Bitcoin as a Treasury Reserve Asset: Institution Adoption Creates New Paradigms

There are few narratives within the crypto conversation that are as potent as institutional adoption. The mere thought of established investors and institutions endorsing digital assets has featured as one of the most compelling factors that propel the prices of cryptocurrencies. Hence, it came as no surprise that news that companies and institutional investors are adopting bitcoin as a reserve asset triggered positive price swings. While events like these have become norms, it is worth noting that the recent surge in bitcoin endorsements is quite different from what we are used to witnessing. It seems like investors and corporations are finally waking up to the disruptive potentials of digital assets and subsequently taking significant steps to reinvent their approach to the crypto market.

Here, I will explore this new trend and determine if the recent appetite for bitcoin and other cryptocurrencies is sustainable.

Institutional Adoption Is on The Horizon

On the 8th of October, Square, Inc. announced that it has decided to hold 1% of its total assets in digital assets by purchasing aggregately $50 million worth of bitcoin. The firm revealed that its decision stems from its belief that Bitcoin remains a vital instrument to establish global economic empowerment. The announcement reads:

“Square, Inc. (NYSE: SQ) announced today that it has purchased approximately 4,709 bitcoins at an aggregate purchase price of $50 million. Square believes that cryptocurrency is an instrument of economic empowerment and provides a way for the world to participate in a global monetary system, which aligns with the company’s purpose. The investment represents approximately one percent of Square’s total assets as of the end of the second quarter of 2020.”

In what seems to be the origin of the bitcoin treasury reserve trend, MicroStrategy had set out as one of the first traditional and publicly listed firms to take a big gamble on Bitcoin. The company currently holds $425 million worth of bitcoin as its principal reserve asset. The CEO of MicroStrategy, Michael Slayor, explained in an interview with Anthony Pompliano that although he had been skeptical of Bitcoin’s viability in the past, he now understands that the technology is a vital component of the future economy.

Saylor also pointed out Bitcoin’s intrinsic value while responding to a tweet by Barry Silbert on the stance of the Bank of England on crypto. He stated:

“#Bitcoin is the first digital monetary system capable of storing all the money in the world for every individual, corporation, and government in a fair & equitable manner, without losing any of it.If that’s not intrinsically valuable, what is?”

Following these events, Stone Ridge, a $10 billion asset management firm, revealed that it had acquired $115 million worth of bitcoin as its primary treasury reserve asset. While commenting on this development, Michael del Castillo wrote on Forbes that Stone Ridge did not just dive blindly into the bitcoin market but had put necessary infrastructures in place to sustain its bitcoin investments:

“The problem was that Stone Ridge needed a way to turn the dollars they wanted to invest into bitcoin and to safely store that cryptocurrency once they had it. And since they were personally invested in bitcoin, they needed to do all that in a way that not only satisfied their clients, auditors and regulators, but themselves as well. So, instead of just establishing a few custom funds for their clients as they’re wont to do, Stone Ridge took the extraordinary step of building execution and custody tools from scratch and kicking off an entirely new line of revenue, executing cryptocurrency purchases, and then holding on to the assets for their customers.”

Likewise, Andrew Singer wrote on Cointelegraph that there is more to Stone Ridge’s adoption of Bitcoin investments and alternative treasury models:

“Indeed, buried within Stone Ridge’s announcement was a call to banks and philanthropies to likewise make Bitcoin a principal component of their treasury reserve strategies. To that end, Stone Ridge was offering up the services of its New York Digital Investment Group unit, which holds a license from New York State to convert dollars into crypto and back again, along with core custody, financing, and Anti-Money Laundering and Know Your Customer capabilities.”

As Saifedean Ammous, economist and author of The Bitcoin Standard: The Decentralized Alternative to Central Banking, rightly puts it, the most exciting thing about this development is how digital asset-based services is not a core product of MicroStrategy:

“What was most interesting for me about the MicroStrategy and Stone Ridge purchases is that these are not companies that deal with Bitcoin as part of their core business, and yet they chose to place the majority of their corporate reserves in Bitcoin, not just a small fraction.”

Moreover, this trend tends to compel more CEOs and firms to explore the benefits of bitcoin as a reserve asset, particularly now that fiat is taking a beating from the ongoing health pandemic. Experts believe that the uncontrolled spending of governments has forced corporations and institutional investors to explore alternative investments, including crypto. Edward Moya, a senior market analyst at Oanda, stressed that we might continue to see more demand for bitcoin as the global economy continues to fail:

“Both Europe and America are struggling with the coronavirus, and investors are widely expecting governments and central banks to continue providing massive amounts of stimulus into the economy. BTC for now remains a risky asset and primarily increases in value when risk appetite is strong. Eventually, once the dollar resumes a steady downward trend, Bitcoin and other cryptos will attract some safe-haven flows alongside gold.”

In accordance with this comment, Fidelity Digital Asset, in a recent report, explained that the allocation of portfolios to alternative investment is vital in the current economic climate. The report reads:

“One of the key reasons for including alternatives in a portfolio is to increase diversification by allocating to assets or investments that are driven by different risk and return factors relative to traditional investments, and are thus imperfectly correlated. The inclusion of assets that are imperfectly correlated may offer downside protection when traditional assets fall and may help reduce volatility. Diversification can lower risk without necessarily causing an offsetting reduction in expected return and is therefore generally viewed as a highly desirable method of generating improved risk-adjusted returns.”

