Despite the volatile tendencies of cryptocurrencies, it may be time for institutional investors to get off the sidelines and explore investments in the nascent industry, according to investment and consulting firm Cambridge Associates.
The firm said that despite the fact prices of various cryptoassets collapsed in 2018, and that its most visible asset Bitcoin saw approximately 75% of its value vanish, it still sees an industry that is strengthening, not weakening.
“Blockchain technology introduces scarcity to the digital world, which can help innovators better monetize their work and foster innovation,” said Cambridge in a recent research report. “It offers the potential to streamline processes across any number of businesses, such as inter-bank settlement. It also holds the hope for a new, more decentralized version of the internet, where users can better manage their privacy.”
The firm said there are several ways for investment managers to gain cryptoasset exposure that range from an illiquid venture capital type of approach to a liquid hedge fund trading approach.
It said that the current available investment options can be grouped into three broad categories: mainstream cryptoasset investing, pre- and post-token distribution investing, and equity investing.
With mainstream cryptoassets, investors can purchase highly liquid cryptoassets, such as Bitcoin, which provide access to blockchain platforms. Because these are traded regularly, liquidity will be better than other cryptoasset investment options. Investors can purchase and have custody of the tokens directly or through centralized exchanges, or they can outsource to passive or actively managed funds that will do it for them.
Pre- and post-token distribution investing includes initial coin offering (ICO) tokens and something called simple agreements for future tokens, (SAFTs). According to Cambridge, SAFTs grant investors future access to a project’s cryptoassets, usually at a discounted price, prior to their public launch. It also said ICO projects can have various liquidity profiles, as some projects distribute cryptoassets immediately, or after a two-year period, for example.
“Despite the shorter time to liquidity, investing in SAFTs and ICOs is inherently no different than investing in early-stage technology ventures,” said Cambridge. “It should be noted here that the ICO mechanism for fundraising has been abused by bad actors and the majority of such projects have been of questionable quality or outright frauds. That said, there have been numerous reputable projects involving ICOs.”
And by using equity investing to gain exposure to crypto and blockchain technology, investors can make investments in companies whose returns are connected to the growth of the asset class and maintain traditional capital structures. The report cited digital currency exchange operator Coinbase as an example.
“Although these companies are impacted by broader cryptoasset price fluctuations, they should be more stable than any one individual investment,” said Cambridge. “They are long-term, illiquid investments held at cost and marked up or down depending on funding rounds. The liquidity of these investments is similar to traditional venture capital investments.”
The report also cited equity investing in a company that owns rights to the tokens a team is developing, which will be distributed or sold at a later date. It said an operating company holding the tokens could also launch other businesses, such as offering services to the network in which an investor would have an ownership stake.
“Investors are increasingly looking to access tokens via equity ownership, particularly given the regulatory uncertainty with regards to ICOs and the restriction on fundraising options for entrepreneurs,” said Cambridge. “It should also be noted that the SEC is currently reviewing proposals for the launch of a Bitcoin exchange-traded fund (ETF), such as the Van Eck SolidX ETF, but approvals are not expected anytime soon.”
The firm added that the vast majority of institutional investors have little to no cryptoasset exposure, but that it expects traditional venture capital funds to increase their investments in cryptoassets, which means institutional investor exposure is also likely to rise.
Lawmakers Introduce Bill to Exempt Cryptocurrencies from Securities Laws
Cryptocurrency Inquiry Introduced by UK Treasury
Crypto Exchange Coinbase Expands into Institutional Market