The Past, Present and Future of Institutional Bitcoin
In December of 2017, bitcoin’s price was surging, even fighting towards $20,000. Meanwhile, CNBC and the cable news set featured a constant string of crypto industry insiders bringing the space to a new audience. It was into that environment that on December 17, 2017, CME Group launched bitcoin futures.
Three years on, bitcoin has punched past the significant marker of $20,000 to a high of more than $23,000. CNBC is running a bitcoin ticker, and crypto commentators are standard fare.
Despite these superficial similarities, the bitcoin and crypto industry of 2020 has matured massively from those heady earlier days.
Earlier this month, CoinDesk hosted a webinar on the state of institutionalization in bitcoin, featuring CME Group’s Tim McCourt, Genesis’ Joshua Lim and digital asset fund manager Brian Kelly. The group discussed how the industry has evolved and where it is headed next.
This piece is a summary of some of the big ideas from that conversation, which you can watch in full here.
On the growth in CME Bitcoin futures
Tim McCourt [TM]: “We’ve come a long way in terms of the derivatives market, but also the adoption by customers. We’ve gone from when we first launched contracts, doing a little over 1,100 futures contracts that first day, to when we look at what we did in November 2020 where we did about 11,500 contracts a day. So let’s call it roughly 10x growth. “
Why CME Group launched Bitcoin futures
TM: “I think a lot of people may have thought we were crazy, you know? All the positive news as well as all the kind of interesting skepticism that was around bitcoin. I think people were generally intrigued. Why is a mainstay central derivatives exchange getting involved?
CME Group got involved because our customers needed it. A lot of our product development is the result of customer demand driven innovation, where we’re trying to clearly solve articulated demand problems in the market. There weren’t regulated futures or a regulated instrument for those folks who wanted to manage cryptocurrency or the risks associated with it to access the market.
It’s really exciting to see that our initial thesis of providing an institutional-grade product for institutional access that also worked for a myriad of participants in the crypto ecosystem become proof positive three years later. A lot of the skepticism we received in the beginning has been proven wrong. Crypto is something that’s here to stay, and CME is certainly one of the more influential players in the community at present. And the institutionalization that we’ve seen has started, I would say probably about a year and a half, almost two years ago. And I think it’s only going to continue to develop from here.”
The evolution of the industry in 2018-2019
Brian Kelly [BK]: “2018 was a pretty interesting year. I think I would look at it two ways. One thing that Tim mentioned in 2018 is how major institutions were able to turn on their strategies. This included a lot of proprietary trading shops. You know, your so-called Chicago prop shops really got into the market. What that did was it really made a market mature very quickly. So as for a fund like myself, I could get a lot more liquidity than I ever could prior to that time. So that was a big game changer.
I think the other thing that I would say that was important was the emergence of custodians and, in particular, Fidelity coming out with their custodial services. That was a huge roadblock. When I first started the fund, we were literally working on ledgers and we would have them in safes. And that’s how we kept everything secure. But institutions can’t do that. Institutions have to report. They can’t come in and say, listen, by the way, here’s my bitcoin. It’s on this thumb drive. It’s just not going to work for them. So, having really brand name custodians come into the space made a complete difference and made the difference in my conversations with institutions when I could tell them, here are our custodians. This is how we keep your bitcoin and cryptocurrency safe. That made a huge difference. And that happened 2018/2019.
Joshua Lim [JL]: “Another area of evolution that mattered was the accessibility of asset management products in crypto. Between Grayscale and CME – those are kind of like the main entry points for a lot of institutional investors. It’s just a very easy way to get access without having to go through a complicated process of getting approvals to hold physical bitcoin and all the sort of security and custody issues around that.
You have to have these onramps into crypto. Now, just thinking outside of the purely financial market, participants in crypto like you also have over the last two or three years, these big announcements from corporate participants. And I think the biggest one was when the Libra announcement was made. So you had this big public announcement of Facebook with a bunch of other Silicon Valley companies and payment companies around the world making an announcement around digital currency and providing consumer services around that.
You’ve seen a lot more of that in the last couple of months – that interplay between real world use cases, corporates and treasuries being allocated into crypto, along with the asset managers that are also providing liquidity for those guys, but also sort of positioning ahead of even more real world use cases are driving this rally.”
