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Riding the Bitcoin Rocket

Written by Will Slattery

What is Bitcoin?

Over the past few years it is more than likely you have either directly encountered Bitcoin or heard of it, and this is for good reason. As cryptocurrencies are still so new and foreign to most people, reluctance and skepticism are a natural hurdle. Just as many people thought the internet was a waste of time during its inception, Bitcoin is bound to face similar issues. However, popular financial figures such as Elon Musk and Anthony Scaramucci have sung cryptocurrencies’ praises for its innovative blockchain technology. Bitcoin has the potential to significantly disrupt current financial systems such as our current fiat money system while revolutionizing data collection and financial transaction systems.

In 2008, a person using the name Satoshi Nakamoto published a white paper on a public online mailing list. The paper, titled Bitcoin: A Peer-to-Peer Electronic Cash System stated the objectives of the currency as well as the actual code for how to make it possible. As the name suggests, the main objective of Bitcoin is to create a decentralized digital currency that is fully peer-to-peer, not requiring any regulators, banks to be a mediator, or middlemen for transactions. Additionally, Bitcoin avoids rapid fiat currency inflationary episodes like we are seeing currently because the number of bitcoin to be mined has been fixed at 21 million. All of these are made possible through the computer code for blockchain which Satoshi provides in the same paper.

Blockchain Technology

Blockchain is the technology that makes Bitcoin and all cryptocurrencies possible. While it is an extremely complicated system altogether, it can be summarized in a fairly digestible way. Blockchain is essentially a linear public ledger of all transactions, using encryption and decryption as a means of verifying transactions. As Bitcoin transactions are made, they are publicly broadcasted to all computers in the blockchain network and grouped into blocks. These blocks must then be decrypted by the network of computers in the system. Once one of these computers solves the block, the ledger is permanently updated with that block being the newest block on the end of the chain. This process continues indefinitely, constantly adding verified blocks full of transactions. This process eliminates the risk of double spending while remaining decentralized. Double-spending occurs when a single digital token can be spent more than once through duplication or falsification of the blockchain record. The information for all of these blocks as well as the individual transactions within them are all public and can be viewed at any time. While the crypto wallet public key is displayed for transactions, no information is linked to the key that could compromise anonymity.

Mining and Supply

There is only a single way new Bitcoins are created. That is through the process of mining. Calling it mining is slightly misleading as in reality mining is an essential process that maintains the blockchain network. Miners are the computers connected to the blockchain network which complete the decryption process to verify and post blocks. Whichever computer eventually solves the encryption by providing the correct 64-digit hexadecimal value is rewarded a set number of new Bitcoins. This is the only way new Bitcoins are added to the system.

About every four years or 210,000 blocks verified, the Bitcoin reward for solving a block is halved. This rate was established at inception to limit the supply growth and cap the total number of Bitcoins that will ever exist at 21 million. In addition to this, the blockchain system adjusts the difficulty of its encryptions to the amount of mining power in the network to maintain this rate. This is how Bitcoin handles inflation. These countermeasures to inflating the supply are hard-coded into the blockchain. Unlike the U.S. fiat dollar system where money can be arbitrarily created whenever needed by the government, Bitcoin has a fixed total supply and rate of adding to the supply that is not controlled by an irresponsible third party. Today, the reward for solving a single block is 6.25 BTC which currently, would be valued at around $144,000.

While a $144,000 payout for running a computer sounds attractive, the odds of actually being the one to solve the encryption is estimated to be about 1 in 22 trillion. Mining technology is becoming more productive every year with inventions like ASICs (Application-Specific-Integrated-Circuit) which are computers designed for the sole purpose of mining Bitcoin. However, even with one of these top-of-the-line computers, odds of solving the encryption are terrible as there are many other individuals and companies running mining operations at a scale that no individual can afford. This issue has led to the creation of mining pools. These are pools of individuals all agreeing to share in the profits of their combined computing power. With thousands of times the computing power, the chances of being the one to solve and be rewarded Bitcoin go up significantly. These profits are then divided up amongst individuals in the pool by how much computing power they offered to the pool.

