At the time of our conversation with Martin, Bitcoin had just broken through the upper limit of $20,000, reaching a new all-time high. We wondered if it was still a good time to invest in Bitcoin, whether we should try to time the market – which Martin advised not to – or use a diversified buy and hold strategy.
Increasingly, Bitcoin is being recognized as an inflation hedge and crypto assets generally are being viewed as an emerging asset class with diversification benefits. Do you think crypto assets have a place in portfolio management and why?
Yes, for a few reasons. The first one is that the potential for returns is very high. Despite the phenomenal returns in the past, the outlook is still very positive for this emerging asset class. Secondly, there is a diversification benefit to having a crypto allocation in the portfolio: historically Bitcoin has been uncorrelated with all other asset classes, with the exception of the market crash in March 2020 when correlations increased across all asset classes. In the European summer, crypto began to move completely independently of stock markets, bond markets and gold again. Investing in crypto is also a of way in participating in the shift towards blockchain-based systems as the momentum gained with Ethereum, DeFi, smart contracts and other applications continues.
Do you see Bitcoin as more of an investment asset class or peer-to-peer cash, as it was initially conceived, i.e. should we be holding or spending Bitcoin?
The Bitcoin narrative has shifted from peer-to-peer cash, which is what it was originally designed for, to digital gold. Most investors see Bitcoin as an inflation hedge and as an alternative to gold. This has created upside potential because even if just a small fraction of the investment in gold transfers to Bitcoin, it will lead to an increase in value. The story of Bitcoin has evolved over the last 10 years, and it is not certain that Bitcoin will continue to fulfil the same function in 10 years either.
The Bitcoin market grew extensively this year driven by factors such as Bitcoin’s new role as the digital gold, the halving of the supply, the entrance of institutional investors and the integration with platforms like PayPal. What do you expect for 2021?
My outlook is positive, even though I do not think we will see another doubling of value in the next two months. Prices will continue to fluctuate but volatility is decreasing in the long term because of a few factors, including: the development of a futures market, the evolving market structure, the entrance of long-term institutional investors and improved liquidity. The futures market allows betting against price increases which has stabilising effect. In terms of market structure, volume has shifted from offshore exchanges such as BitMex, which allowed amateur traders to leverage positions, towards more regulated or institutional grade exchanges.
What do you make of MicroStrategy investing a considerable part of its balance sheet in Bitcoin?
Looking at the price today, it was a genius move, as MicroStrategy has more than doubled its share price since the announcement. At the same time, I am somewhat critical of the whole story. When MicroStrategy first invested half of its treasury in Bitcoin, it made a lot of sense to me, since it seemed to be a good way to manage excess liquidity. But leveraging its balance sheet to buy even more Bitcoin changed the story. The latest bond issuance, which was exclusively used to buy Bitcoin, was fully subscribed, which is proof for the demand for institutional grade Bitcoin investment vehicles in the US. This is positive for crypto.
However, from an investment thesis perspective, I believe that Bitcoin investments should be left to specialised investment vehicles rather than operating companies with unrelated core businesses. MicroStrategy is an analytics software business, which has now become a de-facto Bitcoin hedge fund. Traditional financial theory suggests that if companies have excess cash, they should return it to their shareholders. Many investors, including myself, prefer to allocate their funds between pure play operating companies and specialised investment funds rather than having operating companies make investment and diversification decisions for them.
What role do you think institutional investors play in making investments in crypto assets more mainstream? Does it make sense for pension funds to invest in crypto through funds, or should they leave it to individuals to invest in crypto directly?
It makes sense to allocate a portion of a fund’s assets to crypto because it offers attractive risk return characteristics. Having said that, large pension funds haven’t invested in crypto directly yet. Technology and markets have evolved faster than pension funds operate, and many institutional investors are still unfamiliar with this new asset class. In order to avoid missing out on potential returns, pension fund managers and other institutional investors should be prepared to invest as soon as they can from a regulatory perspective.
Do you think that the infrastructure around crypto restricts institutions from making investments? For example, it is difficult for an institution to have cold storage of Bitcoin on an external hard drive or to institute processes around who is authorised to trade.
It is still a problem, although there are now providers who offer infrastructure for crypto to investment grade institutional funds. In theory, all the infrastructure is there. In addition to investment funds there are now structured products you can invest in, regulated exchanges you can trade on and regulated custody providers which have very high standards for security.
