The market for digital assets is growing, with more institutional investors entering the nascent asset class. But most of them only invest in Bitcoin. What are the reasons for this one-dimensional investment focus, and why does diversification matter.
One-third of all institutional investors hold blockchain assets in their portfolios, according to a study by asset manager Fidelity Investments. 45 percent of the European investors surveyed said they owned crypto assets or crypto derivatives – in the USA, the figure was 27 percent. Among the survey respondents were mainly pension funds, family offices, investment advisors, and hedge funds.
“These results confirm a trend we are seeing in the market towards greater interest in and acceptance of digital assets as a new investable asset class,” says Tom Jessop from Fidelity – a trend that has been accelerated by the COVID pandemic.
Asset managers are under pressure
There are two key reasons for the growing institutional interest in digital assets: One is that they are under pressure to deliver returns. According to Fidelity’s Jessop, European investors are particularly supportive and accommodating, as the negative interest rates in many countries make Bitcoin more attractive.
Additionally, broad diversification has become more critical in the current market environment. Since blockchain assets are mostly uncorrelated with other asset classes, they are suitable diversification tools.
One-dimensional focus on Bitcoin
The survey results also show that Bitcoin remains the preferred blockchain asset among institutional investors. More than 25 percent of all respondents hold Bitcoin in their portfolios, while only 11 percent invested in Ether.
There are several reasons for this one-dimensional investment focus on Bitcoin:
First, Bitcoin is the oldest crypto asset and also the one with the highest market capitalization. Investors have more confidence in Bitcoin, and the risk of total loss is minimal. Bitcoin also has significantly higher liquidity than other crypto assets.
Second, institutional investors are subject to strict regulations regarding asset custody, no matter if their assets are analog or digital. That’s why many institutional investors do not invest directly in crypto markets but through specialized asset managers and service providers that offer a legally compliant custody solution. Many of these third-party providers, however, only specialize in the leading crypto assets, as the demand from investors is significantly higher.
Additionally, there is legal uncertainty associated with smaller blockchain assets, especially concerning ICO tokens. From a legal point of view, most of these tokens are not considered securities; hence securities laws do not apply. As it is unclear how these assets will be regulated in the future, institutional investors shy away from investing.
Volatility and risk management
Although there are valid reasons for Bitcoin being the preferred institutional crypto asset, a Bitcoin-only strategy exposes investors to unnecessary concentration risks. As with other asset classes, a diversified portfolio is better protected against single asset risks.
Bitcoin-only also ignores the return opportunities of other blockchain assets. Bitcoin has generated a return of 39.2% year-to-date, while Ethereum has gained 90.0 %. Other crypto assets have had an even better performance.
The Fidelity survey shows that high volatility is still the primary concern among institutional investors, making diversification and risk management even more important. Most companies have too little experience in trading digital assets and no proven risk management strategy to effectively manage the volatility of the asset class.
That said, INVAO’s experience over the last two years has shown that active risk management can be successful in blockchain markets: Since December 2018, INVAO’s Blockchain Asset portfolio has outperformed the blockchain market by 106 percent, generating a total return of 147 percent.