why financial advisors should invest in bitcoin

Why Bitcoin Has Reached a Tipping Point with Financial Advisors

“It’s easier to build a new financial system than it is to reform the existing one.”

— Naval Ravikant, entrepreneur, investor, co-founder AngelList

The ecosystem that has grown up around digital assets over the past 12 years since the Bitcoin network first went live has been nothing short of a revolutionary time for financial services.  Not only has Bitcoin grown to become a world-wide phenomenon, but thousands of other cryptocurrencies have sprung up by copying (or forking in computer terms) the Bitcoin code and adding new features to it.

And not only other coins have launched, but also decentralized exchanges (for swapping them), decentralized finance (for investing and lending them) and even decentralized collectibles (NFTs) as well.

“The stock market is filled with individuals who know the price of everything, but the value of nothing.”

— Phillip Fisher, founder of investment firm Fisher & Co. and author of Common Stocks and Uncommon Profits

The wealth management industry has been slow to adopt digital assets as a legitimate investment option for client portfolios with advisor understanding and acceptance being a serious roadblock.

An online discussion recently was hosted by Blockworks Group included two of the leading proponents of cryptocurrencies in the advisor community:

You can find the full video of their conversation here.

But in case you don’t have time to watch the whole hour-long video, this article pulls together a summary of the key points.

Travis Kling is a former long/short equities portfolio manager who now runs a crypto investment firm called Ikagai Asset Management.  He posted this brilliant tweet last month:

Bitcoin is worth a trillion dollars, yet it has:

  • Never spent a dollar on marketing.
  • Never had a CEO or a board meeting.
  • Never had a budget.
  • Never hired a lobbyist, lawyer or auditor.
  • Never entered into a partnership.
  • Never existed in physical form.

And we’ve never had anything like it.

It’s true that many startups are now focusing on Bitcoin and they have spent a lot of money on marketing, legal, lobbying, etc. But that’s precisely Kling’s point. A network of open source code convinced thousands of people all over the world to start companies and invest capital using only game theory and mechanism design. That’s amazing! (See Money Re-Imagined: Cryptocurrency & the Disruption of Investing)

The idea for Bitcoin fundamentally grew out of the Cypherpunk movement of the 1990s. Many of the leaders of this movement, like John Gilmore, Julian Assange, Eric Hughes, Hal Finney, and Timothy C. May, held libertarian-esque ideas about privacy, limited government, and freedom of speech, and some eventually became involved in the growth of Bitcoin itself.

“We the Cypherpunks are dedicated to building anonymous systems,” Eric Hughes proclaimed in his essay “A Cypherpunk’s Manifesto,” for “privacy in an open society requires anonymous transactions.” The most famous Cypherpunk was Satoshi Nakomoto, the author of the original Bitcoin white paper published in 2008, who designed a network that supported anonymous transactions protected by cryptography. Satoshi even has a section in the White Paper dedicated to privacy.

As Bitcoin’s value and institutional acceptance continue to grow, new investors are attracted to the market, not as many of them for ideological reasons. Many Bitcoin users were lured into the market by romantic stories about overnight billionaires and promises of get-rich-quick schemes. Conversely, many Bitcoin users are individuals out of range of any significant banking institutions or living in countries experiencing inflationary crises. (See 4 Hurdles Bitcoin Must Overcome to be a New Asset Class)

Regardless of whether or not people fully comprehend why they will inevitably choose to use Bitcoin, they will make this decision because of the economic properties of this new technology (which can be best understood by reading Saifedean Ammous’ book The Bitcoin StandardThe Decentralized Alternative to Central Banking) and because of the ideas of propagated by the modern libertarian movement.

According to Edelman, cryptocurrency vendors don’t understand how to explain it to advisors.  They spend too much time on the nuts and bolts of cryptography, public/private keys or the blockchain.  The majority of advisors aren’t interested in the underlying distributed infrastructure, they just want to know how crypto fits into their current processes.

“Don’t explain how the internal combustion engine works. Just show them how to drive the car,” was another Edelman quote to vendors about how to talk to advisors about Bitcoin.

Since none of the technology providers currently used by advisors supports crypto, it forces firms to handle it manually, similar to illiquid investments like private equity or real estate.  RIAs are working hard to increase automation and adding manual investments does not help improve overall firm efficiency.

