Dan Zuller: Stablecoins, ‘Unsung Heroes and Other Institutional Crypto Takeaways

It is clear that crypto is having its institutional moment. The investment decision is moving from speculation to allocation, and we are witnessing the maturation of crypto and digital asset investors in the process. In formalizing a dedicated digital asset investment strategy, institutional investors should assess the landscape thoughtfully with the goal of building an optimally constructed portfolio to achieve their desired investment objectives. Below, we summarize our top 10 takeaways from 2020 for institutional investors, based on our recent report “An Institutional Take on the 2020/2021 Digital Asset Market.” 

1. Active management roars back.

Following a challenging 2019 market in which concentration in bitcoin (largely viewed as the market’s beta, or its headline volatility indicator) prevailed over distinctive asset diversification, active management came roaring back in 2020. According to VisionTrack data as of October 2020, crypto hedge funds generated net returns of +116% on average, 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 finance and can be best thought of as an emerging sector within the frontier digital asset market. Total value locked in DeFi contracts surged 25x to ~$15 billion as of the end of November, from ~$600 million in January. Investors that put capital to work in this thematic sector of digital assets generally outperformed bitcoin and the digital asset market beta in 2020.

3. Digital asset yields are sustainable, for now.

Digital assets offer highly attractive yields compared to traditional market instruments such as high-yield savings accounts. Will that continue? 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 yields are sustainable for the foreseeable future.

4. The remarkable rise, fall and rise again of crypto derivatives.

After a challenging 2018-2019 market regime, crypto derivatives have made a fascinating comeback in 2020. CME BTC daily futures volumes recently peaked at $2.2 billion at the end of November 2020 while Bakkt BTC daily futures volumes peaked at $178 million in September.  “First a trickle and then a flood,” once the industry’s mantra back in 2018-2019, has proven true in 2020.

5. Crypto hedge funds are institutionalizing, but some more than others.

There are now a variety of beta- and alpha-focused hedge fund strategies rising to institutional “gold standards” in preparation for 2021. However, not all managers are evolving with the times. According to our VisionTrack database, approximately one in four managers have shuttered their funds since 2017 as a result of failed operations.

6. There’s liquid and there’s venture, but liquid venture is a tougher pitch.

The distinction between liquid hedge fund strategies (primarily liquid, short-term) and illiquid venture fund strategies (primarily illiquid, long-term) continues to be clear. However, the digital asset market continues to have hybrid “liquid venture” funds that attempt to capture the best of both the liquid and private worlds. While the opportunity set for such funds is certainly expanded, such strategies are not without their complexities and challenges. 

7. Simplicity prevails: How the easy 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.  Given the lack of a regulated bitcoin exchange-traded fund, investors have sought high quality, single asset vehicles, specifically bitcoin-only ones, to express their investment thesis in digital assets. There are also strong incentives for investors to maintain simplicity and capture the beta first when entering an emerging market. [Grayscale is a CryptoX sister company.]  

8. As the bull returns, beta competes against venture for capital.

Investors who allocated to venture funds as of Jan. 1, 2020, expecting a 3.0x return multiple over eight to 10 years would have achieved 90% of their return target and remained liquid in just the first 11 months of 2020 if they allocated to BTC instead. An allocation to ETH would have performed even better (4.7x return).

9. Stablecoins have become the market’s unsung heroes. 

The rise of stablecoins boosted liquidity in the crypto market and enabled digital asset trading to become cheaper, faster and stablecoin-denominated. In 2020, the market capitalization of stablecoins has nearly quintupled from just under $5 million in 2019 to nearly $27 billion at the time of writing.

10. From speculators to allocators: witnessing crypto’s investor maturation.

While the crypto industry has witnessed some occasional institutional moments since 2018, none quite resulted in direct price appreciation the way 2020’s institutional movement did.  Tudor Investment Corporation, Rothschild Investment Corp., Fidelity, JPMorgan, Raoul Pal, Stanley Druckenmiller, Citibank, Guggenheim, Alliance Bernstein, BlackRock, Square and MicroStrategy, to name a few, have enhanced bitcoin’s social proof this year.

We believe we are in the early phases of a 12- to 24-month bull market cycle in digital assets as part of a multi-decade long investment opportunity. Crypto investing is increasingly moving from speculation to allocation as high-quality institutional capital leads the current cycle. In 2021, it will be even more important to have a dedicated and intentional strategy to express the digital asset investment thesis. 

There are now many different ways to invest into the growing digital asset class, ranging from single or multi-asset passive beta strategies to differentiated venture fund and hedge fund strategies. We expand on each of these in more detail below.  

See also: Pantera’s Paul Veradittakit’s 2021 Predictions

Passive strategies can be accessed via single 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 expected to grow significantly in 2021.  

We believe bitcoin will continue to be the first stop for many allocators who are new to digital assets. It is reasonable to assume that in order to build conviction in this asset class, allocators need to get comfortable with the general notion of how a blockchain works, and why its value proposition is unique relative to everything else in their investable universe (that may also come with longer and more established track records of success). In 2021, investors are also likely to expand their definition of beta to include ether in addition to bitcoin.

Venture funds in crypto generally focus on equity only, tokens only or equity and tokens across various stages from a structural perspective. We estimate dedicated crypto venture fund AUM to be in excess of $10 billion. 

We believe we will see continued growth of dedicated crypto venture fund strategies into 2021.  In addition to Fund II’s and Fund III’s, 2021 more focus is likely to turn to thematic differentiation (e.g. DeFi vs. infrastructure), structural differentiation (equity vs. tokens), stage differentiation (pre-seed, Series A, growth stage), and geographic differentiation (U.S., Asia, emerging markets, etc.).

At Vision Hill, we segment all crypto hedge funds into one of three strategy categories: fundamental, quantitative and opportunistic. There is currently $2.4 billion in dedicated crypto hedge fund AUM in VisionTrack. 

We believe 2021 will be a breakout year for crypto hedge funds. With an expected bullish market regime, we expect distinctive (idiosyncratic) asset selection will present opportunities for differentiated and uncorrelated outperformance (alpha).  

Investors should create a dedicated, thoughtful and comprehensive investment process for digital asset portfolio construction as they would with any other investment vertical such as equities, credit or real estate. This begins with understanding the overall opportunity set, categorizing the different types of investments, their risk and return profiles, investment horizons and durations, and liquidity. The next step is gathering the best data possible to make more informed and smarter investment decisions. The future is bright for digital assets.