A fresh wave of institutional investors poses new risks to crypto.
This episode is sponsored by NYDIG.
In this episode of “The Breakdown,” NLW discusses a fresh wave of investors and their potential disruptions to markets, including:
- Two new major hedge funds, Point72 and Soros Fund
- Inevitable short-term investors as part of market maturation
- Troublesome possibility of regulation forming around institutional trading habits
In early 2020, institutional investors flowed into the crypto space nonstop, including hedge funds, corporate treasuries and insurance companies. This new type of investor changed the space, with surging and plunging prices following news of investors coming and going. Then the flood stopped as the always-controversial Elon Musk’s Tesla balked at bitcoin’s energy consumption and walked back accepting the top cryptocurrency in exchange for the company’s trendy vehicles.
In the last quarter, institutional investors have been stepping back into crypto. Point72, Steve Cohen’s company, stated it would be “remiss to ignore a now $2 trillion cryptocurrency market” and is looking to hire a “Head of Cryptocurrencies.” Besides Point72, internal management at George Soros’ Soros Fund has given the “greenlight to actively trade bitcoin.”
Are these two hedge funds just the tip of the iceberg for a resurgence in institutional investment? How will this new mass of money impact markets and regulation?
Image credit: Sean Gallup/Getty Images Europe, modified by CoinDesk
What's going on guys? It is Thursday, July 1, and today we are talking about George Soros and Steve Cohen getting in on the bitcoin game and why that might not be a good thing. Now, speaking of institutional bitcoin. This is a narrative that has been, if we're honest, a little flagging of late. Last year in the early part of this year were a nonstop flow of new types of investors into the bitcoin space. It started with hedge funds, then corporate treasuries got in, then insurance companies, and then, and then and then. Over the last quarter, there have still been some major moves in the space Morgan Stanley, for example, revealing holdings in GBTC. But, especially since Elon and Tesla started walking back their bitcoin engagement, there has been relative quiet.
Yesterday, however, we saw news of not one, but two relatively major hedge fund players making interesting crypto moves. The first was Point72, a massive U.S. hedge fund that has about 1500 employees and has a little over $22 billion in assets under management. In May, the firm told their investors in a letter that "We are exploring opportunities around blockchain technology and its transformative and disruptive capabilities, we would be remiss to ignore a now $2 trillion dollar cryptocurrency market." The firm said that if it invested, it would be through its private investments unit or its hedge fund, but that it's too early to say what paths we will ultimately pursue and when.
Yesterday, The Street broke the story that the firm is looking to hire a Head of Cryptocurrencies. This type of role is extremely competitive right now as all of these types of firms try to staff up, and funny enough, I bet these guys wish they hadn't let Travis Kling, who used to work at Point72 before founding Ikigai slipped through their fingers.
In any case, as I mentioned, this wasn't the only big hedge fund news. Again, as broken by The Street, two sources have said that Soros Fund Management's Chief Investment Officer Dawn Fitzpatrick has given the quote "internal green light to actively trade Bitcoin." As with Point72, there was some indication of this earlier in the year. In March, Fitzpatrick told Bloomberg that they had been investing in crypto infrastructure. She said that it was a quote "really important moment in time and that while Bitcoin could have stayed a fringe asset, the money supply surging had given it a clear purpose," quote, "so there's a real fear of debasing fiat currencies. And when you think about Bitcoin, I don't think it's a currency. I think it's a commodity and it's a commodity that's easily storable. It's easily transferable. The IRS classifies it as a physical asset, it has a finite amount of supply, and that supply is halved every four years. So I think it's interesting."
The premise of this show, however, is that these moves might not be a good thing. So, what's the deal with that? First, let me tell you about the New World Order and the coming great reset. Nah, I'm only joking. But seriously, when I tweeted about this yesterday, there was a barrage of comments that were not bullish. And I think there's one that some folks didn't even see. First, there is Soros' dubious reputation with regard to currencies. Someone tweeted: "'Great news, Soros has entered our currency market' said no one ever." In 1992, Soros was the most notable among a number of currency speculators who broke the British Pound, literally shorting it so hard the Great Britain was forced to withdraw from the European Exchange Rate Mechanism, a precursor to the agreement that created the euro. Could Soros try to exert that influence again, but in our crypto markets?
More broadly, there's just the question of what the interest of these firms is. These are traders who are ultimately focused on making money, not being devoted to a particular market thesis, much less a particular world philosophy. Chris Wesson, a market researcher who was quoted in Barron's said: "The report merely said the firm had cleared to trade this. So, without actually knowing much about what they plan to do, they could be lumping into short positions and futures. If they take a view that liquidity beneficiaries are going to take a hit as the Fed's balance sheet starts to grow at a far slower pace and the front end of the yield curve lifts, maybe being short crypto isn't such a bad play."
Remember, the hedge funds that we saw come in last year did come in because of a particular market thesis. Paul Tudor Jones' "Great Monetary Inflation" set the tone and these are themes that Stan Druckenmiller has repeated as well. Now, as I mentioned above, Dawn Fitzpatrick, the CIO at Soros, did point to some of this sort of thinking as well, when she was describing why the firm was interested in this space. If we go back to what Point72 said, however, it was that they shouldn't be ignoring a $2 trillion asset class. That's very different than having conviction around why it's a valuable asset class.