There are some custodians that do support direct investments in digital assets like Bitcoin.  Fidelity launched their Fidelity Digital Asset Services in 2018 after five years of stealth development. However, its services are intended for institutional investors, not advisory clients. Account minimums are set at $100,000.

Last year, Fidelity landed a sub-custody deal with Kingdom Trust to handle digital asset custody for their clients.

Cryptocurrency represents an undisclosed portion of Sioux Falls, S.D.-based Kingdom’s holdings on behalf of an extensive network of RIAs, family offices and individuals.  Kingdom’s clients can now opt to place the keys (wallet passwords) to their digital assets in cold storage with Fidelity who holds them offline. (See Is Cryptocurrency Ready for Wall Street?)

Financial advisors are feeling pressure from all sides as national RIAs and wirehouses try to steal their HNW clients while roboadvisors look to peel off mass affluent clients with promises of similar services for much lower fees.  Advisor’s profit margins are being squeezed as they struggle to hire additional staff and deploy new technology to stay ahead of the robos.

The last thing they need is a complicated user experience when investing in digital assets for their clients. As Tuteja noted, most advisors want to be guided through the process when investing in crypto rather than being left to their own devices.

While it has become relatively simple for end investors to buy and sell crypto, it is still difficult for fiduciaries to purchase blocks of digital assets and then allocate it across multiple client accounts as they can do with equities or fixed income securities.  An advisor can’t just open an account on Coinbase to purchase Bitcoin for her clients.

A number of innovative startups have entered the space to provide RIAs with a smooth and seamless experience for digital assets. One of these is San Francisco-based Blockchange, which built their BITRIA™ Platform to bring professional grade portfolio management capabilities to digital asset investing. Their goal is to empower RIAs to build their own model portfolios of digital assets just as smoothly and efficiently as their current non-digital securities.

We’re expecting platforms like Blockchange to revolutionize the industry’s access and usage of cryptocurrencies as they are better integrated into advisors existing workflows.  Blockchange is the only product with true digital asset rebalancing and trading system with connectivity directly to the Gemini cryptocurrency exchange for execution and custody.

This tweet generated a lot of discussion. One person asked if Edelman was referring to product kickbacks.  To which I replied that Edelman meant was that there aren’t any standard investment products with direct crypto exposure that can be billed in standard RIA processes.

Brendan Crews, a portfolio manager at Daviman Financial, commented:

In all my interactions with other advisers about digital assets I’ve never once heard an advisor ask how they would get paid. I’ve heard how do I define it for asset allocation, how can I aggregate it for perf reporting, or figure out the estate planning part, but never comp.

This is the opposite of what Edelman clearly has been hearing, but you have to assume that not everyone is familiar with digital assets, so both sides can be right here.

Samantha Russell, Chief Evangelist at FMG Suite, asked, “Wouldn’t it be something if Crypto was the thing that finally nudged advisory firms to embrace alternative fee models?”

Yes it would!  I believe that a lot of the advisory business model will change as digital assets become more mainstream.

We’re seeing a solid trend of AdvisorTech vendors building tools and services, or acquiring products, to help RIAs with marketing and client communications.  eMoney Advisor, Orion Advisor Tech and YCharts (to name a few) have all launched software and content to help advisors with marketing, even though it’s not directly related to their core technology offerings.

What these firms have realized is that advisors are generally bad at marketing and lack tools to automate and scale their communications beyond simple mass emails.  By combining communications software and services, they hope to make their primary applications stickier, learn more about advisor behaviors and also create an additional revenue stream.

Digital asset technology vendors should follow this lead and provide advisors with content and education for their end clients around cryptocurrency.  The more that advisors rely on their crypto vendor to support this part of their business, the stronger their relationship and the less likely the RIA bolts to an established provider when they finally get around to supporting crypto.

Millennials are just one of the generations who have discovered digital assets as a productive investment.  Investors of all ages have purchased Bitcoin and other cryptos as the valuations rise and more exchanges and mobile apps launch to provide easier access to this non-traditional asset class.

While younger investors are naturally more inclined to buy the latest fad, as the breadth and depth of available digital assets has increased and as Bitcoin passed its 10-year anniversary, older investors have started to dive in.

Even more promising is the wave of institutional investors that have come to the party including Mass Mutual, Morgan Stanley, and Tesla, who purchased $1.5 billion in bitcoin in February.

