As our recent review on cryptocurrency has shown, the meteoric rise of digital assets is undeniable. As the pandemic-ravaged world was catapulted into a new way of life at almost every level, the geopolitical environment became increasingly destabilised, global debt reached record highs, the need for increased monetary stimulus grew, and interest rate projections flattened. These events left economists questioning the future of the world’s declining fiat currencies and investors looking for avenues to decrease their reliance on the failing financial system.
In the face of these challenges, some of the world’s savviest institutions and investors have shifted their focus to decentralised finance, further diversifying their portfolios into digital assets as part of their risk mitigation strategies. And one of those primary investments of choice is Bitcoin.
What started as a trend, seems to have settled into the mainstream, and it has not escaped family offices‘ attention. According to Nelson Minier, Head of OTC Sales and Trading at Kraken, “Over the past couple of years, there has been an increased general interest in the market from family offices in crypto assets. This has been due to the increase in money printing, which has distorted the traditional market valuations to historically high levels.”
As cryptocurrency continues to move from the fringe to the mainstream, should family offices be looking to Bitcoin as part of their long-term risk management and investment strategies? To answer this question requires a review of recent developments.
A growing interest in alternative investments
For many family offices, considerations surrounding alternative investments, including digital assets and cryptocurrencies, are not new. Amid the prolonged low-interest-rate environments of the past few years, and with the advent of “smart investing,” even the most conservative family offices have slowly shifted away from solely traditional investment focused mindsets.
In recent years, many families have gone beyond the traditional 60-40 equity to fixed income asset allocation framework within their portfolios, making way for broader diversification into alternative asset classes. A notable trend during portfolio rebalancing in mid-2020 when, according to the 2020 UBS Global Family Office Report, many favoured cash, precious metals, gold and equities in developed markets within alternative investment categories.
However, as global events continued to unfold, geopolitical tensions heightened, and doubts surrounding fiat currencies grew. The increased risks associated with holding cash make doing so less appealing. With these weighty concerns in mind, asset-backed digital financial instruments and cryptocurrencies have garnered renewed interest among investors the world over, with Bitcoin emerging as one of the frontrunners in the quest for alternatives investment avenues.
Why Bitcoin?
For those who need a refresher, Bitcoin is a decentralised cryptocurrency built on a cryptography-based blockchain network, that supports direct peer-to-peer electronic payments globally. It is not subject to the tracking or control of any individual, organisation or government. It has a verifiably limited supply of just 21 million coins that can exist, which means it cannot be inflated. Essentially, Bitcoin eliminates intermediaries and restores financial sovereignty and privacy to its users, an increasingly attractive prospect in uncertain times.
These factors, coupled with the cryptocurrency’s track record of gaining over time, and its stellar outperformance of every mainstream asset class in recent years, captured Wall Street’s attention and placed it firmly back on the radar of investment groups that may have once dismissed it. Renowned digital asset advisors, Fidelity even produced an investment thesis for it. Respected companies in the fields of business intelligence like MicroStrategy, asset management groups like Stone Ridge Holdings and the world’s wealthy joined its ranks of investors.
Since its inception in 2009, Bitcoin has been subject to scepticism and harsh criticism. As recently as 2020, it was still considered a fringe investment and even trivialised by billionaire investor Warren Buffet who stated that it held “no value.” However, as debt and money supplies continue to rise steadily, Bitcoin’s potential as a viable alternative to the current system and a way to hedge against expansionist monetary policies has rapidly been recognised. In fact, earlier this year, Buffet’s company, Berkshire Hathaway, reportedly invested $1-billion in crypto, implying his initial concerns have now been assuaged.
Bitcoin and family offices
It is no secret that family offices view strategic asset allocation and diversification as the cornerstones of long-term wealth preservation and accumulation. Many subscribe to modern portfolio theory (MPT) methodologies, which encourage diversification and minimise risk without reducing returns. But even these strategies cannot protect against systemic risk. The traditional concern surrounding Bitcoin has always been the associated risk. However, in the face of the market-wide volatility encountered over the past few years, it has proven that as an uncorrelated asset showing a correlation coefficient of around zero over its lifetime, it may ironically be a viable risk mitigation solution.
According to Andrew Howard, Chief Business Development Officer, Bitcoin Reserve, “Bitcoin and family offices very logically complement each other: Family offices aim for long-term wealth preservation throughout generations, while bitcoin is a form of money that can’t be inflated, and can therefore retain its value over time.” This is a very appealing prospect for families considering diversification into decentralised finance as part of their investment and risk mitigation strategies in the current low yield environment.
It also provides an alternative to cash, and according to analysts at JP Morgan and Deutsche Bank, even gold, both of which formed part of many family offices’ mid-2020s portfolio rebalancing. While Bitcoin’s potential volatility can be a concern for those entering the market, family office capital is traditionally patient, with many investments executed with a long term view. This makes the cryptocurrency’s volatility less of a concern to families than to those with shorter investment timelines.
Still, Minier advises that before investing in Bitcoin or crypto investment, families should be aware that the history, security, community involvement and expertise of a crypto partner are all vitally important. Therefore family offices should be diligent in who they choose to work with. The right partner is not just a place to perform a transaction but should have a truly knowledgeable and weathered team. He adds, “Custody issues are an underlying factor in family offices – in order for families to not use a custodian, they have to be comfortable with holding their own private keys.”
It was only a matter of time before new technologies became available to help navigate the risks and overcome the various challenges. One example is Multi-Party Computation (MPC) technology which can help eliminate the need to hold keys. Companies like Qredo are bringing these enterprise-grade wallets to market, built on MPC technology. Similarly, other companies are coming online to tackle other challenges around custody, trading, brokerage, liquidity and asset management. There’s also a growing number of experts in this space. People like Chris Harmse whose experience as a buy-side equity analyst highlighted how crypto infrastructure can be applied to reduce the inefficiencies of traditional financial services and improve incumbent business models.
With recent global uncertainty and instability, a looming financial crisis and inflation concerns and increasing adoption by UHNWIs, investors and organisations, there is a very compelling case for family offices to take their place in the new financial revolution. At least part of this should involve the consideration of investments in cryptocurrencies like Bitcoin.