Podcast Summary: E126 - How Much Bitcoin Should Institutional Investors Hold? with Bitwise’s CIO

Podcast Information

• Title: How I Invest with David Weisburd
• Host: David Weisburd
• Guest: [Name not provided], Chief Investment Officer of Bitwise
• Episode: E126: How much Bitcoin should Institutional Investors hold?
• Release Date: January 3, 2025

Introduction

In Episode 126 of "How I Invest with David Weisburd," host David Weisburd engages in a comprehensive discussion with the Chief Investment Officer (CIO) of Bitwise. The conversation delves into the optimal allocation of Bitcoin within institutional investment portfolios, the evolving role of cryptocurrencies in global finance, and the potential impact of regulatory changes under the Trump administration.

Bitcoin Allocation in Institutional Portfolios

Starting Point: 1-2% Allocation

The CIO emphasizes that institutional investors should “start with at least 2%” allocation to Bitcoin. This recommendation is grounded in benchmarking against global asset distributions, where Bitcoin represents a significant $2 trillion asset compared to $100 trillion in global equities. Allocating below 1-2% effectively places an investor “short Bitcoin versus your benchmark” (01:04).

Potential Upside: Up to 5% Allocation

Beyond the initial allocation, the CIO suggests that increasing Bitcoin to “up to about 5%” can enhance the portfolio’s Sharpe and Sortino ratios, thereby improving risk-adjusted returns. This is likened to “adding spice to food”—a modest addition enhances flavor without overwhelming the palate (01:32, 03:39).

Behavioral Risk and Volatility Management

The discussion underscores that allocating more than 5% to Bitcoin introduces significant behavioral risk. Bitcoin’s historical volatility, including multiple “50% plus pullbacks”, can make it the primary driver of a portfolio’s maximum drawdown, potentially triggering panic selling during downturns (06:06). Maintaining Bitcoin within a 5% cap is advised to balance its influence and mitigate adverse emotional reactions during market fluctuations.

Bitcoin as a Hedge: Short-Term vs. Long-Term

Short-Term Correlation with Equities

In the short term, Bitcoin exhibits a correlation with equities, pulling back alongside the market during downturns. However, the CIO notes that Bitcoin “recovers faster than equities” and often “outperforms equities as it rebounds” (05:10). This behavior makes Bitcoin a favorable hedge for long-term investments spanning years rather than weeks or days.

Inflation Hedge Debate

While Bitcoin has been touted as an inflation or stock hedge, its effectiveness depends on the investment horizon. The CIO clarifies that its hedging capabilities are more pronounced over extended periods, aligning with long-term investment strategies (05:10).

Evaluating Bitcoin Investments: Case of MicroStrategy

Michael Saylor’s Strategy

The conversation shifts to Michael Saylor’s approach with MicroStrategy, which involves leveraging zero-interest bonds to purchase Bitcoin. The CIO describes this as an “incredible trade” that has made MicroStrategy’s stock one of the “best performing” globally (08:27).

Risks of Premium Trading

However, the CIO cautions about the risks associated with MicroStrategy trading at a premium to its Bitcoin holdings. If the premium fluctuates significantly, investors could incur losses even if Bitcoin’s price remains stagnant. He advises understanding the “premium variation element” before investing in such stocks (08:27).

Diversifying Beyond Bitcoin: Embracing Other Cryptocurrencies

Ethereum and Programmable Blockchains

The CIO advocates for institutional investors to consider other cryptocurrencies like Ethereum, which he describes as a “technology investment” akin to mainstream tech stocks. Ethereum’s role in developing a new “Internet for money and finance and social networks” positions it as a valuable addition to diversified crypto portfolios (10:19).

Basket Approach vs. Picking Winners

Given the difficulty in predicting which cryptocurrencies will succeed, the CIO recommends a basket approach to investing in multiple leading crypto assets rather than trying to pick individual winners. This strategy mitigates the risk associated with the unpredictable nature of early-stage technologies (11:23, 12:56).

