PMC Weekly Review – September 28, 2018

A Macro View: The Institutionalization of Bitcoin

When most investors are asked what they know about Bitcoin, their typical response includes references to money laundering, magical internet money, or a form of currency that is used by criminals. Although all of these may have been largely correct at one point in Bitcoin’s history, today’s environment has changed significantly. And going forward, Bitcoin may serve a much broader purpose and be recognized as a legitimate asset class for institutional and retail investors alike.

Most investors’ knowledge of Bitcoin is limited to mainstream media news articles covering crypto exchange hacks or wildly optimistic price predictions. Given the revolutionary technology that Bitcoin brought into existence, it is easy to understand why investors are excited and have such varying opinions.

To begin to comprehend Bitcoin, we need to understand the fundamental technology upon which it is built. In its simplest terms, Bitcoin is an internet protocol that governs how value is communicated over a communications channel. Before jumping into this new internet protocol, let’s briefly review another one that we have more experience with: email. Email is based on Simple Mail Transfer Protocol (SMTP), a widely used internet protocol that governs how email messages are sent and received, ensuring that our messages are sent to the correct destination and observable by only the desired recipient. Much like SMTP, Bitcoin is a protocol that allows us to interact with others around the world by transferring value, in a matter of minutes, to anyone who has a Bitcoin wallet! This is accomplished by network participants (Bitcoin miners) maintaining an up-to-date ledger of every historical and ongoing transition. This ledger is maintained on thousands of computers throughout the world, and to date, has never been hacked or compromised. This highly secure network creates a building block upon which participants can store value, send, and receive transactions. Just as SMTP and other internet protocols have built a foundation for the countless numbers of applications that we use today, Bitcoin is new protocol that enables a new way for people to interact, and a foundation for which new types of application can be built. The network is still in its infancy: How it will be adopted, used, and built upon remains to be seen.

Despite Bitcoin’s obscure past, it continues to grow in acceptance, as governments begin to introduce new regulations and institutions pivot to include it in their business model. One such example that may become particularly important in the acceptance and use of Bitcoin is the upcoming launch of Intercontinental Exchange’s (ICE) Bitcoin trading platform, Bakkt. ICE owns the New York Stock Exchange (and other global exchanges), but Bakkt will be its first federally regulated Bitcoin exchange, and its expected launch in November will make Bitcoin accessible to all institutional investors, most of whom have remained on the sidelines.

Regardless of an investor’s opinion of Bitcoin, history has shown that it can potentially provide diversification to a larger portfolio of traditional assets, as it is largely uncorrelated with these assets. Studies show that adding a 1% to 5% allocation of Bitcoin to a portfolio can help reduce its overall volatility and potentially improve its risk-adjusted return. Only time will tell how quickly institutional money managers will allocate to this new asset class once Bakkt launches in November, but if Bitcoin’s history is any sign of its future, it is likely to be an exciting ride!

Scott, Keller     
Portfolio Manager

Download the full PDF

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this weekly review is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results.

Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet|PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) securities are subject to interest rate risk, which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates. Exchange Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Investing in commodities can be volatile and can suffer from periods of prolonged decline in value and may not be suitable for all investors. Index Performance is presented for illustrative purposes only and does not represent the performance of any specific investment product or portfolio. An investment cannot be made directly into an index.

Alternative Investments may have complex terms and features that are not easily understood and are not suitable for all investors. You should conduct your own due diligence to ensure you understand the features of the product before investing. Alternative investment strategies may employ a variety of hedging techniques and non-traditional instruments such as inverse and leveraged products. Certain hedging techniques include matched combinations that neutralize or offset individual risks such as merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. Leveraged products are those that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse products utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. As with all investments, there is no assurance that any investment strategies will achieve their objectives or protect against losses.

Neither Envestnet, Envestnet|PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.

© 2018 Envestnet. All rights reserved.