Dan Zuller: Stablecoins, ‘Unsung Heroes’ and Different Institutional Crypto Takeaways
It is clear that crypto is having its institutional moment. The investment decision moves from speculation to allocation and we are witnessing the maturation of crypto and digital asset investors. In formalizing a specific digital asset investment strategy, institutional investors should carefully evaluate the landscape in order to build an optimally built portfolio and achieve their desired investment goals. In the following, we summarize our ten most important findings from 2020 for institutional investors, based on our most recent report “An Institutional View on the Digital Asset Market 2020/2021”.
This post is part of CoinDesk’s 2020 Year in Review – a collection of posts, essays, and interviews about the year in Crypto and beyond. Dan Zuller, CFA, is a partner at Vision Hill Group, an investment advisor and digital asset manager.
1. Active management roars back.
After a challenging market in 2019, where the focus on Bitcoin (largely viewed as the beta of the market or the main indicator of volatility) outweighed the pronounced diversification of assets, active management returned in 2020. According to VisionTrack data from October 2020, crypto hedge funds achieved a net return averaging + 116% and outperforming Bitcoin (+ 92%) by approximately 2,400 basis points (bps).
2. For investors, 2020 was the year of defi and asset selection.
DeFi stands for Decentralized Financing and can best be viewed as an emerging sector within the Frontier Digital Asset Market. The total value set in DeFi contracts rose 25x from $ 600 million in January to ~ $ 15 billion in late November. Investors investing capital in this thematic digital asset sector outperformed bitcoin and the beta of the digital asset market in general in 2020.
3. The returns on digital assets are sustainable for the time being.
Digital assets offer extremely attractive returns when compared to traditional market instruments such as high yield savings accounts. Will it go on like this? Growing demand from institutional counterparties and borrowers such as hedge funds, over-the-counter (OTC) desks, market makers and liquidity providers leads us to believe these returns will be sustainable for the foreseeable future.
4. The remarkable rise, fall and rise in crypto derivatives.
After a challenging market regime for 2018-2019, crypto derivatives made a fascinating comeback in 2020. CME BTC’s daily futures volume peaked at $ 2.2 billion at the end of November 2020, while Bakkt BTC’s daily futures volume peaked at $ 178 million in September. “First a trickle and then a flood”, once the industry mantra in 2018-2019, has proven to be true in 2020.
5. Institutionalize Crypto Hedge Funds, but some more than others.
In preparation for 2021, there are now a variety of beta and alpha-focused hedge fund strategies that move to institutional “gold standards”. However, not all managers develop over time. According to our VisionTrack database, since 2017, around one in four managers has closed their funds due to failed operations.
6. There is liquid and there is venture, but liquid venture is a tougher pitch.
The distinction between liquid hedge fund strategies (mostly liquid, short term) and illiquid risk fund strategies (mostly illiquid, long term) remains clear. However, in the digital asset market there are still hybrid “liquid venture” funds that seek to make the most of the liquid and private worlds. While the options for such funds will certainly expand, such strategies are not without complexity and challenges.
7. Simplicity prevails: How the simple trades continue to win (and scale).
Throughout 2020, we continued to see investors prefer the simpler trades in the market. One of the most popular examples of this is the success of Grayscale’s investment trust products. In the absence of a regulated, exchange-traded bitcoin fund, investors have been looking for high quality stand-alone assets, particularly bitcoin-only vehicles, to express their investment thesis in digital assets. There are also strong incentives for investors to keep the simplicity and catch the beta first when entering an emerging market. [Grayscale is a CoinDesk sister company.]
8. When the bull returns, Beta will compete with the venture capital.
Investors who had allocated risk funds on January 1, 2020 and expected a 3.0-fold multiple return over a period of eight to ten years would have achieved 90% of their return target and would only have remained liquid in the first eleven months of 2020 if they had allocated BTC instead. An allocation to the ETH would have developed even better (4.7 times the return).
9. Stablecoins have become the unsung heroes of the market.
The rise in stablecoins increased liquidity in the crypto market and enabled digital asset trading to become cheaper, faster, and denominated in stablecoin. In 2020, stablecoins’ market cap has increased nearly five-fold from just under $ 5 million in 2019 to nearly $ 27 billion at the time of writing.
10. From speculator to allocator: witness the maturation of crypto investors.
While the crypto industry has occasionally experienced institutional moments since 2018, none led to such a direct price hike as the institutional movement of 2020. Tudor Investment Corporation, Rothschild Investment Corp., Fidelity, JP Morgan, Raoul Pal, Stanley Druckermiller, Citibank, Guggenheim , the Bernstein, BlackRock, Square and MicroStrategy alliance, to name a few, have improved Bitcoin’s social proof this year.
A look towards 2021
We believe that we are in the early stages of a 12- to 24-month bull market cycle for digital assets in a 10+ year investment opportunity. Crypto investments are increasingly shifting from speculation to allocation as high quality institutional capital leads the current cycle. In 2021, it will be even more important to have a targeted strategy to express the digital asset investment thesis.
There are now many different ways to invest in the growing digital asset class, from passive beta strategies for single or multiple investments to differentiated venture fund and hedge fund strategies. We’ll go into these in more detail below.
See also: Pantera’s predictions by Paul Veradittakit for 2021
Passive strategies can be accessed through individual asset vehicles (e.g. BTC only) or index funds for multi-asset exposure. Reported Assets Under Management (AUM) in VisionTrack is now $ 13.6 billion for passive beta strategies and is expected to grow significantly in 2021.
We believe that Bitcoin will continue to be the first port of call for many allocators who are not yet familiar with digital assets. Presumably, allocators need to familiarize themselves with the general idea of how a blockchain works and why its value proposition is unique compared to anything else in their investable universe (it may be) in order to build a belief in that asset class to come with longer and more established track records). In 2021, investors are likely to expand their beta definition to include ether in addition to Bitcoin.
From a structural point of view, venture funds in crypto generally focus only on equity, only tokens, or equity and tokens in different phases. We estimate the dedicated Crypto Venture Fund AUM at over $ 10 billion.
We anticipate that the strategies for dedicated crypto venture funds will continue to increase through 2021. In addition to Funds II and III, 2021 will likely focus more on thematic differentiation (e.g. DeFi vs. infrastructure) and structural differentiation (equity vs. tokens), tiered differentiation (pre-seed, series A, growth phase) and geographic differentiation (US, Asia, emerging markets, etc.).
At Vision Hill, we divide all crypto hedge funds into one of three strategy categories: fundamental, quantitative and opportunistic. There is currently a dedicated crypto hedge fund AUM in VisionTrack worth $ 2.4 billion.
We believe 2021 will be a breakout year for crypto hedge funds. Given an expected bullish market regime, we expect that a pronounced (idiosyncratic) selection of assets offers opportunities for differentiated and uncorrelated outperformance (alpha).
Prepare for 2021
Investors should create a dedicated, thoughtful, and comprehensive investment process for building a portfolio of digital assets just like any other investment industry such as stocks, credit, or real estate. This starts with an understanding of the general opportunities, the categorization of the different types of investments, their risk and return profiles, the investment horizon and duration as well as liquidity. The next step is to collect the best possible data to make smarter, smarter investment decisions. The future for digital assets is bright.