How Institutions Are Investing In Crypto? Detailed Analysis

How Institutions Are Investing In Crypto? Detailed Analysis

Skepticism about cryptocurrencies is ending: Institutions are increasingly investing in crypto assets. According to recent surveys among financial firms and institutional investors, investments in cryptocurrencies are rising fast. Even the companies that have been historically against crypto assets, are recognizing the long-term potential value appreciation of crypto assets, leading to an incredible Bitcoin (gold) rush.

However, most institutions are not investing in cryptocurrencies by holding them in Web3 wallets, but using more sophisticated ways and products to gain exposure to crypto assets while increasing the return's potential and reducing underlying risks. So, how institutions are investing in crypto? What are their favorite crypto products?

Institutions are investing in crypto mainly through ETFs (Exchange-Traded Funds) and crypto index funds (customized crypto baskets based on Alpha, Beta, and Smart Beta models), aiming to obtain higher returns than the market's benchmarks while reducing volatility and risks.

Institutional investors don't like to get exposure through "traditional" Web3 wallets and single cryptocurrency investments because they prefer to prioritize security, ease of use, and advanced crypto trading strategies. As demonstrated since the launch of the first Bitcoin ETFs, institutional interest is increasingly rising, and new advanced products are emerging to fit financial institutions' needs and requirements.

At PlasBit, we analyzed and tracked various financial firms to better understand how they operate and their investing strategies, discovering interesting models. We aim to unveil the institutions' most advanced strategies to empower retail investors with the knowledge to improve their trading performances and results.

History of Institutional Investments in Cryptocurrencies

Institutions' perceptions about cryptocurrencies have changed significantly over the years. From strongly opposing crypto assets to approving the first Bitcoin ETFs, financial institutions are now accepting cryptocurrencies as an emerging and revolutionary financial asset.

Early Stages: Skepticism and Risk Aversion

In the early days of Bitcoin, only a few tech-savvy enthusiasts and retail investors believed in the potential of blockchain technology and cryptocurrencies. The remarkable volatility, the association with illegal activities, and the difficulty of use were challenging factors that made cryptocurrencies accessible and attractive to only a very small minority of people. At that time, financial institutions were largely skeptical, and investing in cryptocurrencies in the long term was considered a crazy move. Traditional finance investors couldn't invest in such volatile, unregulated, and unconventional assets, and they missed the early days of Bitcoin and cryptocurrencies, together with the potential returns.

The First Movers: Hedge Funds and Family Offices

Even if most financial institutions were still against cryptocurrencies from 2009 to around 2020, a few hedge funds and family officers began investing in cryptocurrencies and exploring blockchain technology. Being minor entities compared to main financial institutions like Blackrock, Vanguard, and others, some smaller hedge funds were able to invest in crypto since they saw the opportunities to gain remarkable returns. However, when they started investing in cryptocurrencies, they did so to seize the short and medium-term opportunities, operating mostly like swing traders, predicting and capitalizing on the crypto market's cycles. This first class of institutional investors made big gains since the capitalization was smaller than today, and market movements were easier to predict, manipulate, and control: A perfect opportunity for high-risk hedge funds.

Entry of Traditional Financial Institutions

Since around 2019-2020, exactly before the third Bitcoin Halving and during the COVID-19 pandemic, institutional investors started to widely recognize the potential of blockchain technology and cryptocurrencies. The crypto market matured, the infrastructure improved, and regulations started to be developed around the world. It also allows the larger financial companies to relatively safely invest in crypto assets, mostly in Bitcoin.

The resilience shown by Bitcoin, which has never stopped since 2009, has been recognized during this period, and widespread adoption has started to grow. Not only did traditional finance companies start exploring cryptocurrencies in this period, but crypto exchanges also became mainstream. New advanced crypto products were born, and both retail investors and financial firms boosted the growth and adoption of cryptocurrencies. However, the following bear market created new doubts about the world of cryptocurrencies, and the most skeptical investors continued to be against cryptocurrencies, as shown by famous quotes of Warren Buffett, for example: “Now if you told me you own all of the Bitcoin in the world, and you offered it to me for $25, I wouldn't take it because what would I do with it? I'd have to sell it back to you one way or another. It isn't going to do anything,” Buffett said at the Berkshire Hathaway annual shareholder meeting in 2022.

