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Posted September 18, 2020
In May 2020, Paul Tudor Jones sent a remarkable letter to the participants of his “Tudor BVI Global Macro” Fund ^1. He revealed that the fund would take a position in bitcoin. Should institutional investors follow this example?
The increased market capitalisation of bitcoin in 2017 meant that a single Dutch institutional asset manager felt compelled to get a better idea of bitcoin and other crypto assets. There was a new asset class on the rise that quickly surpassed the market capitalisation of other asset classes in which investments were already made. A lack of solid fundamental valuation methods and sky high volatility led to continuing domination of skepticism. Nevertheless, renowned institutional parties give bitcoin a place in the portfolio 3 years later. Why would an institutional party consider investing in bitcoin? In this article I share two thoughts to help you formulate an answer to that question yourself and I conclude with a vision for the future.
What drove bitcoin’s creation?
Satoshi Nakamoto (the pseudonym of bitcoin’s still unknown creator) saw the ‘trust problem’ as the main reason behind bitcoin’s design. According to Satoshi, the biggest problem with conventional money was the huge role that trust plays in making the system work. For example, to transfer money you have to trust a number of central parties in order for that transaction to be successful and you must be convinced that your funds are safe in custody. But a level higher, holders of the funds have to rely on central banks not to allow for (too much) devaluation of this money. Unfortunately, over the years and even today, there are plenty of examples where this trust is broken. Think for example of Argentina, Zimbabwe or Lebanon. The most terrifying example is Hungary in 1946, where prices doubled every 15 hours. In the first block of the bitcoin blockchain, Satoshi refers to this trust issue in a hidden message: “The Times 03 / Jan / 2009 Chancellor on brink of second bailout for banks”.
Current state of fiscal and monetary policy
Prior to the Covid19 outbreak, global debt levels were already at unprecedented levels. Despite the fact that we all believe that the amount of debt must be curbed and that we also make clear agreements about this (think of a debt ceiling in the United States and the use of a debt / GDP limit of 60% in the EU), we do not always succeed to meet those agreements.
Every time the financial markets fall (or threaten to) fall into decline, the central banks’ buy back programs are revived to keep the markets afloat. According to the ECB, debt-to-gdp ratios will mainly deteriorate further in 2020.
Paul Tudor Jones reported to his clients in May that global money creation of USD 3.9 trillion has already been seen since February 2020, and is expected to grow even further to USD 16 trillion. Contrasted with the global money supply (M2), which was 95.7 trillion USD at the end of 2017, according to the CIA ^2, printing 16 trillion is a significant change in supply.
Ok, but what does bitcoin have to do with that?
“Bitcoin is a non-sovereign, hard-capped supply, global, immutable, decentralized, digital store of value. And it’s an insurance policy against monetary and fiscal policy irresponsibility from central banks and governments globally.”
These two sentences perfectly sum up the essence of bitcoin, and that last sentence in particular is the driving force behind institutional interest. Bitcoin is a digital decentralised medium whose maximum number of units in circulation is limited to 21 million. That 21 million is estimated to be reached asymptotically in 2140 because inflation automatically halves every 210,000 blocks (approximately 4 years). This makes it the first and only implementation of absolute scarcity. It enables us worldwide to store and irreversibly exchange value with each other without the involvement of a central all-powerful entity. In countries such as the Netherlands where the payment system works fine, everyone has a bank account and the value of the money is relatively stable, bitcoin seems to have little added value at first sight. However, where people are struggling with capital controls, war, political unrest or economic instability, bitcoin is adored. As we witness monetary easing globally, further devaluation of our conventional money is looming. Especially from this angle, bitcoin is found interesting by institutional parties and corporates, as most recently shown by MicroStrategy.
But aren’t there enough other instruments that are able to protect us against inflation?
There are several instruments and investment strategies available that protect against inflation. Jones’s letter lists all the alternatives and gives them a score on the properties of purchasing power retention, reliability, liquidity and portability. In that comparison, bitcoin ends last place. But if we look at the differences in order of magnitude for both the score and the market cap, we see that while the scores are close in order of magnitude, the market cap for bitcoin is several orders of magnitude smaller. Jones concludes that although bitcoin is a suitable instrument to protect against inflation, there are alternatives that are more suitable. But the magnitude difference of the differences between eligibility scores and market cap leads Jones to believe bitcoin offers a great investment opportunity.
When you compare the investment preferences of different generations, you see that each generation clearly has its own preferences. For example, according to research by Tom Lee of Fundstrat ^4, the silent generation was interested in gold, baby boomers particularly liked to buy equities and generation X was crazy about hedge funds. But now the millennials are presenting themselves as investors and this generation is even larger than the baby boom generation and has grown in a world that is becoming increasingly digital. The change in lifestyle and attitudes directly affects investment preferences. If the majority of invested capital comes from those younger generations, then you can expect the preferences of these generations to be reflected in the asset allocations. Bitcoin will increasingly be found there.
What does the future hold?
I foresee that there will be an increasing demand for bitcoin and other crypto assets in the coming years. The introduction of Central Bank Digital Currencies will certainly contribute to this. After all, one will have to work with digital currencies in wallets specifically set up for this purpose. As a result, everyone gets a crash course in digital assets and then the step to crypto assets is suddenly not very big anymore. Although in the Netherlands it is still mainly a party of retail, high net worth and family offices, I expect that more institutional parties will follow due to further strengthening of the infrastructure and a better understanding of the opportunity. Outside our borders, the first large parties are already anticipating. Now that this course has been set, I expect that within 5 years the use of crypto assets will be just as normal as the use of mobile phones. I think that bitcoin has further strengthened its position and that every pension fund board, following corporate treasury departments ^5, has at least seriously considered bitcoin as an investment.