The narrative shift in the 2020 rally
JL: “For the most part, I think what we’ve seen over the last three years is just a real evolution in the underlying thesis for a lot of investors going into crypto. The biggest change has been from this idea that it maybe has some utility as a rails or some utility as an enterprise blockchain. Now, it’s this idea that it’s really just a store of value or something that people are kind of thinking of as an alternative to gold.”
BK: “Bitcoin had become more of a safe haven asset, more of a hedge against excess money printing a hedge against the response to COVID-19. The catalyst which reinforced that view in 2020 was the Federal Reserve’s meeting in Jackson Hole, where they talked about more QE. I can tell you, the week after that Jackson Hole meeting, my phone was ringing off the hook with institutions saying, “OK, that was it, that was the buy signal. That was the last straw for me. I need to own some bitcoin because every central bank in the world is printing money.” And that really changed the character of the market. We went from a market that was dominated by derivatives traders to a market that is becoming more dominated by stock traders.”
How the data shows more institutions are moving in
TM: “We’ve averaged 103 large holders for the month of November, which is a 130% increase year over year. And when we look at the peak, we just peaked last week at 108 large traders holding Bitcoin futures at CME Group. A large trader is defined as someone who is holding at least 25 contracts. That would be someone holding the equivalent of 125 bitcoin. And at these price levels, that’s almost $2.5M. So, when you think about that 108 people holding that type of position, I think that’s one of the strongest signals that we’ve had: larger firms – larger institutions – are not only getting into bitcoin, but also holding bitcoin. And as we’ve seen, large trader and the average daily open interest both continue to grow. It’s quite substantial in terms of the change of scope here in 2020.”
Changing career risk for asset managers:
BK: “if I look at narrative and career risk, Paul Tudor Jones announcing that 1-2% of his fund was going to be in bitcoin – was a huge event to take a lot of the career risk off the table. So I talked about the beginning of this webinar about how I’d go into a pension fund or I go into an endowment and there’d be 20 people, half like it, half hate it, half hated those who were pushing for it. They could only push so far because there was that career risk. And the conversation has changed dramatically since then. It used to be: “I can’t buy this right now because it’s going to you know, if it goes up, great! It’s fantastic! But if it goes down, I lose my job.” That conversation has shifted to: “Well, listen, Paul Tudor Jones is in it. Everybody else is getting it. I have to be in it now.” That’s a dramatic conversation that has changed dramatically this year.”
The need for prime brokerage:
JL: “I think what’s missing and what is continuing to evolve over the next year or so is the rise of prime brokerage-type solutions or these sort of service providers for institutional asset managers that wrap up all these other products.”
BK: “I look at it from my perspective as a fund manager. Prior to my life in bitcoin, I ran a global macro fund. And it was very easy, right? I had my accounts. I had my broker I could execute. No problem. End of the day, I got my reports and I’d walk away.
Coming into the crypto world, what I’ve had to do over the last three or four years is cobble together what I’ve called a decentralized broker. So, I might go out and buy bitcoin with one OTC broker. I’ll go over to Josh, and I’ll loan it out over to him; maybe I’ll get some cash back maybe for that. And then I can bring that over to the CME, and I can use that cash for my futures position. And I’m juggling all these things and I spend a lot of time kind of juggling the infrastructure as opposed to the investment side.
So as these all converge in prime brokerage, it’s going to make it a lot easier for not just crypto native funds like myself, but also for other funds to carve off a section, a little carve out of the fund to say, OK, this is our crypto division, because they can just plug and play and say, well, yeah, all right. But I want to borrow. I want to short it. I want to be long futures. You can do it all in one place and it makes it easier. So looking forward, I think reducing that friction for institutional players to come in is going to just open up so many avenues for this space.”
Why increasingly, institutional investors have to have an opinion:
TM: “I think it just really echoes what Brian was saying. When you look at it, we’re at the period of time where you can no longer not have an opinion. I think a lot of the frictions that we saw even going back to 2016-2017 was an unfamiliarity, perhaps being a bit a bit timid or unknowing of how it worked. You had a curiosity, but maybe not a good investment strategy or a way to deploy capital in pursuit of accessing the market or managing that risk. And I think now it’s just in the grand scheme of things, right?
We’re only out of the first decade with respect to bitcoin. And there’s many more paths that will avail themselves in cryptocurrency. We’re at this point here in 2020 with a significant increase in the adoption of institutional accounts. We’re using the product. We’re still early days in the grand scheme of things. And I would just encourage folks to look at derivatives as a useful means to either access the market or manage your risk.”