First think about what value bitcoin provides as a store of value. Given that, it makes sense who are the early investors in bitcoin.
While this is an over-simplification, there are three classes of investors today in bitcoin.
(a) Early tech adopters for obvious reasons: They see a platform for the future even if they don’t always understand all the financial implications.
(b) Gold bugs and other anti-Fed / anti-inflation types: They like the limited supply of bitcoin and view this as a new ‘gold’.
(c) Family offices and individuals within hedge funds: These are the first semi-institutional investors in bitcoin. Family offices do not have strict external guidelines for their investments and don’t have to worry as much about documentation and compliance issues. Individuals in hedge funds that cannot yet invest institutionally have being doing so personally.
What is the thought process here? If you put 1-3% of assets in bitcoin, the volatility of bitcoin has limited impact on your overall portfolio (that is probably moving 1-2% daily anyway). In terms of ultimate outcomes, the downside case is that it goes to close to $0. The upside case is probably 10x to 20x from the current prices. The probability of each case is an unknown. A lot of people will take that bet with 1% of their assets. If it does not work, a 1% loss does not change anyone’s life in any way. If it does go up 10x, then you get to feel very smart, a visionary and so on.
The pure institutional investors are still, for the most part, on the sidelines. This is understandable. Bitcoin just entered the general business consciousness in October 2013, less than 3 months ago. It will take time for both financial institutions,their support industries (legal, accounting) and regulators to understand bitcoin and figure out the liquidity, regulatory and compliance issues.
- How do you prove to your auditors that your fund does in fact control $10M worth of bitcoins? It is a solveable question, but the infrastructure is not yet in place
- Can you buy and sell $5M of bitcoins (a trivial amount of money) without moving the market. Today the answer is ‘No.’
- Are you willing to take the counterparty risk of the current exchanges?
I don't think the institutional investors will stay on the sidelines forever. The financial services industry is relentless attracted to fee-generating opportunities and will find their way to bitcoin too.