Last month Financial Advisor checked in with Matt Hougan, global head of research at Bitwise Investments, to check in and get his latest thoughts on the state of the market for digital assets. Hougan is a true believe in the future of this emerging asset class and he sees many parallels with other early-stage investments. On November 19, Hougan and Edelman Financial Services founder Ric Edelman will con conduct a webcast on the subject with Financial Advisor at 2:00 p.m.

1. Matt, one year ago, Bitcoin was at $6,200. Today, it’s at $6,400. Prices are down sharply from their all-time peak near $18,000 and opinions on where things go from here all over the place. What happened?

The right way to think about crypto is to think of it like an early-stage venture capital investment. It combines high potential returns with high levels of risk. The difference with crypto is that it also comes with intraday liquidity, so you can see the expression of that risk and return in real time.

I like to make the analogy to Airbnb. Back in the day, before Airbnb was established, there was a moment where it was banned in San Francisco. Imagine what would have happened to the price of Airbnb’s stock if it were trading at that time. It would have been down 50 percent-plus, 80 percent, maybe more!  But early-stage venture capital investments typically get priced once a quarter or once a year, so you don’t see that kind of intraday volatility.

The past year’s volatility is nothing new. Crypto has experienced four 70 percent-plus drawdowns in the past; at the same time, prices are up 1,000X or more. In each case, the drawdowns set the stage for a subsequent rally. I think the crypto markets got a little ahead of themselves in December of last year, and the pullback was a healthy correction. 

The question is: Now that prices have stabilized for a while, where do we go from here? The answer to that question will depend on the speed at which professional investors move into the space, and on the speed at which the massive development effort taking place in crypto right now results in meaningful real-world applications.

We will see, but I’d note that we’re seeing fast-moving institutional adoption. In the past few weeks alone, Yale, Harvard and Stanford have all allocated to crypto. It should be an institutional rest of the year.

2. Aside from prices and markets, crypto-currency trading desks have sprung up all over the place. What’s going on with the crypto infrastructure?

Crypto infrastructure is evolving and maturing at an incredible rate. Just a year ago, the space was largely dominated by startups and crypto-specific firms. Today, virtually every major financial services company has launched a pilot program serving the space, and many firms are live with commercial offerings. Fidelity made a big splash recently with its offering, but the list of firms entering the space this year has been unreal: Jane Street, Susquehanna, Nomura and so on.

There is still a ways to go, even on basic things like custody. The number of different coins that can be handled by SEC-qualified custodians is still somewhat limited, for instance. But that’s changing quickly.

The last big shoe to drop will be exchanges adopting a pro-regulatory approach with a strong emphasis on AML/KYC (anti-money laundering and know-your-customer processes), surveillance-sharing agreements and anti-manipulation tools. We have seen significant regulatory signaling that this is important, both in the New York Attorney General’s report on crypto exchanges and in the very pertinent questions the SEC has raised about crypto ETF filings.

There are people who think that crypto exchanges will resist adapting to these policies because of fear of losing existing customers. I think that’s almost precisely wrong; I think taking a pro-regulatory stance will help attract a much larger group of much larger customers, including institutional investors, and I think the exchanges know this. I suspect we’ll look at the crypto exchange ecosystem in 6-12 months and it will be fundamentally transformed for the better.

3. One fear some people have about crypto currencies is that it’s the Wild West with little regulatory oversight. Is that evolving?

Absolutely, in two ways.

First and foremost, regulators have spent the past 12 months really coming up to speed on cryptoassets. The level of understanding and the quality of questions coming out of regulators these days is impressive.

Secondly, all the regulatory actions and official statements we’ve seen on the space have been incredibly positive. We’ve seen both positive regulatory enforcement targeting the least desirable parts of the crypto ecosystem and constructive regulatory engagement with the most promising parts of the ecosystem. One great example was SEC Director Hinman’s June 2018 comments clarifying that Ethereum is not a security and laying a pathway for assets that raised money through an ICO to convert from being securities to not being securities. It’s hard to overstate how important that statement was for the crypto ecosystem; it removed a massive legal threat that had been hanging over the market for years. If Ethereum and other cryptoassets had been labelled securities, the trading and brokerage ecosystem would have had to completely reinvent itself.

In general, there was significant concern at the start of this year that regulators would kill the golden goose through excessive and careless regulation. What we’ve seen instead has been balanced and thoughtful.  I think the degree of negative regulatory risk has dramatically fallen in the past year. It’s been really impressive.

4. Do you see Bitcoin and other crypto currencies as a store of value like gold, a medium of exchange, a hedge against potential currency crises in the future or something else?

I think the primary current use of bitcoin specifically is as a non-sovereign store of value. The bitcoin blockchain is uniquely well-suited to facilitating the store of value use case: it’s broadly adopted, extremely secure and relatively slow. It’s worth noting, of course, that the market for a non-sovereign stores of value is significant: gold is a $7 trillion market, and offshore wealth is another $20 trillion, so succeeding in just this one area would be significant.

Other cryptoassets (and to an extent bitcoin as well) are tackling many additional markets, some of which are smaller than the store of value and some of which are larger. The use of the term “cryptocurrency” is misleading; the likelihood that you and I will be paying for lunch with bitcoin in the next five years is low. It’s likely that the first broadly adopted use cases will be in business-to-business applications such as international payments or remittance. We are already seeing firms like IBM and others using cryptoassets to make those systems better, faster, cheaper. 

5. Most advisors we talk to are skeptical about the area, though some think clients might want to have 1 percent of their assets in crypto currencies in case they are wrong. What’s your read on advisors’ take on the space?

Here’s what we know about financial advisors and crypto. We know, first and foremost, that advisors’ customers are asking about crypto. Surveys suggest that well over half of all financial advisors have had clients ask questions about crypto. That means that every financial advisor, whether they want to allocate to the space or not, needs to get educated on it.

Second, the data suggest that a small allocation to crypto—between 1-5 percent—can have a meaningful impact on your overall returns. We have a white paper on the topic on our web site; because crypto has had low correlations to other asset classes, a 1 percent allocation to crypto has significantly increased returns without meaningfully increasing risk on a historical basis.

Finally, I’d add this: Anyone who still reflexively dismisses crypto needs to take a step back and re-approach the problem. Harvard, Yale and Stanford are allocating to crypto; Fidelity has launched a major new investment portal for crypto; Andreesen-Horowitz, one of the world’s premier venture capital firms, has launched a fund focused just on crypto; the New York Stock Exchange’s parent company has a major new initiative.

Crypto is not going away. Everyone needs to study it, and most advisors should consider an allocation.

6. You have a fund. How old is it and what has your experience been so far?

Our fund launched on November 22, 2017, and has been running ever since. It offers accredited investors an easy way to get broad-based exposure to the top 10 cryptoassets in a fund that is professionally managed, professionally traded, and uses blue-chip partners for everything from custody to audit to tax. It’s been described as the S&P 500 for crypto; a simple, one-stop shop for high-quality crypto exposure.

We currently serve nearly 700 limited partners in the fund, including high-net-worth individuals, family offices, multi-family offices and RIAs. We’ve had a great reception from investors. I think there are a lot of people out there who know something important is happening in crypto—who see folks like Yale, Stanford and Harvard investing—and want exposure, but don’t know where to start. Our fund offers an easy way to get broad-based exposure to crypto without any idiosyncratic risk. People know that picking winners in tech isn’t easy: Bitcoin has first mover advantage, but then again, so did MySpace. It’s better to get diversified exposure to the space.