Why and How Corporations and Institutions Can Add Bitcoin to Their Portfolios
Article

Why and How Corporations and Institutions Can Add Bitcoin to Their Portfolios

by Noah Buxton
April 07, 2021

Bitcoin used to be just a novel buzzword in the world of finance. But it has found its way into everyday conversations, including those in the boardroom. Here’s a look at the reasons some public companies and institutional investors  are turning to bitcoin (BTC) as a treasury asset or portfolio asset and some important considerations for getting started. (For a deeper dive, check out our recent webinar, Bitcoin Goes Public.).

An Overview of the Current Marketplace

Institutional investment in digital assets among large, well-known asset managers has been growing in popularity, particularly since late 2020. For example, BlackRock has started to dabble in bitcoin, adding bitcoin futures to two of their funds, and BNY Mellon has a dedicated book for bitcoin . Noted hedge fund manager Stanley Druckenmiller recently said that he’s long on cloud technology stocks and broad Asian equities and currencies, and short on Treasuries, expecting bond prices to fall and long-term yields to rise. He’s also long on commodities and short on the dollar — an investment philosophy that right in line with the economics of bitcoin.

Also on the rise is corporate interest in bitcoin as a treasury asset. As of early March 2021, 42 public companies have invested around $60 billion in BTC, including high-profile corporate leaders like Elon Musk ($1.5 billion in BTC), MicroStrategy CEO Michael Saylor ($2.2 billion in BTC) and Square CEO Jack Dorsey ($354 million in BTC).

Much of the interest, from both institutional investors and corporate leaders, stems from perceived weakness or instability observed in traditional asset classes, even the U.S. fiat currency. As the U.S. — and global — economy has wrestled with the COVID-19 pandemic, uncertainty has increased and long-term Treasury yields have risen significantly, signaling a lack of confidence in bonds. While bonds are typically seen as a stable investment vehicle, digital assets like bitcoin are now being viewed by institutional investors as either an alternative to or a hedge against bonds and other fiat-based investments.

Another significant driver in the digital asset marketplace is the rise of decentralized finance (DeFi). DeFi allows investors to lend and borrow funds free from a centralized, middleman-based structure. The blockchain allows this to be done in novel ways, and the number of DeFi solutions has been rising every month. This makes it easier for investors to get involved without navigating through expensive brokers and institutions with slow, cumbersome processes. While the evolution of the decentralized loan officer is still in very early days, there is incredibly promising innovation happening in DeFi lending, liquidity and market making, borrowing and asset exchange.

At the same time, recent regulatory changes have made it possible for regulated parties to act as custodians or brokers for digital assets. This provides a convenient entry point for SEC-registered companies because they can now engage with digital assets, unencumbered by regulatory restrictions.

A Hedge Against Inflation and Depreciation

Bitcoin was invented as a direct response to irresponsible behaviors by traditional market participants in the run-up to the 2008 financial crisis. A similar and related issue is governmental monetary policy, inflation and the steady decline in the purchasing power of fiat currencies.

While firing up the money printer can help unemployed Americans or failing businesses in the short term, in the long term, it destabilizes the American (and global) economy. In 2020 and now in 2021, fiat-based monetary policy has resulted in trillions of dollars being suddenly injected into the global market. The true inflationary impact and how equities markets will react is yet to be seen.

The staggering impact of inflation is felt by all, but not realized by most. A dollar held since 1971 only has 15% of its original purchasing power today. Bitcoin’s monetary policy by code has a set schedule of inflation and a fixed supply. So, while bitcoin has shown volatility, it has also demonstrated risk-adjusted returns that outpace all other asset classes over the last decade. Investors and corporates are seeing the writing on the wall and seeking to diversify with BTC.

Bitcoin’s Rise: A Product of Scarcity and Early-Stage Growth

An asset such as bitcoin gains value if it becomes more desirable over time. This is a product of several factors, two of which are scarcity and early-stage growth.