The notion that these firms are traders, not hodlers, came up a lot on my feed when I tweeted about them. Someone wrote, If you think these folks entering is all positive news, think again, they just care about short term P&L, and that does not include five year hodl horizon. Yep, not a good sign, they are traders, they will accumulate then dump after having shorted the future, they will use funds to manipulate the market. So do I think we should be worried about that? Not really, for two reasons. One, it's absolutely inevitable. The larger this space gets, the more traders are going to come in who don't have any real conviction around the asset long term, but who just see opportunity in the chart one way or another. This could be bad in price suppressing, but ultimately, that's part of bitcoin's maturation. What matters way more is that the base of strong hands continues to grow, and by every metric it is, that's the group that sets real price floors and keeps the tradable supply restricted. So as long as that group is growing in both size and conviction, we're directionally fine.
Speaking of directionally, it's nearly impossible for me to concoct a scenario where Bitcoin in the entire asset class around it, doesn't continue to just increase in value. There's just too much being built and too much money that hasn't allocated yet for that not to be the case. That means directionally over time. The only position that makes sense is net long. That's not financial advice. But I mean, come on. Again, this is not to say at all that these types of actors couldn't read some short term havoc, but with the right time horizon, I'm just not worried.
There is, however, another reason that I think there could be at least some concern around the involvement of these investors. I think there are risks to crypto being perceived by regulators as a plaything of the hedge fund industry. Yesterday's House hearing on the crypto frenzy got me thinking about this. The intro paragraph of the Committee memorandum includes this line: "A May 2021 survey conducted by PricewaterhouseCoopers found that hedge fund investment in digital assets doubled over the past year, with one in seven hedge funds holding at least 10 to 20% of their total assets under management in cryptocurrencies. According to another survey of hedge fund executives in North America, Europe and Asia, 98% of survey participants plan to invest in digital assets within the next five years. And while I called out yesterday how ridiculous it was that they were referencing Jim Cramer, it still is notable that the memorandum discusses crypto derivatives and leverage as a systemic risk to the broader economy.
Alexis Goldstein, the director of financial policy for the Open Markets Institute, flush this out in her testimony. Her primary point was that the participation of these types of hedge fund institutions in this space was where systemic risk enter the equation. She wrote: "Earlier this year, the blow up of a single family fund Archegos Capital led to $10 billion in bank losses after the firm's bets on a dozen total return swaps imploded. Apart from long options, no derivatives are required to be reported on the SEC's Form 13F, which meant the banks and regulators alike were in the dark about Archegos' positions until its implosion. The Federal Reserve's May 2021 financial stability report noted that both Archegos and GameStop volatility quote 'highlighted the opacity of risky exposures and the need for greater transparency at hedge funds and other leveraged financial entities that can transmit stress to the financial system. The extent of hedge fund involvement in cryptocurrencies are a similar blind spot for regulators and banks acting as Prime brokers to these funds, should a substantial portion of the hedge fund market move into cryptocurrency, extreme volatility and crypto could spread to other financial markets.' The lack of reporting by private funds on their cryptocurrency positions will make it difficult for regulators to determine if this market creates systemic risk concerns. Signs indicate the presence of hedge funds and cryptocurrency is growing. While the failure of Archegos didn't crash the banking system, it was enough to cause tremendous losses and highlight the failure of the Federal Reserve and its stress testing process. If the majority of hedge funds with billions and assets under management hold 10% or more of their positions in cryptocurrency, then it may produce dire risks to the financial system, such as future crises, as sharp swings in the volatile cryptocurrency markets could lead to forced liquidations of other assets."
Now before we scream "FUD FUD FUD!" I think it's important to point out that the target of this concern isn't just crypto per se. It's acknowledging that crypto is volatile, which on a short term time horizon, and it's something that is designed not to have the sort of centralized intervention of central banks, it is. The real concern, though, is the total opacity that hedge funds operate with and that's a concern that extends far beyond just crypto markets. Also, to be clear, this isn't something I'm seeing lots of, it's not like regulators yet are saying a big problem with crypto is the involvement of hedge funds. I'm pulling some different strands together and zooming out to identify something that I could see becoming a risk from a narrative perspective. I don't think though, we've fully seen the fallout of Archegos and I think all it would take is one more Archego, or an Archegos that has an even bigger effect, for there to be major scrutiny on this dimension.
There is one more piece of the same story that's worth noting: one thing that isn't speculation for the future is the fact that the SEC has concerns about crypto market manipulation. This is, it seems, the biggest reason that a Bitcoin ETF hasn't yet been approved. Given that, we may not love association with a guy like Steve Cohen, who was convicted of insider trading, slapped with a $1.8 billion fine, the largest ever find for insider trading, and barred from managing outside money for a few years. So, I've given you all the bad possibilities and the negative takes, but what do I really think about this news? Is it bullish or somehow bearish? My feeling is that it's absolutely bullish. I explained why I think that net long is the only position that any firm who stays in this industry long enough will take and why short term volatility is just short term. More than that, though, I think that the sentiment expressed by Point72 in that email, that this space is now fundamentally just too big to ignore, is the thing that's going to keep pulling more traditional investors in. Yes, there will be true believers that form along the way and yes, the folks that aren't true believers may trade against us. But ultimately, that great sucking sound you hear is Bitcoin attracting minds and capital and it is a self reinforcing force. Anyways guys, I hope you are having a great week. I appreciate you listening and until tomorrow, be safe and take care of each other, peace!