Cryptocurrencies have grown from an obscure side project to a multi-billion dollar asset class over the past decade. While there have been plenty of setbacks, the market has been robust enough to draw in billions of dollars in investment. Retail investors have been the biggest driving force thus far, but institutional investors are starting to warm up.
Let's take a look at how the cryptocurrency market is evolving from an immature retail investment to a mature institutional market, as well as what lies ahead for investors.
Investing in Crypto
Cryptocurrency and blockchain investments have gone mainstream among retail investors following Bitcoin's meteoric rise. In late 2017 Coinbase reported more customers than Charles Schwab, a stock brokerage that has been around for decades, although it's worth noting that Schwab had far more assets under management — roughly $3.26 trillion.
Coinbase may let investors purchase cryptocurrencies and hold them in a wallet, but exchange-traded products (ETFs and ETNs) promise to open up the market to a wider investor base. WisdomTree recently launched a physically-backed Bitcoin ETP in Switzerland under the ticker symbol "BTCW", saying that it sees many similarities between crypto and commodities.
At the same time, the CME Group introduced crypto futures and options, enabling traders to speculate on the direction of cryptocurrencies without actually buying and selling them. These markets also enable traders to hedge against some of the risks of cryptocurrencies and could help stabilize prices over time by forecasting future prices.
Finally, blockchain investments have been picking up steam in recent years. There are eight blockchain-related exchange-traded funds (ETFs) in the United States with more than $200 million in assets under management and many others abroad. These ETFs have attracted a growing amount of capital as investors embrace the potential for the breakthrough technology.
Institutional Interest In Crypto
Retail investors may be driving the current boom in crypto and blockchain investment, but institutional investment could become the key driving force. While venture capital funds have long invested in cryptocurrency and blockchain projects, institutional investors have been slow to get involved due to uncertainties about the market and its regulation.
Growth in Crypto Fund Assets Under Management - Source: Crypto Fund Research
Morgan Creek Digital, a private equity venture capital fund, recently attracted $55 million in investments from two pension funds in Fairfax County, Virginia. The pension funds are using these blockchain and crypto assets to replace small cap U.S. equities as a high-risk, high-return part of their portfolio — a trend that seems to be catching on elsewhere.
Many pension funds are struggling with low interest rates, which has made crypto and blockchain investments an attractive way to meet return targets. While crypto has been performing well in recent months, most funds are primarily interested in blockchain exposure given the technology's potential to revolutionize a wide array of industries.“
We’re not doing this for crypto exposure, but we do get some of that, and it does so far exhibit some uncorrelated behavior relative to other asset classes,” said Andy Spellar, CIO of one of the pension funds, in an interview with CoinDesk. “To be honest it’s so early in its lifecycle that I don’t have a good idea of whether that will hold up or not.”
There have been many efforts to introduce a Bitcoin exchange-traded fund (ETF) in the United States, but the Securities and Exchange Commission (SEC) has been hesitant to approve them. While some applications have been denied outright, others have been delayed or canceled due to onerous regulatory requirements and delays by the SEC in responding to requests.
Kryptoin, Crescent Crypto and Wilshire Phoenix have ETF proposals that are currently pending SEC approval. The SEC's biggest concern thus far has been price manipulation, which Chairman Jay Clayton expressed in June of last year. The agency doesn't see Bitcoin or other cryptocurrencies as "regulated markets of significant size" where an ETF makes sense.
Without any domestic ETF options, many investors are forced to purchase cryptocurrencies directly through exchanges like Coinbase. These purchases entail their own set of challenges with accounting, since each transaction generates a capital gain or loss that must be reported to the IRS — even if it's a crypto-to-crypto transaction involving no cash profits.
Fortunately, there are some tools that can help streamline the tax reporting process and enable traders and investors to participate in the market without onerous reporting requirements. ZenLedger simplifies crypto tax reporting requirements by aggregating transactions, computing capital gains and autofilling popular IRS forms.
The Bottom Line
The crypto market is quickly evolving into an attractive alternative asset class that interests institutional investors. While the underlying blockchain technology is generating the most interest right now, these investors are keeping an eye on the opportunity to reduce correlation and improve portfolio returns over time using Bitcoin and alt coins.
Investors should keep an eye on these dynamics since institutional involvement in cryptocurrencies could dramatically reshape the market by increasing demand and potentially providing a catalyst for prices. At the same time, investors should pay attention to opportunities in the adjacent blockchain space that continue to draw investment.
In the meantime, investors can still purchase cryptocurrencies directly through exchanges, which offer competitive pricing and access to a wide array of different products. The only challenge is keeping crypto wallets secure and ensuring that you’re up-to-date with tax reporting to avoid any costly fines or penalties for underpayment.
If you're an investor in the crypto space, consider using ZenLedger to manage your taxes without the headache of aggregating transactions, calculating the capital gain or loss for each one, and reporting those on various tax forms.