Bitcoin Today

Fourteen years later, it is hard to imagine Satoshi had any idea that his creation would become such a big deal with some countries even using Bitcoin as legal tender. While the coin came from extremely humble beginnings, with a value as low as $0.09 per Bitcoin in 2010, it has hit astonishing highs of nearly $69,000 per Bitcoin just last year. Bitcoin’s price has fallen considerably from this point, today being worth just under $23,000 per coin. This decline is largely from a recent crypto panic caused by the crashing of multiple extremely over-leveraged crypto companies. Despite this recent dip, Bitcoin still shows immense promise for all of the reasons listed above. Even for those skeptical about Bitcoin, the blockchain technology surrounding it has taken off in every sector from food and supply chain to insurance and banking. American Express, Facebook, Walt Disney, and Berkshire Hathaway have all invested in the technology. As the fiat money system becomes more and more problematic and the importance of data collection grows, individuals and countries will be looking to Bitcoin and blockchain technologies for guidance.

Investing in Bitcoin

If you are considering putting money in Bitcoin there is a lot to consider. Crypto wallets can be intimidating and are only for direct investment in crypto assets. Instead, we will be focusing on investment opportunities that are tradeable like typical stocks but still provide exposure to the crypto markets. These come in a wide variety and may have different approaches to how they offer crypto exposure. For our purposes, we will cover three of these opportunities.

The first fund has been in the news for the past couple of months. Grayscale Bitcoin Trust (ticker: GBTC) is a closed-end fund holding purely bitcoin assets.  Unlike actual bitcoin, GBTC can be held in a tradional investment brokerage account or an IRA (individual retirement account).  Grayscale currently has assets under management of around $15 billion, making it the largest Bitcoin fund in the world. The fund provides the opportunity for people to gain exposure to the direct price changes in Bitcoin. Grayscale has plans to convert to an exchanged-traded-fund (ETF) which would allow them to use the creation and redemption technique of an ETF to stabilize the value to the net asset value (NAV). Currently, Grayscale’s inability to use this stabilizing technique has led to GBTC trading at nearly a 30% discount from the NAV of the underlying Bitcoin. In June, the SEC denied Grayscale’s application to convert to an ETF, citing concerns of potential manipulation. Grayscale is now suing the SEC over the decision following previous inconsistent approvals from the SEC for a Bitcoin futures ETF. If Grayscale ends up receiving approval for conversion, the current 30% discount will become a 30% profit for investors as the price will return close to NAV.

The next few investment opportunities take on more of a “pick and shovel” approach to investing in Bitcoin and crypto. This means investing in the tools that make this sector possible, such as computer chips and ASICs and the mining companies, rather than the crypto assets themselves as they can admittedly be volatile. The first of these is Fidelity Crypto Industry and Digital Payment ETF (Ticker: FDIG). This ETF holds assets across Fidelity’s entire Crypto Industry and Digital Payment Index, closely tracking the performance of the crypto sector rather than the potentially volatile prices of the cryptos themselves. Currently, FDIG holds assets under management of about $13 million with a NAV of $16.71. The second company we have an eye on takes a similar pick and shovel approach to invest in crypto. Bitwise Crypto Industry Innovators ETF (Ticker: BITQ) is another ETF holding shares of companies innovating in and supporting the crypto industry. Specifically, only companies that generate at least half of their revenues from crypto business activities. BITQ currently has assets under management of $72 million and a NAV of $8.10. These could be good options for those who are interested or have faith in crypto but want to take a more diversified approach on the sector.

   

 

 

 

 

 

An investment in GBTC, FDIG or BITQ can be as volatile as owning bitcoin or any other crypto.  We recommend only modest allocations to the crypto space of 1% to 5% within an investment portfolio because of the higher risk and speculative aspects of this nascent industry/technology. Servant Financial client portfolio models include GBTC and were recently rebalanced to purchase more given the market correction in the crypto sector along with traditional stock and bond markets.  More risk tolerant client models also hold Hut 8 Mining (NASDAQ: HUT) and these models were also rebalanced.  We typically do not invest in ETFs that do not have more than $100 million in assets under management so we will continue to monitor FDIG and BITQ.