Regulatory Landscape and Institutional Adoption

Impact of the Trump Administration

David Weisburd probes the potential actions of the Trump administration regarding Bitcoin adoption. The CIO responds by highlighting that the U.S. government already holds approximately 200,000 Bitcoin from seizures, with a “90%” likelihood of retaining rather than selling them (20:07). He speculates a 25% chance that the government might begin purchasing Bitcoin, which could drastically influence its market price (20:07).

Regulatory Clarity and Market Participation

The CIO asserts that a pro-crypto stance from the administration and Congress would alleviate regulatory concerns, the primary barrier for institutional investors. This clarity is expected to “unleash thousands of high quality entrepreneurs” and attract significant institutional capital into the crypto market, heralding a “golden age of crypto applications” (21:51, 23:47).

Consumer and Career Risk Considerations

Addressing the challenges institutions face, the CIO notes that managing large funds involves mitigating career risks associated with volatile and uncertain assets like cryptocurrencies. Regulatory clarity could reduce these risks, encouraging more institutional investors to allocate to crypto (25:03).

Valuation of Bitcoin

Supply and Demand Dynamics

The CIO emphasizes that Bitcoin’s valuation hinges on supply and demand, given its capped supply of 21 million Bitcoins. He posits that if Bitcoin captures an equivalent market share to gold’s $18 trillion valuation, each Bitcoin could be valued at approximately $1 million (27:30).

Net Present Value Approach

By assessing Bitcoin’s current price against its potential market penetration and applying a net present value framework, investors can estimate Bitcoin’s future value. The CIO anticipates that Bitcoin is still in its “early stage” and has significant room for growth, particularly if it achieves parity with gold or expands into international settlements (27:30).

Bitwise Investments: Bridging Investors and Crypto Opportunities

About Bitwise

As the CIO of Bitwise, the guest explains that Bitwise is a specialist crypto asset manager facilitating high-quality exposure to crypto investment opportunities. Since 2017, Bitwise has pioneered the first crypto index fund, designed to offer broad-based exposure akin to the S&P 500 for cryptocurrencies.

Investment Strategies and Resilience

Bitwise has successfully navigated various market cycles, avoiding major collapses such as FTX and Luna, while maintaining exposure to robust assets like Bitcoin and Ethereum. The firm continues to innovate with Bitcoin ETFs, Ethereum ETFs, and other alpha strategies, aiming to serve as a bridge between investors and the crypto market for the long term (29:13).

Staying Informed

For those interested in following Bitwise’s insights, the CIO recommends following him on Twitter (@togan) and subscribing to the CIO Memo on the Bitwise Investments website. The memo provides a succinct, weekly analysis of market trends and developments (30:20).

Conclusion

Episode 126 of "How I Invest with David Weisburd" offers a nuanced exploration of Bitcoin’s role in institutional portfolios, balanced by strategic allocation and an understanding of behavioral risks. The conversation underscores the transformative potential of cryptocurrencies, particularly with impending regulatory clarity and mainstream institutional adoption. Bitwise, under its CIO’s leadership, positions itself as a key facilitator for institutional investors navigating the evolving crypto landscape.

Notable Quotes

• On Behavioral Risk:
  “The biggest risk in crypto is behavioral risk… if you put too much of it in your portfolio and we get another one of those pullbacks and you sell at the bottom, then you've done real harm to your portfolio.” (00:00)

• On Starting Allocation:
  “Bitcoin has emerged as a multitrillion dollar asset… if you're below 1 or 2%, I'd argue that you're effectively short.” (01:29)

• On Portfolio Construction:
  “You get higher returns without significantly increasing your risk. And that's a beautiful thing when building a portfolio.” (03:54)

• On MicroStrategy’s Strategy:
  “He's found a way to raise money in the public markets through bonds that pay 0% interest and then to buy an asset that's appreciating historically at 100% a year.” (08:27)

• On Regulatory Impact:
  “Regulatory clarity in the US on crypto… that's a sea change.” (21:51)

• On Bitcoin Valuation:
  “If Bitcoin indeed rises to be as important in the world as gold, every bitcoin will be worth roughly a million dollars.” (27:30)

This summary encapsulates the critical themes and insights discussed in the episode, providing a comprehensive overview for those unable to listen to the full podcast.