Recent Developments and Crypto ETFs

In the last year, from mid-2023, a new crypto bull run started. As you can imagine, it brought a new rapid and wide crypto adoption, and most of the financial firms have been "forced" to offer crypto products to their services, seeing the rising demand. In early January 2024, the first Bitcoin ETFs were approved, and it fueled the influx of new institutional capital in crypto assets. Now, even if you're not familiar with blockchain tech and crypto wallets, you can invest in crypto assets through traditional ETFs on traditional investing platforms. 21Shares, WisdomTree, CoinShares, and VanEck are only a few of the crypto ETF providers that offer advanced products to institutional and retail investors. This new influx of capital is still in process, and new ETFs are being discussed to be released these days, such as the Ethereum ETF, the Solana ETFs, and probably more soon. The revolution of finance through crypto assets is still at the beginning, and the best is yet to come, with new advanced crypto products being launched in this period with ETFs and crypto index funds.

Reasons Why Institutions Invest in Cryptocurrencies

Institutions are investing in cryptocurrencies for various reasons, mixing financial, strategic, and technological factors. So, how institutions are investing in crypto and what are the specific reasons behind it?

Portfolio Diversification

One of the main reasons is portfolio diversification. On one side, by allocating a small percentage of their portfolio to crypto assets, institutions aim to diversify their exposure to financial assets. In fact, cryptocurrencies are progressively decorrelating from traditional assets such as bonds, stocks, and real estate, offering a means to mitigate overall portfolio risks. In this way, institutions can potentially reduce volatility while achieving a better risk-adjusted return. On the other side, investing in multiple cryptocurrencies reduces the risks of a single cryptocurrency' collapse, spreading the risks over multiple cryptocurrencies. For example, if you had invested solely in Luna a few years ago, in 2022, after its collapse, you would have lost everything. On the contrary, by distributing your budget in a diversified portfolio, including several cryptocurrencies, the collapse of a single cryptocurrency would be much less impactful, improving your risk management.

Potentially High Returns

In the 12 years between August 2011 and April 2024, Bitcoin had a compound annual growth rate of 108.27%. If we consider that the S&P 500, the main benchmark index of the stock market, has an average compound annual growth rate of 10%, we can easily understand that the potential returns of Bitcoin are incredible. Financial institutions don't want to miss high-returns opportunities, and crypto assets could be the best performing assets of years to come.

Aiming for higher returns than main benchmarks and investors' performances, institutions are strongly investing in crypto assets, and the trend is expected to rise more in the coming years.

Hedge Against Inflation

Since 2020, the US has printed nearly 80% of ALL US Dollars in circulation, causing a high inflation rate and remarkable currency devaluation. Quantitative easing policies stimulate the economy by creating new money, and it means that, based on demand-offer mechanics, fiat currencies are losing their value quickly, and it doesn't make sense for financial firms (and also retail investors) to keep money stored in fiat currencies. Bitcoin, as its quantity is mathematically limited to 21,000,000, is probably the best tool against inflation, potentially functioning both as a store of value, a safe haven, and maybe in the future, also everyday currency. It makes it perfect to be a hedge against inflation, and institutions perfectly understand it.

Technological Innovation and Blockchain

Blockchain is unstoppable, incorruptible, and (relatively) impossible to hack: Tokenization of assets is inevitable, as also affirmed by Larry Fink, CEO of Blackrock, the biggest financial corporation in the world. If the world's largest corporations publicly support cryptocurrencies, it means that Bitcoin is not a trend, but it's here to stay for the next decades (or centuries). Blockchain tech offers unlimited applications in various fields, including (but not only) finance, supply chain, voting, real estate, digital identity, and more. Tokenizing assets could bring a lot of benefits to various industries, bringing innovation, efficiency, security, and trust.

Growing Adoption and Regulatory Clarity

Seeing the increased adoption of retail investors and the improved regulation, financial institutions don't want to miss the opportunities. The development of institutional-grade and regulated products, such as crypto ETFs and index funds, facilitated easier and safer exposure to crypto assets, reducing the perceived risks and uncertainties associated with crypto assets. Now, institutions see crypto as a viable, safe, and credible investment option, supported by a robust infrastructure, with high return potential.