Looking Forward

Crypto is still only in its beginning phase. With the application and acceptance of Bitcoin and other cryptos increasing each year, demand is expected to increase significantly. Broader acceptance and application of the technology is expected to lead to improved regulation of these currencies which will serve to increase adoption and overall understanding of cryptos as well as the benefits they have to offer. Bitcoin and crypto will continue to establish themselves as major disruptive forces to the current financial system. Bitcoin and crypto can potentially disintermediate traditional financial institutions much like what the internet and e-commerce did to traditional retailers, like book stores. As innovators such as Steve Jobs, Nikola Tesla, and Jeff Bezos will tell you, being on the right side of change can reap financial benefits and societal advancements.

Going, Going, Gone! Is Inflation Running Away with our Money and our Investment Returns?

Written by Ailie Carlene Elmore

On the field that is the U.S. economy, currently loading the bases are looming interest rate hikes, the value of the U.S. dollar, and rising Treasury yields. On the mound, is Federal Reserve Chairman, Jerome Powell, and everyone from investors to consumers are waiting to see what will happen next with monetary policy and the economy. Early in the game, the COVID-19 pandemic threw a curveball, and ever since, the economy has been dribbling a series of weak grounders from persistent unemployment, to supply chain disruptions and a declining labor force participation rate. Will Chairman Powell toe the rubber to strike out runaway inflation and imperil economic growth or is the US economy in for extra innings?

How did inflation get so out of hand?

The U.S. Bureau of Labor Statistics reported that in January 2022, the consumer price index rose 7.5% from January 2021, the highest rate of inflation since February of 1982. Some of the industries seeing the largest price hikes are the energy, gasoline, housing, and food sectors which is of no surprise for anyone who has bought groceries or visited the gas pump lately. Even with the rise in prices, it hasn’t generally stopped consumers from spending. The Commerce Department reported that retail sales are up 3.8% year over year with large gains reported in vehicle, furniture, and building supply purchases. Home sales have been on the rise as well with the National Association of Realtors citing that home sales in January were up 6.7% from the previous month. This comes as home buyers are trying to secure financing at lower interest rates before the anticipated Federal Reserve rate increase next month.

Source: SpringTide US. Inflation Trends

While this level of inflation is unlike anything Americans born after the 1970s and early ‘80s have ever experienced, many economists are not surprised by this spike in the CPI. The federal government has shelled out more than $3.5 trillion in COVID-19 relief funding in the form of stimulus checks, unemployment compensation, and the paycheck protection program. The figure below shows the allocation of this spending with more spending earmarked through 2030 as the government continues to combat the aftershocks of the pandemic. The excess liquidity in the market, combined with the supply chain disruptions and labor shortages, has created the perfect cocktail for inflation to brew. While this spending was necessary to keep the economy out of a recession, some argue the federal reserve hasn’t been aggressive enough in unwinding its pandemic era policies to combat rising inflation. The Federal Reserve has announced that rates will start to rise in March, but by how much? Experts, such as economists at Citibank, are predicting anywhere from a 25 to 50-basis point hike with the later end of the spectrum becoming more likely as inflation rises. They are then expecting three to four more 25-basis point hikes by the end of 2022. Economists feel this could help slow inflation by the end of the year, but supply chain disruptions and incipient wage inflation risk still loom.

Source: CNBC analysis of Treasury data compiled by the Pandemic Response Accountability Committee

Is 2022, the new 1980?

The survivors of the last battle with inflation in the 1970s and 80s know all too well what runaway inflation looks like.  It has some questioning whether we are in for a blast from the past in 2022. Inflation peaked in 1980 at 14.8% and while we haven’t hit those levels yet, the jump we have experienced has people on their toes for a line drive heading for them. Inflation in the ’80s was driven by a variety of factors from unpredictability in interest rates to soaring oil prices. Most economists believe that this time is different than the 1980s as recent inflation has been caused by COVID-19 aftershocks of excess liquidity and supply chain issues. These factors are expected to normalize over time.

