significantly from nearly 90% roughly 15 years ago. But if funding levels for pensions have fallen during one of the longest bull runs in history for stocks, imagine their funding status once a market downturn strikes. See CCR study.
Historically low sovereign bond yields, above-average valuations for risk assets, unsustainable debt levels, and slowing global growth are the perfect storm to drive institutional demand for crypto assets. Rising debt levels are not inherently bad, but a weakening economic outlook for much of the world hinders the argument we can simply grow our way out of our debt problems. The more likely outcome is widespread currency devaluation, even in advanced economies like the U.S., which will help to alleviate some of the debt burden by reducing the value of the currency it is being paid back in.
Dethroning King Dollar
Ironically, network effects are a large driver behind the U.S. dollar’s status as the global reserve currency. Below are a few key reasons why it boasts such an important title.
Most of global trade is settled in USD.
Likewise, many commodities are quoted in dollars, with oil being the most significant.
One of the strongest reasons though is the demand for U.S. Treasuries (UST) by global central banks as the reserve asset of choice.
In our view, the real key to the dollar unwind lies on the demand side of the equation much more than the supply side. The “deficits don’t matter” narrative is likely to prove true in the near-term because, until a better alternative interest-bearing global reserve asset comes along, the U.S. Treasury can continue to issue more debt if there is substantial demand supporting it. However, foreign governments are well-aware of their dependence on the U.S. dollar and, as a result, have been trying to thwart its dominance (Russia, China, etc.). This comes at a time when the U.S. is issuing massive amounts of debt to help finance its growing budget deficit. Reduced demand for U.S. Treasuries abroad would cause yields to rise (barring a drastic surge in domestic purchasers), pushing up the cost of servicing this growing debt load.
Now it's unlikely the U.S. winds up defaulting on its debt given its track record, but that doesn't mean the world's largest economy will skate free and clear. The more likely scenario in our view involves the Treasury issuing more debt to fund its operations, increasing the budget deficit and sparking an extended period of increasingly pessimistic sentiment towards the dollar.
The Option on “Digital Gold”
The combination of these trends makes a compelling case for a comeback in gold as investors tend to flock to the precious metal as a safe haven asset during times of uncertainty. Gold’s performance is also a reflection of the amount of trust people have in governments, rising when the risk of currency devaluation heightens. As we've noted, a devaluation of multiple major currencies is not out of the question if governments fail to stimulate more robust economic activity to begin chipping away at their growing debt obligations.
Bitcoin exhibits many of the same traits as gold (durable, scarce, predictable supply). While its track record is limited, it addresses a few of gold's critical limitations, making it an attractive complement to the precious metal in an increasingly digital age. Aside from its supply hard cap, it is much more portable than gold (especially in large quantities), it’s divisible (sats), and is more easily verified given the transparent nature of its blockchain. The most significant difference, however, is that Bitcoin is censorship-resistant, meaning it cannot be seized, is accessible to anyone, and no central authority can block a valid transaction. On the other hand, it is much more difficult for the average person to get their hands on physical gold and most people who “own” gold don't actually have it in their possession; they buy gold-backed investment products (mutual funds, ETFs, etc.) or derivatives to gain exposure to the underlying. Not your vault, not your gold, right?
As with all emergent technologies, there’s a non-zero chance Bitcoin fails. Meanwhile, the world is grappling with unsustainable debt burdens and a slowdown in economic growth, making developed economies increasingly vulnerable when the next downturn finally arrives. The demand for a true non-sovereign, digitally-native store of value asset has never been greater as the risk of widespread currency devaluation grows. The backdrop for Bitcoin doesn’t get much better.
There are still several hurdles to overcome before we see major institutions put capital to work in this space, but given the headwinds most conventional asset classes face in the coming years (the details of which we examine in our report), a small allocation to crypto could make a significant impact on a portfolio's performance if this market does take off. The asymmetric upside potential is unparalleled in today's investing environment.
Next Steps: If you’re interested in reading more, please visit the Delphi Digital website or email us at firstname.lastname@example.org. You can also find us on Twitter. We’re always looking to connect with those who share our passion for crypto and investing!
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Interested in crypto research? Look no further. The premier research firm in the space, Delphi Digital, has two subscription offerings for individuals and institutions alike. Take a look at their Bitcoin and Ethereum reports to get a taste of their analysis. [Click here]
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