How institutions are investing in crypto?

Types of Institutional Investments in Cryptocurrencies

We've just understood the factors behind the institutional interest in cryptocurrencies, but how institutions are investing in crypto?

Direct Purchase of Cryptocurrencies

The most straightforward way for institutions to invest in cryptocurrencies is through direct purchases. However, considering the complexities of investing in cryptocurrencies (considering different blockchain, wallets, coins, etc.), direct purchase is not always the best solution for institutions. Since their investing strategies are based on advanced models and quantitative analysis, they often prefer to invest through more sophisticated and advanced products, such as ETFs or customized crypto baskets. Institutions don't use common crypto exchanges to buy cryptocurrencies but typically use over-the-counter (OTC) trading desks to execute large transactions without significantly affecting crypto prices.

Investments in Cryptocurrency-related Companies

Another way for institutions to gain safe exposure to crypto assets is to invest in companies related to cryptocurrencies. For example, by investing in stocks of companies like Microstrategy, Coinbase, or Riot Platforms, institutional investors can indirectly invest in crypto assets while not owning them directly. It includes bitcoin mining companies, crypto exchanges, blockchain technology firms, and businesses related to crypto. Even if this is not the straightforward best way to invest in cryptocurrencies, investors can gain exposure to crypto assets using traditional instruments like companies' stocks, also gaining significant governance power as large shareholders.

Crypto ETFs (Exchange-Traded Funds)

Since January '24, a new way to invest in cryptocurrencies has been available to institutions and retail investors: Bitcoin ETFs. The first approval of crypto ETFs came in January, but they are still limited to a single exposure to Bitcoin. It could be quite limiting for institutions looking to diversify their portfolios and seize the opportunities of the crypto market. However, new ETFs are coming, such as the Ethereum ETF and probably also the Solana ETF, this year. Investing in ETFs allows investors to gain exposure to cryptocurrencies through traditional products already familiar to financial institutions, making it simpler to invest in crypto assets safely, adhering to underlying regulations. We must point out that even if ETFs are a remarkable innovation and turning point, at the moment, they don't allow institutions to implement advanced strategies based on complex quantitative models, such as Smart Beta strategies.

Derivatives and Complex Financial Products

Institutions looking for advanced strategies applied to cryptocurrencies cannot do it through ETFs or direct ownership, but they need more sophisticated products. Through derivates, including futures and options, institutions can speculate on crypto without owning the underlying assets, at the same time improving the trading possibilities. With derivates, they can use leverage to maximize their exposure and returns' potential. That's not all, because new complex products are emerging, such as customized crypto index funds: proprietary crypto baskets focused on advanced models to try to outperform the market's benchmarks. In this way, they can apply advanced models based on quantitative analysis and systematic investing.

Staking and Passive Income

Another additional way to gain exposure to cryptocurrencies while also obtaining a passive return is through staking. In fact, directly owning crypto allows institutions to stake their assets and earn fixed returns on their holdings. However, this strategy is suited mostly to investors who strongly believe in crypto's growth because it's required to lock the assets for a long time, and it doesn't allow the implementation of extremely speculative short-term strategies. Anyway, staking offers a way for institutions to generate steady returns on their crypto holdings without engaging in active trading.

Investment Strategies of Institutions

Different investment strategies are used by institutions, depending on their short or long-term approach and goals.

Risk Management and Security

Risk management is one of the priorities of most institutional firms, since they want to limit inherent volatility and potential security threats of cryptocurrencies. Implementing sound risk management practices, such as focusing on obtaining lower Beta compared to benchmarks, allows institutions to safely invest in cryptocurrencies while limiting the risks. So, how institutions are investing in crypto while limiting the risks?

  • Diversification: Spreading crypto investments across various cryptocurrencies and related assets to reduce exposure to any single asset's risk.
  • Hedging: Using derivatives such as futures and options to hedge against price fluctuations and protect against adverse market movements.
  • Stop-Loss Orders: Setting stop-loss orders to automatically sell assets when their price falls below a certain threshold, limiting potential losses.
  • Security Measures: Employing robust security protocols to safeguard digital assets, including the use of hardware wallets, multi-signature transactions, and cold storage solutions to prevent hacking and unauthorized access.