Examining our Investment Strategy

Markets have been off to a shaky start in 2022 with inflation and geopolitical risks in Russia & Ukraine driving the recent volatility. Economists and investors worry that if war broke out between Ukraine and Russia, it could cause more supply chain disruptions of commodities which could prolong inflation. While the Federal Reserve’s announcement of a March interest rate increase has curbed some concerns about more inflation, these new geopolitical risks could overshadow efforts to reduce inflation through monetary policy. As a result, investors are watching markets closely in addition to exploring inflation-protected physical assets such as gold or farmland. Below is the historical correlation between several asset classes and the consumer price index using returns data from 1970-2020. The CPI has historically had a positive relationship with bonds and precious metals but a negative relationship with equities.

Source: Data supplied by the TIAA Center for Farmland Research

Physical assets such as precious metals and farmland have taken center stage the past few months with gold values up 5.3% year to date and farmland values up 22% in parts of the Midwest since this time last year. While these physical assets have been investors’ go-to during high inflationary periods in the past, investors have also been allocating more of their portfolios to cryptocurrencies as well. Cryptocurrencies have a relatively short history compared to traditional assets which makes it difficult to analyze their performance with inflation, however, some investors are calling it “digital gold.” Even Mr. Wonderful, Kevin O’Leary, claims that his portfolio has more holdings in cryptocurrencies now than gold. Crypto enthusiasts cite its ability to be shielded from the effects of government money printing and spending largesse.

Servant Financial has been keeping tabs on inflation and has updated its investing strategy accordingly based on investors’ risk tolerance. While we are still allocating a portion of portfolios to equities and fixed income instruments, we’ve had a higher portfolio tilt towards allocation to precious metals, real assets, and Grayscale Bitcoin Trust (BTC) as protection for client portfolios from inflation. INFL, Horizon Kinetics Inflation Beneficiaries ETF, has recently been added to the portfolio as well. It is an actively managed ETF designed to capitalize on growing inflation trends. Currently, INFL has $896 million assets under management with holdings in transportation, financial exchanges, energy and food infrastructure, real estate, and mining companies. While INFL has a diverse group of global holdings, its top holdings are in PrairieSky Royalty (Oil & Gas), Archer Daniels Midland (Food & Agribusiness Processing), and Viper Energy Partners (Oil & Minerals).

While inflation has threatened investors’ portfolio returns, an adjustment in investment strategy for the purposes of inflation hedging will help investors score in the performance game in the later innings of this economic cycle. A watchful eye must be kept on key economic signals such as changes in interest rates, inflation trends globally, and the supply chain normalization. If you would like to discuss your asset allocation so you can do well in all facets of the investment game like the alert and observant Willie Mays, the Say Hey Kid (Say who. Say what. Say where. Say hey.), contact Servant Financial today.

Go with the Flow — Investing in Hydropower

Written by Annie Dysart , John Heneghan

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What is Hydropower?

Hydropower is a type of renewable energy that uses the force of flowing water to produce electricity. Its energy comes from the water cycle: the continuous movement of water on, above, and below earth’s surface.

Hydropower is a renewable technology because it captures naturally occurring energy from the water cycle and produces electricity without reducing or using up water. The marginal cost of production for hydropower — and renewables like solar, wind, and geothermal energy — is zero.

Check out this 3-minute video on hydropower.

The most common type of hydropower production is an impoundment facility. Impoundment dams hold river water until its release through a turbine that activates a generator and produces electricity. The U.S. has over 90,000 dams, yet only 3% are active hydropower facilities. The majority of dams in the United States were built for irrigation or flood control purposes.

In 2019, conventional hydroelectricity’s generation capacity in the United States was 79,746 megawatts (MW) — or about 80 million kilowatts. This is enough electricity to fuel 32 million homes a year. The state of Washington produces the most energy from impoundment. It is home to the Grand Coulee Dam, the largest U.S. hydropower facility. The dam is also the largest U.S. power plant in generation capacity.

