If and when the institutional herd comes to crypto, how will we hear its thundering footsteps?
Here at BlockFi, we are moving forward with our goal of bringing the best of traditional financial products to cryptocurrency investors, which puts us in the necessary position of driving the institutionalization (hah) of the industry. As our clients become more and more comfortable with denominating their wealth in cryptocurrency terms, we see certain institutions get more and more comfortable doing business in crypto natively.
So, for those crypto-curious that do not see institutional activity in real time like we do here at BlockFi - how much noise is the herd making already, and when will it finally complete its great migration out of traditional assets and into digital ones? Without disclosing any confidential client information, using public filings can provide a great deal of insight into who is already here, and where the next wave will land.
To start from the top, there are approximately 40,000 registered investment advisers in the U.S. 10,500 of these manage “private funds”, roughly speaking - hedge funds, private equity funds, and venture funds. The total number of private funds managed by these advisers is approximately 60,000 - a truly staggering number that also serves as a testament to the bandwidth of the U.S. legal filing system and the business models of service providers in the space. In general, each private fund will have at least one service provider for: (i) prime brokerage (a catch-all term for a provider of financing and trading/buying/selling/shorting), (ii) custody, (iii) administration, (iv) marketing, and (v) audit. Additionally, each service provider relationship will require separate legal agreements, negotiations, reporting, and of course, payment.
Running a private fund - from a legal and operational perspective alone - is a daunting undertaking already, and we have not even discussed what happens when any given portfolio manager decides that it is time to add cryptocurrency exposure to the fund. In short, what happens is that most of the existing service providers are not currently able to provide service against a single satoshi of exposure. This has created the opportunity for a whole new set of service providers to compete for business, and for a wise cadre of existing service providers, such as Fidelity, to future-proof their platforms. In simpler terms: retail wants lambos, institutions just want an administrator like MG Stover and Triple Leo to strike a monthly NAV for their investors.
To give some sense of scale of the various service provider ecosystems, the most serviced fund in the world is D.E. Shaw Oculus Portfolios LLC, with 51 prime brokerage relationships spanning from J. Aron & Co (a long-time cog of Goldman Sachs) to Wells Fargo Securities. Second place goes to Millennium Partners LP, with a more svelte 33 prime broker legal entities. Rest assured, there are no cryptocurrency funds that have 51 separate legal entities chasing them for prime brokerage business (“wallet share”) - yet.
There are barely more than 51 funds with crypto exposure total. There are exactly 201 private funds with crypto exposure. The virus is definitely spreading, but so far it has only infected 1.3% of the total private fund population. Just like there are bitcoin OGs - people who have been in the space for a long time, bought at really low prices, and/or made a lot of money (or any combination thereof, but usually with an evangelical bent) - there will one day soon be institutional bitcoin OGs - institutions for whom the same criteria will apply. These 201 funds are among that trailblazing cohort.
The 201 institutions can be broken down into three distinct segments:
Traditional hedge funds that invest in and/or trade around crypto
Crypto-only funds that mostly raised money at the end of 2017 to invest directly into cryptocurrencies and Initial Coin Offerings (ICOs)
Venture funds that invest in crypto companies (like BlockFi), with a portion of assets sometimes invested directly into cryptocurrencies
In the traditional fund industry, there are always “billion dollar club” rankings of all asset managers in a certain segment, focusing on those with assets over $1bn - so that wall street salespeople know who to call first. Although generally we are not fans of such ossified classifications, BlockFi’s inaugural “billion dollar club” list includes 18 traditional hedge fund managers with assets of over $1bn who are already in crypto. Their total AUM is $286b. Assuming that only 1% of this is invested in crypto, that is ~2.5bn of traditional hedge fund money (i.e., hedge funds that don’t have the word “blockchain” in their name) currently working in crypto. To add to this, crypto-fund only AUM (i.e., funds that do have “blockchain” in their name, but excluding venture funds) is roughly an additional ~$2.5bn. So in total, there is likely at least $3 - 5bn of traditional fund money already in crypto, before including venture funds, market-makers, family offices, ultra high net worth individuals, sovereign wealth funds, sovereigns, overseas funds, etc.
Part of the methodology for determining this institutional OG crypto participation was scraping Form ADV brochures for mentions of crypto-related terms such as “bitcoin”, “blockchain”, “crypto”, “digital asset”, “ethereum”, and “virtual currency”. This resulted in fascinating data which we partially summarize here, along with some fun facts. We will let the reader determine which cryptocurrency institution has the best legal name: is it (i) Moonbase 1C LP, (ii) Space Whale Capital LP, or (iii) Odin88 Crypto Master Fund?
Outside of the hedge fund and crypto fund institutions described above, other types of market participants include:
RIA / Wealth Management: Traditional RIAs and wealth management platforms that invest high-net-worth and ultra-high-net-worth client assets into crypto. There appears to be a growing niche of RIAs that focus their marketing on being crypto-friendly and crypto-forward. The largest wealth management platform that discloses bitcoin investment in any capacity is Morgan Stanley (under the Alternative Investment Partners brand).
“Maybe One Day”: Managers that disclose they are contemplating investing in cryptocurrencies in the future - the largest is Squarepoint Capital, with ~$15bn of AUM.
“WE WILL NEVER”: Managers that took it upon themselves to pay their legal counsel to add a clause to the Form ADV brochure that the manager will never invest client assets into digital assets - for whatever reason.
