Family offices have traditionally been risk averse, but some have been tentatively dipping their toes into the crypto space. We look at what is attracting them.
It’s not often that a new asset class captures the imagination of investors as cryptocurrency has. And although many institutional investors such as family offices are still undecided whether crypto is an investable asset class, some are now dipping their toes in the water.
This may appear surprising: a family office’s primary objective is to preserve wealth for future generations. As anyone who bought at the top of one of its bull markets knows, crypto can be a great wealth destroyer. Generally, family offices follow safer opportunities. And their performance benchmarks, which are generally returns of 7% to 10%, are a far cry from crypto’s risk profile.
Yet in a world of continuing low interest rates, with good yields hard to find, family offices are having to look at alternative asset classes, including crypto. A July 2021 survey by Goldman Sachs found that 15% of the 150 family offices that responded held an investment in digital assets, with 45% interested.
However, although crypto returns can be higher, so are the risks and volatility. So family offices will keep well within their alternative investment allocations – that is, in low single digits.
Should you invest in bitcoin or blockchain disruption?
It is important to distinguish between buying crypto in the spot markets – and investments that seek exposure to the disruptive potential of its underlying blockchain technology.
The crypto complex presents much greater opportunities than simply making an allocation to bitcoin, the premier crypto asset.
A less risky approach may be emerging around themes such as tokenisation of existing asset classes, decentralised finance and new metaverse technology. Assets like non-fungible tokens (NFTs) are already unlocking value by enabling verifiable ownership of unique digital (and non-digital) goods.
However, even though the market for NFTs attracted cash estimated at $22bn in 2021, price discovery and due diligence in sub-sectors such as art NFTs remain problematic.
The attractions of crypto should also be seen in context of the significant shift from traditionally traded investments to private equity and fund investment.
Many of these funds invest in unproven tech or tech start-ups, attracting speculative fund flows. Not surprisingly, family offices will be seeking fivefold returns or more from their crypto allocation.
In some respects family offices are better positioned than other crypto investors because they can take a longer-term view. For instance, a typical family office investment committee will appreciate that although bitcoin is highly volatile, its risk-adjusted returns are much improved when calculated over longer timeframes.
Also, a relatively small amount can go a long way if fivefold returns can be realised, putting less capital at risk.
Cryptocurrency security and ESG concerns remain a problem
Family offices will also retain significant concerns around corporate governance and the security of assets on a blockchain, given the hundreds of millions lost to hackers every year.
Many blockchain investment managers are known only by a small circle in the crypto world. The crypto ecosystem has come a long way in two years, but much work is still to be done regarding business practice and governance.
Another concern is the amount of computing power needed to secure the bitcoin network and mine new coins. Bitcoin’s “proof-of work” protocol has been criticised as both wasteful and inefficient, because of the low throughput of transactions per second (seven) compared with payment networks such as Visa (approximately 2,000 per second).
That’s not a good look at a time when environmental, social and governance (ESG) considerations at the front of investors’ minds. However, many crypto networks don’t use the same wasteful proof-of-work number-crunching as bitcoin.
Cryptocurrency regulation is on the way
Another risk is lack of regulation. However, regulators in the major economies are moving to implement many proposals from the G20’s Financial Action Task Force, around anti-money laundering, know-your-customer processes and anti-terrorist financing.
These are likely to include “travel rules” requiring “virtual asset service providers” to record identifying details of senders and receivers of digital assets. Areas of interest to banks, such as stablecoins and custody, will also be subject to greater oversight.
All of this could make the sector more attractive to family offices.
Crypto presents unique challenges. As due diligence and reporting requirements grow ever more complex, enlisting third-party support will prove invaluable.
At Intertrust Group, our ongoing investment in tech-driven compliance, data warehousing in secure environments for financial investment and general investment in data knowledge will continue to expand, providing essential backup for family offices looking at crypto.