Dams are controversial because of potential harmful environmental impact. They destroy carbon sinks in wetlands and oceans, deprive ecosystems of nutrients, reduce biodiversity, cause habitat fragmentation, and displace poor communities. Fish ladders — a series of ascending pools that allow fish to circumvent a dam — are a solution to impoundment facilities that would otherwise hinder the migration of species like salmon up and down rivers.

Another type of hydroelectric power is diversion, also known as a run-of-river facility. This method diverts part of a stream through a canal or penstock. The water then spins a turbine and produces electricity before rejoining the main river. The typical capacity of a diversion facility is less than 30 MW.

Both small individual operators and large utilities own run-of -river facilities. In some cases, large utilities view these facilities as low value assets due to old equipment, inefficient operations and low power prices.

Pumped storage facilities store energy for later use by pumping water uphill when electricity is cheap to a reservoir at higher elevation. When there is high electricity demand, they release water to a lower reservoir and through a turbine to generate electricity.

Hydro operations can operate under federal, public, or private ownership. There can also be public-private and public-federal partnerships. Federal agencies operate about half of the total installed hydropower capacity in the U.S.

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Hydropower accounts for around 6.6% of the electricity generated in the United States. Hydropower was the nation’s largest source of renewable energy until wind power surpassed it in 2019. According to the U.S. Energy Information Administration, total annual electricity generation from utility-scale non-hydro renewable sources (wind, solar, biomass, etc.) has been greater than hydropower generation since 2014.

Total renewable energy resources represent 17% of U.S. electricity generation. Dirty coal still represents 23% of generation and is a major contributor to greenhouse gases. Renewable energy sources are poised to take coal’s market share aided by technological advances in energy storage.

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Advantages of Hydropower

Hydropower offers the lowest levelized cost of electricity across all major fossil fuel and renewable energy sources. Hydro is a reliable, cost-effective energy source due to low-maintenance equipment and longer facility lifespans that amortize significantly large upfront capital costs over time.

The total conversion efficiency of a hydropower plant ranges between 90-95%. Conversion efficiency is the useful energy output divided by the energy input. For hydro, it is the hydroelectricity output divided by the kinetic energy of flowing water input. Hydropower’s conversion efficiency is greater than the conversion efficiency of both wind and solar, with wind at a rate of about 45% and solar at 25%.

Hydropower has high diversification potential with other renewable energies. A portfolio with hydro, wind, and solar energy that is diversified across energy sources and regions can have a stabilizing effect on asset portfolios.

Hydroelectric facilities provide baseload power; they run continuously to meet the minimum level of power demand. This consistency makes hydropower complementary to intermittent renewables like wind and solar that can only generate electricity when the sun is shining or the wind is blowing. Hydropower depends on the more reliable flow of water to help meet baseline electricity demands while other renewables can supply peak demands.

Hydropower and Renewable Energy Storage

The push for decarbonization through renewables will require innovation in energy storage technologies that addresses the intermittencies of wind and solar energy. While pumped-storage hydropower accounts for 95% of U.S. utility-scale energy storage, lithium-ion battery storage has seen tremendous growth. The price of lithium-ion batteries has fallen by about 80% over the past five years, enabling the integration of storage into solar power systems.

NREL’s Renewable Electricity Futures Study estimated that if 80% of the United States’ electricity is powered by renewables by 2050, 120 gigawatts of storage would be needed across the nation. The U.S. currently has 22 gigawatts of storage from pumped hydropower and 1 gigawatt from batteries.

Another opportunity looming on the hydro horizon is the potential coupling of hydropower and Bitcoin mining. Bitcoin mining lacks an eco-friendly reputation as an energy-intensive process with a large carbon footprint. However, this can change if miners use electricity from renewable sources.

Much like energy storage utilizing lithium-ion batteries, Bitcoin and other cryptocurrencies are an energy storage technology. Converting energy into bitcoins and storing it for future purchases can help contribute to the storage needed for the renewable energy revolution.