Partnerships with Custody Platform

Since security is among the priorities, many institutions partner with the most reputable custody providers, implementing institutional-grade security and compliance. Self-custody is not easy also for institutional investors, and it brings security and trust concerns among stakeholders. Consequently, custody platforms are the safest option to store large amounts of cryptocurrencies, reducing risks and adding a layer of credibility and trust, essential for institutions.

Involvement in Governance and Decision-Making

As large shareholders of both crypto assets and companies related to cryptocurrencies, institutional investors like Blackrock take an active role in the governance and decision-making process. They influence the development and direction of blockchain networks, and Ethereum is probably the best example of institutional influence in cryptocurrencies, supported by major companies like Intel and Mastercard, just to name a couple of them. In this way, institutions can enhance security, regulatory compliance, and scalability while safeguarding their investments and contributing to the ecosystem's growth and health.

Long Term vs Short Term Approach

Depending on time horizons and goals, institutions implement different strategies. For example, a long-term approach implies holding crypto for extended periods (years or decades), aiming for value's appreciation and growth through the compound effect. Institutional investors that focus on long-term approaches prefer cryptocurrencies with strong fundamentals and high-growth potential. However, the most popular choice of investors is still Bitcoin, which is considered the king (and most secure) cryptocurrency.

On the other hand, institutions focusing on short-term goals, often prioritize strategy based on speculative trading, taking advantage of short-term price movements. It usually involves active trading, use of leverage, and sophisticated algorithms to execute high-frequency trading, aiming for substantial returns. However, this approach brings higher risks and requires advanced technical expertise.

Leveraging Data and Analysis

Differently from retail investors, institutions' approach is focused on data-driven decision-making, using advanced analytics, machine learning algorithms, AI, and sophisticated models. Using this approach, they can deeply analyze market trends, sentiment, trading volumes, and on-chain metrics to make strategic investment decisions. Additionally, they monitor and leverage macroeconomic factors, geopolitical developments, and regulatory changes to stay updated on market trends and integrate these data points into their advanced investment strategies. In this way, institutions can make informed decisions and quickly and flexibly adapt to evolving market trends and conditions while implementing advanced models based on quantitative analysis and systematic trading and investing models.

Engaging with Regulatory Bodies

Since large institutions have both significant capital and governance power, they implement a proactive approach with regulatory bodies to ensure compliance, influencing regulatory frameworks. They participate in both industry associations and regulatory consultations, always being at the forefront of regulatory development and contributing to shaping policies that support growth and stability of crypto's ecosystem.

It helps build relations with regulators, fostering compliant innovation, trust, and transparency, anticipating regulatory changes and adjusting their strategies accordingly, minimizing potential legal risks.

How Institutions are Investing in Crypto? A Final Recap

As crypto gains prominence and widespread adoption, institutions are increasingly investing in this innovative asset class, attracted by the potential for portfolio diversification, higher returns, and innovative tech applications. High-inflation policies are eroding people's purchasing power in most countries in the world, and institutions have deeply understood how the financial system works: The current model was born in 1971 when also the US left the Bretton Woods agreements, and the system switched from being backed by gold to being backed by trust in central bank's policy. The system is not working, and both common people and institutions are looking for solutions, and cryptocurrencies seem the most feasible. It has been a long journey since Satoshi Nakamoto created Bitcoin in 2009. After more than 15 years, we're now all recognizing the potential of cryptocurrencies (especially Bitcoin) as a tool to create a more fair, democratic, transparent, and secure financial ecosystem.

At PlasBit, we strongly believe that cryptocurrencies are here to stay and revolutionize the finance industry. Crypto and blockchain technology can help individuals to obtain financial freedom while respecting privacy and human rights. Institutions have already understood the potential of crypto and are trying to get as much exposure as possible to gain a competitive advantage over future crypto adopters. The key is education: By knowing how the blockchain works, you can understand the potential of cryptocurrencies and work to gain your financial freedom for the first time in human history. PlasBit is here to assist you with all the information, knowledge, and tools you need in your Web3 journey.

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