There’s a lot of talk on Crypto Twitter, Reddit and other forums about what if the rich people of the world just allocated 1% of their portfolios to Bitcoin?  This is still wishful thinking, but now market analysts are posing similar questions and it is driving their firms to give the green light to their clients buying crypto.

JP Morgan suggested a 1% allocation in February of this year.  According to Bloomberg, JPM strategists Joyce Chang and Amy Ho stated in a note to clients as follows:

“In a multi-asset portfolio, investors can likely add up to 1% of their allocation to cryptocurrencies in order to achieve any efficiency gain in the overall risk-adjusted returns of the portfolio.”

Of course, Edelman has been suggesting a 1-2% allocation for some time now:

“The stock market makes 10% in a year. #Bitcoin routinely moves up or down 10% in a day. And so it is the potential for outsized returns. It is the number-one-performing asset class of the last one, three, five, and ten-year periods since inception and many people believe it’s still in its infancy. So there’s a tremendous opportunity.’

Ever since Bitcoin first hit the mainstream news, there has been a steady stream of doubters attacking it. Self-described serial bitcoin entrepreneur, Dan Held, wrote a terrific piece on Medium that took apart most of the Bitcoin FUD attacks.  Here are a few of my favorites:

Bitcoin has no intrinsic value – Complaining it has no intrinsic value when their primary currency has absolutely no intrinsic value. As the Federal Reserve puts it “Bitcoin units have no intrinsic value… the U.S. dollar, the euro, and the Swiss franc, have no intrinsic value either.”

Way back in 2017 (a lifetime for Bitcoin), Zachary Karabell, the former Head of Strategies at Envestnet, wrote, “Money has only the value that is ascribed to it over time. Fiat currency, issued by nations, has always faced distrust from skeptics who say it is backed only a government’s good faith. That helps explain the nostalgia for the gold standard, when dollars and other government paper represented a fractional interest in gold.”

Bitcoin is bad for the environment – why financial advisors should invest in bitcoinNo one questions the morality of your electricity consumption. You’re free to do whatever you’d like after you pay for it. For example, I’m not going to shame you for your Christmas lights, video games or just watching the cooking shows.

Finally, complaining about energy consumption, without first comparing it to the energy consumption of gold mining, the financial system, government, courts, military, selfies, or Netflix.

I’ve had a number of discussion on Twitter with people pushing this argument. But they never have a direct response to this free market reasoning for electricity use. To these doubters, there can be no justification for “wasting” energy on Bitcoin.

Bitcoin is used for money laundering – Approximately $2T a year globally is laundered, Americans spend $100B on drugs annually, Crypto market cap is $440B as of this email. “Cryptocurrency [represent a] “low risk” for money laundering and terrorist financing activities… according to FATF.

The Chainalysis 2021 Crypto Crime Report detailed that in a year bitcoin shattered previous price records, largely driven by the increased demand for institution investors, the overall use of cryptocurrency for illicit purposes dropped. In 2019, criminal activity accounted for 2.1% of all cryptocurrency transaction volume, roughly $21.4 billion in transfers, for which the number dropped to just 0.34% or less than $10 billion in 2020.

After years of complete ignorance that transitioned into a mix of denial and outright hostility, the tide seems to be turning for digital assets at wealth managers.  The percentage of financial advisor allocating crypto into their client portfolios jumped 49% in 2020 to 9.4%.  This still leaves over 90% of advisors who are not allocating, so there’s a lot of room to grow.

According to the San Francisco-based asset management firm Bitwise, 58% of advisors allocating to crypto are RIAs and 82% of advisors who reported crypto allocations for clients also held it themselves.  This is a strong vote of confidence and makes sense since clients feel more comfortable if their advisor is putting their own money in as well.

There are a number of alternatives for advisors to provide digital asset exposure to clients:

Why financial advisors should invest in bitcoin

Tuteja and Edelman made a very strong case not only for Bitcoin, but for all digital assets. We believe that it’s just a matter of time before Bitcoin portfolio allocations are adopted by one or two global asset managers, which will open the floodgates for the rest to follow suit. Similar to how Schwab was the first to announce zero commissions and caused a stampede afterwards.

With competition coming from all directions and investor interest in cryptocurrency growing fast, advisors need to get ahead of the digital asset wave and establish themselves as experts in the field. Otherwise, crypt-savvy clients will look elsewhere for advice.

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