Hence, Bitcoin, which has proven over the years that it is “imperfectly correlated” to traditional markets, has become the go-to investment option for investors adopting portfolio diversification strategies:

“The rationale of certain bitcoin holders for allocating to bitcoin is similar to their rationale for allocating to alternative investments—notably, portfolio diversification and return enhancement. Additionally, the interest in bitcoin and other non-yield-generating alternative investments could also increase in response to the Federal Reserve (and many other central banks) cutting their benchmark interest rate to zero (or below zero) this year. In a world where benchmark interest rates globally are near, at, or below zero, the opportunity cost of not allocating to bitcoin is higher.”

Besides, a recent survey by Evertas, a crypto asset insurance company, discovered that more institutional investors are planning to incorporate bitcoin investments in the future. According to the study, 26% of the 50 institutional investors that collectively control over $78 billion worth of assets in the United Kingdom and the United States interviewed agree that family offices, insurers, and pension funds will increasingly adopt cryptocurrency. While reiterating the findings of this report, J. Gdanski, CEO and Founder of Evertas, explained:

“Our research shows that institutional investors are enthusiastic about increasing their exposure to cryptocurrencies and crypto assets in general, but there are clearly many issues regarding the infrastructure that supports these markets that still concerns them. These clearly need to be addressed if the full potential of investment from institutional investors in crypto assets is to be realised.”

More Money Flows into The Crypto Market

The immediate effect of crypto institutionalization is that more money will flow into the market. The growing appetite for crypto investments promises to increase market activities and, in turn, trigger the prices of digital assets to rise. Business Insider reported that Raoul Pal, a former Goldman Sachs hedge-fund manager, commented that he expects “an enormous wall of money” to find its way into the crypto scene. “Just from what I know from all of the institutions, all of the people I speak to, there is an enormous wall of money coming into this,” stated Pal. “It’s an enormous wall of money just the pipes aren’t there to allow people to do it yet, and that’s coming. But it’s on everybody’s radar screen, and there’s a lot of smart people working on it.”

Following the chain of events fueled by increased institutional adoption, some have begun to posit that if corporations continue to adopt bitcoin as a reserve asset, then shortage of the coin is inevitable. It is worth mentioning that Bitcoin has a limited supply of 21 million coins, and over 18.5 million is already in circulation. Hence, it is not foolhardy to iterate a scenario where the supply of bitcoin does not come anywhere near its demand. Eventually, this will cause the price to skyrocket. As implied, recent reports detail the shortage of sellers as the holdings of crypto exchanges shrinks significantly. Galssnode highlighted this trend in a tweet:

“Bitcoin accumulation has been on a constant upwards trend for months. 2.6M $BTC (14% of supply) are currently held in accumulation addresses. Accumulation addresses are defined as addresses that have at least 2 incoming txs and have never spent BTC.”

In tandem with this observation, Michael van de Poppe, a full-time trader at the Amsterdam Stock Exchange, belives that it is a bullish sign for bitcoin. He tweeted:

“More and more #Bitcoin getting out from exchanges and most probably being transferred to non-custodial wallets. This suggests slightly lower liquidity and lower selling pressure going forward.”

What are the propelling factors for crypto institutionalization?

According to Paul Cappelli, a portfolio manager at Galaxy Fund Management, institutional investors prefer their crypto investments and infrastructures to have a similar feel to the traditional alternatives:

“Institutions mainly want their digital asset investments to look and feel like other more traditional investments in their portfolio with everything from service providers to reporting.”

Hence, he believes that the influx of traditional investments and auditing firms in the crypto industry is a propelling factor of the widespread institutionalization of crypto that we are currently witnessing. More importantly, the emergence of certified crypto banks has fortified confidence in crypto investment instruments. Mark Binns reiterated this sentiment in a recent publication where he projected that in the next couple of years, banks that fail to understand and adopt the disruptiveness of crypto would fall further down the pecking order:

“What will happen if banks don’t join the party? Any bank still approaching cryptocurrency with trepidation over the next 18 months is at risk of finding itself dead in the water at the hands of Kraken and other banks that jump on board and take the plunge. Now is the time for traditional fiat banks to engage in empowering the individual with greater access to crypto. If they don’t, they will be swept away by the rising tide of cryptocurrencies ripe to reinvent the world’s financial system one way or another.”

What Are the Barriers?

Even though companies like Square and MicroStrategy have made a bold statement, other conservative firms will wait for more regulatory clarification before opting for bitcoin. Note that OCC directives that banks can custody crypto assets must have reinforced bitcoin’s viability and, to an extent, driven these companies to implement it as one of their reserve assets. Similarly, the introduction of more crypto-friendly regulations will strengthen the case for crypto institutionalization. And so, crypto regulation will remain a factor that could determine the rate at which corporations and institutional investors adopt crypto.

Another barrier is education. Recall that Saylor was once a skeptic of cryptocurrency, and it was not until he understood the intricacies of this technology that he began to incorporate its functionalities. The same is true for other executives faced with the similar responsibility of choosing the right investment model for their companies. Therefore, crypto education is vital for a sustainable crypto adoption trend.