Key Takeaways

• Fundamentally, crypto is a very different type of asset and technology from the rest of the traditional finance world and traditional asset classes.
• BlackRock views bitcoin as an emerging global monetary alternative—a global, scarce, nonsovereign, decentralized asset that’s not associated with any one country or its fortunes.
• Bitcoin is the largest and most significant cryptocurrency in the space, representing roughly 70% of its market cap.
• Bitcoin is a unique portfolio diversifier in many ways.
• A lot of the bad actors and bad episodes in crypto have been driven by the absence of regulation.
• Institutional investors are still trying to wrap their heads around crypto’s portfolio behavior.

Stephen Margaria: Hi, I’m Stephen Margaria, a manager research analyst covering multi-asset and alternative strategies for Morningstar Research Services. Investors have looked on in awe at the incredible gains of cryptocurrencies over time, while also observing their gut-wrenching drops and volatility along the way.

Last year, the SEC approved the launch of ETFs tracking the spot price of popular cryptocurrencies bitcoin and ether. So, instead of opening a digital wallet to invest in those cryptocurrencies, investors can now invest through ETFs right in their brokerage account with their other investments. Now that those cryptocurrencies are more accessible than ever, many investors are thinking about incorporating them into their portfolios.

I’m moderating a panel at the Morningstar Investment Conference, where I’ll be joined by three experts to dive deeper into integrating a cryptocurrency into investment portfolios. One of those experts is here with me today. Robert Mitchnick is head of digital assets at BlackRock.

Robert, thank you for being here.

Robert Mitchnick: Yes, thank you so much for having me.

Why BlackRock Sees Bitcoin as a Global Money Alternative

Margaria: All right, so to level-set, what separates crypto from other asset classes, and why should investors care about it?

Mitchnick: Well, fundamentally, this is a very different type of asset and technology than what we see in the rest of the existing sort of traditional finance world and traditional asset classes. I think it’s actually helpful to think about this crypto space as two different components. You have bitcoin, and then you kind of have everything else. Though the technology underpinning those two sub-buckets is the same, the use case and the investment thesis have become quite different over time and are likely to continue to diverge.

When you think about bitcoin, we really at BlackRock view that as this emerging global monetary alternative, this global, scarce, nonsovereign, decentralized asset that’s not associated with any one country or its fortunes. That’s similar, of course, in a lot of ways to how people have been drawn to gold over the years, and so there’s a certain way that you would expect that to behave from an investment perspective.

Then you think about the rest of crypto, which is really more focused on a broader and different range of technology applications of blockchain technology, ether and ethereum being the largest one of those, but there are many others, of course. So there for investors, that’s really a bet around innovation and adoption happening around blockchains.

Why Bitcoin Stands Apart From Other Cryptocurrencies

Margaria: I think it’s important to kind of make clear that when we talk about allocating to crypto, we’re really talking about allocating to established cryptocurrencies like bitcoin. What distinguishes bitcoin from meme coins, say, like dogecoin, and do you think there are any other cryptocurrencies with investment merit?

Mitchnick: Meme coins don’t even pretend to have any value or utility, right? They mostly are based around jokes, or funny news, or a cultural phenomenon. Everyone in them knows that they will eventually go toward zero, but there’s a speculative ride that traders in those assets are on. We don’t really spend a lot of time at all around meme coins of BlackRock. We don’t see really any of our clients taking an interest in those.

When we think about other assets, and bitcoin, of course, is the largest and most significant in the space—it represents roughly 70% of the market cap of the whole space, even though there’s tens of thousands of other assets that have come after it, it’s still close to 70%—and, there, it’s a much more complex picture that investors are digesting around how do we think about this in a portfolio? How do we think about volatility assumptions, correlation assumptions, expected return projections? Obviously, the historical returns have been astronomical. Those certainly won’t be repeated. It would be almost impossible for those to be repeated when we’re talking about over 100% a year annualized over the last 15 years on average.

Then, thinking beyond bitcoin, we, as you noted, did do an exchange-traded product around ether, which has done pretty well in its own right, although it’s a fraction of what is in our bitcoin product today. We think ether, as the largest in that second bucket within crypto of these technology innovation platforms built around blockchain and exploring this flexible array of blockchain use cases, that ether, which also is a multiple the size of its next largest competitor by market cap, did merit its own product. To go beyond that, we’ll continue to look at it on a case-by-case basis, driven by our conviction in the investability of the asset as well as the level of interest and demand that we see from our clients.

How Bitcoin Can Be a Unique Portfolio Diversifier

Margaria: What primary role does cryptocurrency serve in a portfolio? Is it a reliable tool for diversification, or is it more of an alpha play?

Mitchnick: We’ve seen it used in different ways by different investors. When we think about bitcoin, which is where the most energy has gone into in terms of how to think about it from a portfolio-impact perspective, we believe that it is actually a unique diversifier in many ways, because even though bitcoin is clearly a risky asset on a stand-alone basis—it’s volatile, it’s relatively new technology—the risks and return drivers for bitcoin are vastly different from those of traditional asset classes. In fact, in certain scenarios, particularly when you think about left-tail potential scenarios for traditional finance assets in terms of debt spirals, money printing, inflation, currency debasement, geopolitical tumult, that actually you could see that being beneficial to an asset like bitcoin, which is not tied to any one country or economic, political, monetary system, etc.