Bitcoin miners can choose their location based on the cheapest cost of electricity. Cheap electricity happens to come from cleaner baseload energy sources like hydro, geothermal, and natural gas. If Bitcoin miners settle near renewable energy plants, they could reduce their emissions and soak up extra energy that would go to waste.

Go with the Flow — Investing in Hydro

Current trends show wind and solar energy assets are more frequently represented in institutional investors’ portfolios than hydropower assets. Hydropower facilities tend to have high upfront costs, complex installation processes, and absence from the market due to a history of public ownership and project sponsorship. These are some of the factors that create a scarcity of hydroelectric investment opportunities.

Brookfield Renewable (BEPC: NYSE) is one of the world’s largest investors in renewable energy. Its strong ESG practices support global decarbonization and create long-term value for stakeholders. In addition, it is geographically and technologically diversified.

There is 19,300 MW of renewable capacity located across North America, South America, Europe, India, and China. Hydro represents 7,900 MW (53% in U.S. & Canada), or 41% of capacity, followed by 4,700 MW of wind (52% in U.S. & Canada), 2,600 MW of solar, and 2,600 MW of energy storage and distribution assets.

Brookfield has an investment grade, BBB+ balance sheet. It has diverse, high-quality cash flows and a strong financial position. In effect, it can pursue growth opportunities and make distributions to shareholders. Brookfield targets annual equity deployment of $800 million in high-quality assets.

Their investment strategy involves acquisition and development of high-quality renewable power assets and businesses below intrinsic value. They also recycle capital from mature, de-risked assets, optimize cash flows through operating expertise to enhance value, and finance businesses on an investment grade basis.

Brookfield partners with governments and businesses to achieve their decarbonization goals. It has an 18,000 MW development pipeline diversified across multiple technologies and geographies, including approximately 2,400 MW under construction.

Since 2012, Brookfield EPC has grown its annual distribution by 6% compound annual growth rate. Brookfield expects to continue distribution growth by 5% to 9% annually. In addition, they deliver total returns of 12% to 15% to unitholders over the long-term.

Brookfield is the best way to go with the flow on the decarbonization megatrend and invest in the inevitable transition to renewable hydro, wind and solar energy.

 

To talk more about investing in hydropower, or other investment opportunities, contact us today. Together, we can find the right investments for you, the ones that align with your values and help you to reach your financial and life goals.

Wake Up to Bitcoin

Written by John Heneghan , Annie Dysart

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What is Bitcoin and how does it work?
Bitcoin (BTC) is the most well-known and successful form of cryptocurrency with a market capitalization of about $170 billion at $9,300 per BTC and daily trading volume of $700 million.  It is especially popular among tech-savvy millennials who find it appealing for investment.  According to a nationwide survey by Bankrate in July 2019, millennials are three times more likely to invest in crypto than Generation X.  Bitcoin is the brand-name category killer and the Amazon of the digitally networked crypto world. 

Bitcoin is a digital and decentralized cryptocurrency built on blockchain technology. Blockchain architecture is designed to address concerns like decentralization, privacy, identity, trust and ownership of data. Blockchain’s democratized model uses distributed data storage, peer-to-peer transmission, consensus protocols, and digital encryption technology to validate transactions.  It is nearly impossible to counterfeit or double-spend cryptocurrency. 

Blockchain uses a public, digital ledger to create a fixed data chain of time-stamped transactions (blocks).  Blocks are chronologically strung together one after the other to form an immutable blockchain.  Transactions are cryptographically recorded and verified by a network of computers (consensus validation) that do not belong to any central authority. 

Every ten minutes, a set “block reward” of bitcoin is awarded to Bitcoin “miners.” Mining is the only way to “print” new Bitcoins into circulation. Miners use high power computers to solve complex math problems called hash functions to verify 1 megabyte, or 1 block, of Bitcoin transactions. 

Hash functions provide proof of work by processing data and generating another hash that matches the original data. Proof of work makes tampering with the blockchain very challenging; alteration of any kind would necessitate the re-mining of all subsequent blocks. 