However, the combination of limited knowledge of the asset class at the level of the institutional investors and their incumbent providers has led to the perception that crypto is still too risky. Most of the infrastructure and product providers tend to be start-ups. For adoption to increase, established players will need to offer products and large asset owners will need to become more familiar with the asset class. Large asset administrators are getting into this space, but the pace of typical pension funds or insurance companies is slow.
The lines between DeFi (decentralised finance) and CeFi (centralised finance) are not as clear as one might think – despite their decentralized infrastructure, most DeFi projects end up highly centralized. Which governance aspects are important for DeFi projects?
Indeed, there are different degrees of decentralisation. One way to think about decentralisation is in terms of censorship resistance – how easy or difficult it is to change the protocol, to manipulate it or to make decisions. An important aspect is the structure of the smart contracts. Administrator keys for smart contracts, allowing one party to make changes to the contract, are a clear case where the infrastructure is decentralised but the protocol itself is very centralised.
Ownership structure is another important aspect of many decentralised protocols. Beyond the technical implementation, it is important to assess the structure and motivation of token holders: is it likely that they will collude or be corrupted? A dynamic that has played out in many protocols is that decisions are made in a way that benefits those who vote. As with listed companies, governance and ownership structure matter.
2020 has seen the rise of decentralized exchange business models such as Uniswap. Speculation has created demand for new types of governance tokens and pushed the costs of Ethereum to all-time highs – do you think the trend is sustainable and are there any specific DeFi business cases you are excited about?
Decentralised exchanges are exciting. I was positively surprised by the pick-up of volume on decentralised exchanges and the adoption of automated market makers. I don’t expect that decentralised exchanges will crowd out centralised exchanges. Decentralisation provides a degree of democratisation of the process of listing tokens on an exchange because no permission is required to list. Decentralised exchanges may also be more secure, despite smart contract risk which exists because users typically do not have the skills and capability to assess the smart contract.
However, in terms of trading efficiency, centralised exchanges will keep an edge for the foreseeable future. In addition, security on centralised exchanges has improved. Hacks have become much less frequent with liquidity being aggregated on a handful of very high volume, secure exchanges.
A frequent criticism of DeFi is that it is basically ‘whales’ making a profit at the expense of the small amateur late-comers. I think this is partly justified, but the story is more complex. If you look at traditional markets, much of today’s regulation is intended to protect smaller investors. The open source principle in crypto changes the paradigm of regulation.
Traditional financial intermediaries are essentially a black box – it is impossible for outsiders to assess their inner workings, so regulation is required to prevent abuse. With open source, you lose that argument, since you can rely on the wisdom and self-interest of the crowd – essentially hackers – to assess systems and improve security, which benefits everyone, including small investors.
Which countries or regions are more advanced in terms of regulation in the crypto space? How is Europe doing?
Europe has not been very proactive with a few exceptions: Switzerland was quite early in establishing crypto regulation proactively, but was quite demanding on crypto firms; Germany was early in clarifying that crypto was not illegal; some smaller countries, like Liechtenstein, have been very proactive and have very advanced regulatory frameworks today.
In the US, the lack of uniform regulation across states is a challenge. In Asia, Singapore is probably the most advanced with Korea following behind. There is has been a fear of China being very restrictive, which they have been on the face of it. However, in practice crypto business is still taking place in China, which is potentially in the government’s interest.
We have seen quite negative regulation in the UK recently, prohibiting the sale of structured / derivative crypto products to retail investors. This has eliminated some quality products and, I believe, has increased the risk that uneducated retail investors will invest in poor products.
What advice would you give to people who want to get involved in DeFi but don’t have the capital to stake 32 ETH for Ethereum 2?
Usually I would say, just give it a try, get a MetaMask wallet, decide what you are willing to lose in the worst case, buy Ether and play around with staking and yield farming. However, if you are starting out with €100, today you won’t get very far because of the current high fee levels.
The second-best thing you can do is to get as far as trying to integrate the protocols, but just do not press the “buy” button if you don’t want to lose €10 in fees for a €20 token purchase. You can also familiarise yourself with the different protocols by looking at the project websites and reading the whitepapers.
Interview conducted by Stephanie Hurry, Olabisi Ayodeji, Matteo Conti, Emon Goswami