Employee Disclosure Only: Managers that add a clause to their Form ADV that typically requires staff to pre-clear cryptocurrency trades, or, often, prohibits them altogether. Interestingly, 11 of the disclosures are for executives who are involved in crypto as a “side hustle”, which is allowed in all cases.
Singularity via Blockchain: A large number of managers disclose “blockchain” as a risk to their investments because it is a disruptive technology alongside artificial intelligence, CRISPR, augmented reality, quantum computing, internet-of-things, etc. One interesting anecdote is how blockchain is slowly aligning itself with ESG portfolios under the banner of financial inclusion for underserved populations and nations.
Going back to hedge funds and crypto funds - the institution that mentions cryptocurrency terms the most in an SEC disclosure is Galaxy Digital, with 751 mentions. Some surprising names in the top rank of SEC disclosure mentions include: DE Shaw, HBK, hj, Autonomy, AHL, Stevens, Zweig-Dimenna, Corbin, and Q Investments. These are a portion of the hedge funds that disclose crypto activity in SEC filings. We will let this information speak for itself.
Top 30 Institutions Ranked by Mentions of Cryptocurrency in Form ADV
Service Provider Circle of Life
For all of these traditional hedge funds and crypto funds to run a compliant and secure institutional crypto trading operation, service providers are required. Major service providers are a required disclosure under Form ADV, which enables us to map out the landscape for most-used service providers in each category.
The service provider circle of life starts with a “prime broker”. Prime brokers are generally a catch-all term for financing, trading (including short sales), research, capital & corporate introductions. The only crypto service provider currently listed as prime brokers are Tagomi, disclosed by Israeli-based Lionschain Capital, and FalconX, disclosed by Adamant Capital.
Note, BlockFi offers light “crypto prime” services - as an aggregator of hodlers’ bitcoin and ether, BlockFi is able to provide BTC/ETH/USD denominated financing to vetted counterparties. In our view, this is one of the few areas of prime brokerage that cannot be commoditized, and is worth forming deep relationships in.
After financing and trading is executed through a prime broker (or BlockFi), the crypto proceeds usually end up at a custodian, which could be an exchange. Custody has been the most often quoted stumbling block for institutional crypto adoption. There are currently 9 custodians that custody institutional fund crypto. The most popular is Coinbase, with 27 funds; Fidelity is tied for the least popular, with 1 fund. As Fidelity’s product has not actually launched yet, we are sure that will soon change - and we will let you know as it happens.
The mirror-end of institutional crypto custody is fiat custody, which really means banking services. Money center banks do not typically provide services for institutional crypto - the largest traditional banking provider in the space is Silicon Valley Bank. Meanwhile, Silvergate and Signature have enabled banking for institutional crypto in a fresh and innovative way, to the extent that Silvergate is partly using its Silvergate Exchange Network to power itself to an IPO. BlockFi is itself a happy client of SVB, Silvergate, and Signature.
Administrators play the important role of valuing an institution’s assets on an ongoing basis and providing reporting with that value (as well as the comfort of having a 3rd party involved) to investors. Administrators also help direct investor subscriptions and redemptions into and out of funds. One of the largest sources of institutional fraud has historically been funds that do not use a 3rd party administrator and/or custodian. Traditional fund administrators are BNY Mellon, State Street, and CITCO; however, these do not offer crypto fund services today. Instead, a new trio of admins, the largest of which is MG Stover, has taken over this space. There also appears to be some overlap between crypto services and service providers in the alternative credit space, such as Theorem Fund Services.
The final component of the institutional lifecycle is the audit, which happens once a year. Audit services are provided by a range of regional and national auditors; these providers generally have more flexibility to accommodate crypto. The two most prominent ones in the crypto space are Richey May and Berkower.
Public filing exploration is a fun and insightful way of demystifying the crypto market, but all results should ultimately be taken with a grain of salt. These filings are informative, and in a way make certain institutional activity as transparent as the blockchain. However, the investment universe is very large, with trillions of assets, and any disclosure made by an investment manager is not necessarily proof of any current or past activity. To give some sense of scope - there are 23 different investment managers managing $2.8bn in assets that find the term and concept of “Elliott Wave Theory” so important to their investing process that they mention it as part of required SEC disclosure.
Nonetheless, it is difficult to conclude anything other than that there is already a large, healthy, and growing ecosystem of U.S. institutions that are in crypto, and they happily disclose this fact, as well the service providers they use to enable crypto activity, to their investors and the SEC. We see this on the ground at BlockFi every day, with growing interest for our institutional crypto and fiat financing products. We work hard to bridge the institutional and retail worlds of crypto, and we are sure that both sides will see direct economic benefits through our products as well as the somewhat more indirect, but just as important, benefit of bitcoin price appreciation.
As the space continues to grow, BlockFi will provide updates on new entrants that make public filings. There is a separate cohort of broker-dealers and market-makers that are not required to file Form ADV reports but rather FOCUS reports. The disclosures under FOCUS reports are more subjective, with just four U.S. broker-dealers currently choosing to disclose crypto activity, out of several thousand filers.
The next set of major filings will start dropping in May 2020, just in time for the bitcoin halving. Stay tuned.
For a spreadsheet copy of the data underlying this blog post, please contact us:
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– The BlockFi Team
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