Balmoral Digital

The cavalry has arrived: institutional adoption of digital assets 

Nothing makes investors happier than their homework paying off big time and an investment catches the exhilarating updrafts of a major changes in economic activity.

Think of buying part of Apple when Steve Jobs first launched the iPhone. I remember where I was when I watched Steve Jobs present what we now would call the iPhone 1. It was apparent that the world had just changed forever. Apple’s ecosystem subsequently grew from strength to strength and became incredibly valuable for both its users as well as its investor owners.

Digital assets are as big a step forward as smart phones were in their day

Like most people I was aware, but very skeptical, of the ‘new and magical internet money’ when Bitcoin launched in 2009. That skepticism however came from my own limitations: I did not understand how we could value something if it did not produce cashflows. Without cashflows it was not a ‘financial asset’ like bonds or equities. If we could not value it then how could we invest rationally?

I have subsequently shifted my thinking and new regard digital assets like commodities. Consider how different a ton of iron ore stranded in a desert is from that same ton of iron ore ready for seaborne export. Yes a digital asset’s value lies in its demand relative to its supply, however understanding demand requires an understanding of both utility and market sizing. There are investors who seek to understand that by digital token – Balmoral does not need to.

It is worth noting there are digital assets which are in fact ‘financial assets’ which produce cashflows. A staked cryptocurrency like Ethereum could arguably be regarded as a financial asset. Smart contract loans are another. In some ways smart contracts can even be superior to traditional fiat loans because of the certainties of blockchain governance. During the first half of 2022 when various digital asset businesses failed to survive stressed conditions, we saw instances of smart contract loans getting repaid yet traditional loans were defaulted on – imagine a world where you could borrow more cheaply through digital smart contracts than via traditional lending! We are not there yet, however I can see the foundations for that displacement of traditional banking forming.

Why the positive outlook for digital asset prices from here?

Accelerating institutional adoption is a huge tailwind for digital assets globally.

Global financial institutions adopting blockchain processes is as important a change in ‘how we do things’ as regulatory authority for Apple to connect its iPhone to mobile telephone networks was.

Institutional adoption will not only amplify the incredible liquidity already in digital assets, it will add significant demand and as importantly reduce the perceived risks. These changes support late adopters to be comfortable investing in this space. On the supply side existing owners will see this increased demand and so become more reluctant sellers. Taken together institutional adoption is a strong foundation for the resumption of the digital assets’ bull market.

Who is already committed?

Recent announcements from financial institutions committing to the functionality and utility digital assets include:

  1. Westpac recently announced its intention to be a leader in digital assets. Given the earlier point about smart contract loans I can imaging the other big 4 Australian banks will not be too far behind.
  2. Blackrock, the largest asset manager in the world, announced only this month it was moving to take advantage of digital assets with the launch of a spot Bitcoin trust as well as linking to Coinbase crypto exchange.
  3. Abrdn, a global UK asset manager, recently announced it is purchasing a stake in regulated digital assets exchange Archaz.
  4. Charles Schwab, a large US broker, has launched an ETF offering exposure to digital assets.
  5. UK asset manager Schroders recently invested into digital assets manager Forteus.

When one institution moves the rest tend to follow

When financial institutions start to move on new opportunities the rest tend to follow fairly quickly. Warren Buffett termed this the ‘Institutional Imperative’. My own view is that market share gains in mature markets are difficult and very expensive, so doing high quality diligence then moving promptly on new opportunities makes sense.

Regulation is filling in the gaps a new asset class has created

Because financial institutions are key to modern society, and history offers ample experience of financial institutions failing, developed economy governments have established sophisticated prudential regulators. A prudential regulator’s job is to make it as hard as possible for financial institutions to fail, regardless of what happens in financial markets or the global economy. In Australia our prudential regulation is APRA.

One of the ways prudential regulators carry out their job is through capital requirements. If you are an Australian bank for example, and you want to invest your balance sheet into shares, you can do so only provided you have to have large amounts of capital set aside to cover expected movements in those shares whilst ensuring you can still meet all your liabilities. Alternatively if you want to invest in government bonds you only need a tiny fraction of capital set aside. Capital is finite and expensive, so the logical consequence is financial institutions figure out where theire best expected return on prudential capital is and invest accordingly.

This is really important for digital assets because until now financial institutions have not had clear guidance on how much capital the regulators required them to set aside to invest in this new asset class. Regulators around the world have been clear that digital assets are here to stay and those regulatory gaps are now going to be filled in.

Digital asset investor legal protections are also getting firmed up

In the UK an entirely new segment of the law is being drafted and discussed to deal with ‘digital objects’. Other legislators, including Australian, will also be considering updating their own legislation.

Legal developments around digital assets are welcome as it brings more certainty to builders, investors and stakeholders.

How to take advantage?

Balmoral Digital is an Australian alternate asset manager specializing in digital assets. We offer two strategies to investors:

  1. The Balmoral Digital Momentum Fund is an investment strategy which harnesses momentum driven digital markets, seeking to maintain exposure in up market conditions then reduce exposure or even go short in down market conditions. The strategy has been trialed very successfully for an extended period using Founder capital and has now been made available to Balmoral’s clients.
  2. The Balmoral Digital Assets Fund is a market neutral digital assets strategy which takes fully hedged positions in digital assets (so market risks are hedged), collecting income from its hedging program. The strategy has not yet had a negative month and over the first 7 months of 2022 increased in value over 14%.

To learn more about investing with Balmoral contact us at invest@balmoral.digital.

Regards Angus