Bitcoin’s supply issuance is strictly and algorithmically bound. The block reward is halved every 210,000 blocks, which takes about four years to mine. In 2009, the block reward was 50 Bitcoins every ten minutes, subsequently halving to 25 Bitcoins in 2013, 12.5 Bitcoins in 2016, and finally 6.25 Bitcoins in 2020. 

The supply of Bitcoin is capped by the blockchain code at 21 million. It would require network consensus to overwrite the coding language which is anathema to the value embedded in the Bitcoin network.  Currently, almost 18.5 million Bitcoins are in circulation, leaving approximately 2.5 million to be mined. The value of this “digital gold” will increase as its scarcity increases over time as fewer and fewer Bitcoins are “printed” with each successive halving until the supply is capped at 21 million.  The 21 millionth Bitcoin is expected to be mined in 2140. 

You can learn more about how Bitcoin and blockchains work in this 9 minute video from SciShow.

 

Blockchain and Fintech in China
China is the global leader in the use and development of blockchain technology.  China has by far the most blockchain patents in the world and more than 70% of the mining capacity.  Some of the biggest names in the crypto space are Chinese firms, including Binance, the world’s largest crypto exchange.  

Moreover, China is arguably the global leader in financial technology (fintech) solutions, particularly smart-phone based payment systems.  For example, the Chinese population has leapfrogged traditional credit card based payment rails with the dominance of mobile based Alipay and We Chat Pay.  Leveraging this fintech leadership, China has taken an early pole position in the development of an alternate global monetary and financial system by being the first country to issue a government backed digital currency. 

 

Why invest in Bitcoin?
Bitcoin is a worthy investment for enhancement of portfolio diversification and improvement of expected returns without significant addition of portfolio risk.  

Although the price of Bitcoin has been highly volatile over time, historically investors that hold Bitcoin for the longer term, called “hodlers,” have been richly rewarded as Bitcoin’s historical return per unit of risk (Sharpe ratio) has been much greater than 1.0 with a five year annual return of 88% through May 31, 2020 on volatility of 66%.  

This compares to Research Affiliate’s forward-looking expected returns and risk for traditional asset classes wherein emerging market equities are viewed as the most attractive asset class.  Research Affiliates estimated EM equity’s Sharpe ratio at 0.42 today based on 10% nominal annual returns and 21% expected volatility.  A Sharpe ratio of 1.0 or better is unheard of in the traditional investment world.

A Bitwise investment study entitled, “The Case for Bitcoin in an Institutional Portfolio” concluded that “adding Bitcoin to a diversified portfolio of stocks and bonds would have consistently and significantly increased both cumulative and risk-adjusted returns of that portfolio over any meaningful time period in Bitcoin’s history, provided a rebalancing strategy is in place.” 

This positive portfolio impact endured even in periods in which the price of Bitcoin fell. The magnitude and consistency of Bitcoin’s contribution to portfolio efficiency when added to a traditional 60/40 portfolio were remarkable.  Bitwise’s study found that achieving these portfolio benefits only required a few critical practices:  

  1. Hold Bitcoin for two years or more – the historical record of positive portfolio contributions quickly approached 100%
  2. Disciplined quarterly rebalancing – sell your winners and buy your losing positions to get back to targeted allocation percentages
  3. Well-thought out targeted allocation percentage – maximum drawdowns are the main limiting factor in deciding how much Bitcoin to add to investor portfolios.

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Bitcoin and Investor Concerns
In March 2020, Fidelity Digital Assets released a study that surveyed nearly 800 European and American institutional investors. In general, institutional investors (hedge funds, pension plans, family offices and registered investment advisors) are keeping a keen eye on Bitcoin and other digital assets, and there are an increasing number of early-movers who have taken the crypto plunge. Key findings of the study include:

  • 36% of respondents say they are currently invested in digital assets (adoption rate is much higher among hedge funds but in the low single digits for pension plans).
  • 6 out of 10 respondents believe digital assets have a place in their investment portfolio.
  • The three most appealing characteristics of digital assets to investors: they are uncorrelated to other asset classes, are an innovative technology play, and have high potential upside. 
  • Investors’ perceived advantages of digital assets over traditional alternatives like hedge funds or private equity: higher liquidity, low transportation costs, low transaction costs, low storage costs, and unique return drivers.

