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The barriers for state and local institutional investors entering the crypto market are come down, including a clearer regulatory framework and more industry scrutiny.
Cryptocurrency has been around for more than a decade, although it has yet to become the financial industry disrupter that tech enthusiasts were predicting. But one big signal that cryptocurrency is on its way to becoming more mainstream is that some public pension funds are investing in the industry.
At least two pension funds in the past three years—California Public Employees' Retirement System and New Jersey’s Common Pension Fund—have invested in companies that make money by mining for Bitcoin, a digital currency created and exchanged independent of banks or governments. Late this summer, Fairfax County, Virginia's employee fund and its police officers pension both invested in a fund that tracks blockchain, the technology that underpins Bitcoin. And this past fall, the Houston Firefighters’ Relief and Retirement Fund became the first public pension fund to invest directly in Bitcoin and Ethereum, another platform powered by blockchain technology.
The pensions are joining a small but growing list of institutional investors to bet on cryptocurrency, a trend that some in the investment industry say will only grow. A 2021 survey of institutional investors found that 33% of U.S. respondents have investments in cryptocurrency, up from 22% in 2019. In addition, the survey by Fidelity Digital Assets said that worldwide, more than 90% of investors interested in digital assets expect to have an allocation in their institution's or clients' portfolios within the next five years.
“More and more asset managers are realizing this is definitely for real,” said Gerry Frigon, whose firm Taylor Frigon Capital Management recently launched a cryptocurrency venture fund. “We’re not looking to buy and flip,” he added. “Our intention is to participate in the long-term, value-generating growth opportunity in the crypto world.”
Institutional Investment Barriers Coming Down
The increased interest stems from the fact that the barriers for institutional investors entering the cryptocurrency market have started to come down. For years, crypto was a relatively illiquid product and it was virtually impossible for institutional investors like pension funds, who deal in $100 million or $200 million trades, to enter the market.
Keith Brainard, research director at the National Association of State Retirement Administrators, also noted that pension fund bylaws tend to bar the funds from holding more than a certain percentage of the total value of a particular investment. That’s been a prohibitive force, given the large trades institutional investors tend to make and the relatively small size of the cryptocurrency market. “They don’t want to be the predominant investor,” Brainard said.
But the trading landscape is changing because there are more companies that offer digital asset products geared toward institutional investors. The Houston firefighters’ fund, for example, used NYDIG to facilitate its investment.
Another issue was the lack of clarity on how (or whether) cryptocurrencies could be regulated. Ajit Singh, HFRRF’s chief investment officer, recently told Institutional Investor that he’d been researching cryptocurrency as an investment for years, but that the unclear regulatory framework was the main issue holding the pension fund back.
That’s also begun to change. At least 17 states have regulated the currency and many others are considering rules. Likewise, several measures pending in Congress address regulation. What’s more, the recently passed $1 trillion infrastructure bill includes new tax reporting requirements for crypto brokers.
And recently, Securities and Exchange Commission Chairman Gary Gensler signaled that crypto exchanges should register with the SEC and that cryptocurrency itself will face increasing regulatory scrutiny.
“With these changes either in process or in effect, the cryptocurrency market will likely see an increased participation from institutional investors, who will see these freshly regulated markets as an opportunity for forward thinking growth,” said Paul Ogawa, who leads the regulatory analysis team at Sovos Compliance.
Crypto More Attractive to Smaller Funds
Brainard expects that if more pension funds start investing in the industry, it will primarily be by smaller funds, such as municipal pensions. That’s because cryptocurrency and the related technology can represent a higher share of their total assets without the risk that the funds will become an outsized investor. Put another way, a $100 million investment in crypto is more meaningful for a $1 billion fund than it is for a $100 billion pension fund.
That’s one of the reasons that CalPERs divested from hedge funds a few years ago, Brainard explained. The pension fund wasn’t willing to invest more than 4% of its more than $400 billion in assets in the volatile investment class. But what it did have invested wasn’t having a material impact on the fund’s overall investment returns.
By that measure, none of the pension funds included in this story are meaningfully invested as cryptocurrency and the related technology make up less than 1% of their total assets.
That said, pensions are putting money into a multitude of investments that would have been controversial just a few decades ago.
“It was not so long ago that it was considered rather exotic to be getting into private equity or real estate,” Brainard said. But as those asset classes have matured, institutional investors seem more comfortable with them, he added. “It is entirely possible that we'll be having the same conversation about the crypto market in 20 to 30 years.”