When an asset is scarce, people see it as being more valuable than one that is plentiful. All forms of money that have been successful have been scarce (or at least started that way). All the fiat currencies created by kings and governments have failed in whole or in part due to hyperinflation (the antithesis of scarcity). Bitcoin is an asset with a finite supply and built-in scarcity because only 21 million BTC are ever going to be available for circulation. It is also in the early stages of its growth, which can offer great potential upside for investors.

Bitcoin’s value proposition is similarly clear to many institutional investors. Buying BTC now comes with the possibility of the investment growing along with continued adoption of bitcoin and other cryptocurrencies.

Not All Digital Assets Are Created Equal

There are literally thousands of cryptocurrencies, each with a different purpose and designed to solve specific problems such as making transactions faster, helping people send money between countries, or incentivizing use of their network. Bitcoin is the Mother of all digital currencies, however, and the Bitcoin blockchain was the first-ever blockchain network. Consequently, bitcoin is the bedrock upon which all other coins have been built. Its value attests to this strength and its integral position as a base layer for all crypto markets.

The popularity of bitcoin has resulted in more people obtaining it and more businesses accepting it. This gives BTC more liquidity than other cryptocurrencies. The rise of DeFi has only added to this liquidity, as bitcoin that was once simply held can now be “wrapped” and ported to other blockchain networks for use in decentralized lending, exchange and borrowing activities. Opportunities to earn interest on bitcoin holdings, through centralized crypto lending providers (e.g., Nexo.io and BlockFi) or decentralized means (e.g., Compound, Aave, Uniswap), turns bitcoin into a store of value that can also produce income for holders.

While some digital assets offer the promise of solving important problems, their lack of network effects limits their current real-world impact, and thus their liquidity and market value. Bitcoin’s network effect, liquidity, global adoption and track record remain second to none.

Key Issues in Onboarding Digital Assets

Going from other asset classes to digital assets can seem like a daunting challenge for corporates and institutional investors. If your company is considering digital assets such as BTC, there are some key things to keep in mind, including:

  • Audit requirements – how will the board enact policies and procedures as well as retain personnel with sufficient expertise to maintain auditable records of digital asset transactions and holdings?
  • Reporting to investors (for public companies) – how will holding digital assets in treasury impact overall public disclosure requirements?
  • Governance issues – how will management ensure that the activity of purchasing, holding and managing digital asset investments aligns with board risk appetite and overall corporate governance?
  • IT & security – what new risks and challenges are created by transacting in or holding digital assets? How can management implement proper controls around the people, processes and technology involved in digital asset transactions and holdings?
  • Exchange and custody partnerships – which providers have sufficient security, reporting and reputation to become your vendor?
  • Bitcoin investment strategy – how do you think about your current investment or treasury positions and how does a digital asset hedge dovetail (or not) with that strategy?
  • General risk management – how do you find human capital resources that have sufficient experience and expertise in managing new risks created by digital asset opportunities?
  • Educating your organization – how can your C-suite and board obtain sufficient education regarding the balance or risk and reward in order to guide decision-making?
  • Knowing when to seek help – when and how can you supplement the on-ramping process with expert consultants?
  • Accounting and finance – what key issues regarding accounting treatment of your bitcoin will need to be addressed and documented?
  • Tax implications – how does transacting and investing in bitcoin change (or not) your current tax implications?
  • Investment lifecycle – if you invested in or held digital assets, what do you do next? How do you ensure you are poised to make the right moves if the market moves against you?

A New Frontier to Explore

The current move to digital assets by corporates, institutions and individuals is supported by sound economic principles. Armed with a pragmatic, thoughtful onboarding process, businesses may be well-positioned to benefit from the impressive upward potential of bitcoin and other digital assets.

For questions or to learn more, contact our Digital Assets & Cryptocurrency team.

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Author
Noah Buxton - Director, Blockchain - San Francisco, CA | Armanino
Managing Director
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