Fidelity’s study also highlighted investor concerns regarding digital assets:

  • Price volatility (53% of respondents) – (mitigated by well-thought out position sizing as suggested by above Bitwise study)
  • Concerns about market manipulation (47%) – (this is a concern for all securities or currency markets.)  
  • Lack of fundamentals to gauge appropriate value (45%) – (fundamental analysis has recently been published in Plan B stock to flow cross-asset analysis).

President of Fidelity Digital Assets Tom Jessop commented, “Investor concerns are largely focused on issues that will resolve themselves as the market infrastructure evolves. We’re proud to be one of many service providers actively driving that evolution for the benefit of the ecosystem and traditional investors alike.”  Fidelity Digital Assets envisions a future where all types of assets are issued natively on blockchains or represented in tokenized form.  In other words, Fidelity expects all traditional assets (stocks, bonds, currencies, etc.) will be issued and held on blockchain or in tokenized form.

 

Grayscale Bitcoin Trust

Grayscale Bitcoin Trust’s (GBTC) absorption of 25% of newly-mined Bitcoins in 2020 indicates higher demand for crypto exchange-traded instruments among retail investors.   With a market capitalization of $3.5 billion, GBTC is the investment vehicle of choice for investors, particularly smaller, retail investors.  

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It is very difficult to buy Bitcoin right now through traditional investment brokerage accounts due to limited investment offerings.  GBTC is one of the few liquid, publicly listed exchange traded vehicles that invests in Bitcoin.  GBTC provides titled, auditable ownership through a traditional investment vehicle, can be held in tax advantaged accounts, and maintains robust security and storage protocols. 

In late June, Servant Financial initiated small, toehold positions in GBTC of 0.5% to 1.0% in client model portfolios, depending on investor risk profiles.  Our statistical analysis using historical data suggested that adding a 1% position in GBTC will increase expected returns by 1% annually while only increasing risk by 0.3 to 0.4% across all client risk models.  

In addition to enhancing portfolio efficiency, GBTC provides schmuck insurance in the event the global monetary and financial system were to fail (an event not represented in the historical data).  The more irresponsible and extreme the monetary and fiscal policy actions of the government become, the more Bitcoin will appreciate as an increasingly scarce store of value.  In extremis,  GBTC, Bitcoin, and gold would be expected to massively outperform traditional asset classes in the event of a total system crash.  With a maximum downside of 0.5% to 1.0%, GBTC provides a “bit or byte” of peace of mind with asymmetric upside for this fat tail risk. 

 

It’s Time to Wake Up to Bitcoin
Institutional investors are waking up to the unique characteristics of Bitcoin and crypto currencies, particularly after the legendary hedge fund manager Paul Tudor Jones recommended Bitcoin as “the fastest horse in the race” to beat the Great Monetary Inflation (GMI) – “unprecedented expansion of every form of money unlike anything the developed world has ever seen” – that we are presently experiencing.  

As Fidelity’s Jessop indicated, the infrastructure for large scale institutional investment in Bitcoin and crypto currencies is still under construction.  Today, there are only a few access points suitable for institutional investors’ large scale deployment.  For example, Jones’ hedge fund will take a “low single digit position” in Bitcoin through futures markets rather than direct holdings of Bitcoin.  His $40 billion fund already has existing connectivity with the major futures exchanges and well-established investment policies and procedures.

The developing nature of the market presents a distinct advantage for smaller, more nimble retail investors to get in front of the institutional money flows.  Recent investor surveys suggest that many retail investors are getting ahead of their investment advisors in knowledge and acceptance of Bitcoin as a suitable investment and are pushing their advisors to #getoffzero and make an initial portfolio allocation.

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