So, very different risk and return properties, even though it, in its own right, is volatile as an asset. That’s the nature of it as a unique diversifier and a potential hedge within a portfolio. But we’re talking about modest allocations here. We would never advocate for it for most investors at a large concentrated position size because then its stand-alone volatility actually can have a really significant impact. But at small allocations, that volatility gets mostly diversified away because it’s idiosyncratic. What you’re left with is this unique source, yes, of a little bit of differentiated potential return, but also some diversification and a potential hedge.

Margaria: It sounds like it could have different utility for different types of investors.

Mitchnick: You could say that, although I think that increasingly what we’re seeing from our client base is that narrative and that use case that I described. No question, you go out to retail markets where they’re trading this, oftentimes with leverage on a short-term basis, they’re not thinking of it in a diversified, rigorous financial portfolio way. They’re thinking of it as more of a short-term speculation asset. Now, the mix of investors in this has shifted over time from that type of trader to a more fundamental, more institutional buy-and-hold type model, but certainly there’s still plenty in that first bucket.

Does a Lack of Regulation and Oversight of Crypto Pose a Risk for Investors?

Margaria: You can’t talk about crypto without mentioning regulation. So does the lack of regulation and oversight pose a risk to investors? And how do you foresee the regulation changing moving forward?

Mitchnick: Certainly, it has produced risks historically. If you think about the episodes that have happened in this space, a lot of the bad actors in crypto and the bad episodes have been driven by the absence of regulation. You could say, “Well, individuals should have just gone with the regulated entities.” But the problem has been up till now there was no concept of being a regulated, for example, crypto exchange in the US.

What’s interesting is if you look at, for example, the FTX fiasco, the only place in FTX’s empire where there was no fraud was in the Japanese subsidiary, which was the only part of the whole corporate structure that was regulated because Japan actually had a regulatory regime. So everywhere else, fraud was running rampant, but in Japan, it wasn’t. The entire asset base was one-to-one backed, exactly as it should have been, and every customer in Japan did just fine.

I think that is a pretty interesting case study and a testament to the importance of having a regulatory framework here. We have it in Europe now. It seems like we’re very close to having it in the US, and I think a lot of people are rightly excited and reassured by that.

Why Institutional Investors Are Slower to Adopt Crypto

Margaria: You mentioned before about this greater adoption from more institutional investors and this excitement about more regulation. Do you see regulation as the largest barrier to broader crypto adoption, or do you think other factors present greater hurdles?

Mitchnick: We’ll see, because I think, as I mentioned, the regulatory barrier is soon going to fall down in terms of having a process and a line of sight now to getting legislation done in the US that would establish a regulatory framework around this asset class.

I think for a lot of institutions, though, maybe an even bigger question is wrapping their heads around the portfolio behavior. I think what causes confusion there is there’s kind of two layers to—let’s focus on bitcoin for a second because that’s certainly where most of the institutional interest is—there’s two layers to the bitcoin market, where you have this first layer, which is primarily retail, tends to be more short-term-focused, trading heavy, speculative, often trades with leverage, and that layer often will treat bitcoin like it’s a tech stock in Nasdaq and trades it up and down accordingly. Now, that doesn’t make a ton of sense based on fundamentals as we talked about earlier, but that’s how that segment will view it.

Now the bottom layer, which is actually much larger in the case of bitcoin, even though it trades less, is more institutional, a lot of ultra-high-net-worth financial advisors, much more buy-and-hold and fundamentally focused. When bad or chaotic things happen in the world or the real economy, a lot of times that first layer just panics and sells, but that bottom layer sees that as a moment where bitcoin’s value has increased and its fundamentals have become more favorable, and they start to accumulate. So, you see this pattern where you have a short-term dip and then, by even a couple of months out, bitcoin’s actually higher than it was before whatever the disruptive event was that happened.

But for institutional investors who are new to the space, they’re trying to wrap their heads around that. How could you have an asset that behaves like this but also like that? They seem to be contradictory with each other. And so there’s a big education and research process to sort through that.

Margaria: It’s new and emerging, and there’s definitely going to have to be that education. I do want to ask more about current events. The Trump family is increasingly entangled in cryptocurrencies with World Liberty Financial and now American Bitcoin. For investors, what are the implications of that, if any?

Mitchnick: I don’t really know, to be honest. I think that’s something that we haven’t been particularly focused on.

Margaria: Got it. Well, Robert, thank you so much for sharing your insights. It was great to have you here today.

Mitchnick: Thank you, Stephen. Appreciate it.

Margaria: All right. I’m Stephen Margaria with Morningstar Research Services. If you want to hear more about this and other salient topics, please join us on June 25 and 26 in Chicago at the Morningstar Investment Conference. We’d love to see you there. Thanks for watching.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.