Just One Thing Stands Between Bitcoin and a Pool of $41.4 Trillion

For the past couple of years, cryptocurrency advocates have anticipated a major catalyst that would surely drive prices higher - the moment when large institutional investors start investing in Bitcoin.

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digital currency prices todayWe've seen some hedge funds dabbling in cryptocurrencies already, but one of the largest pools of institutional money in the world - pension funds -- has stayed almost completely on the sidelines.

And pensions in the world's 22 top pension markets make up a massive, price-moving pool of $41.4 trillion, according to Willis Towers Watson.

Should even a small portion of this money trickle into primary cryptocurrencies like Bitcoin, it could cause the prices of those cryptos to double or even triple.

While this traditionally conservative corner of investing isn't likely to jump into the crypto universe with both feet, the sector's unusually high returns have started to catch the attention of pension fund managers.

"We're looking into it," TerriJo Saarela, director of corporate governance for the State of Wisconsin Investment Board, admitted to Forbes in March.

One major obstacle is holding them back...

What Pension Fund Managers Are Waiting For

When you manage a fund worth billions of dollars, security is a major concern. So imagine being a pension fund manager who's considering investing in Bitcoin reading news story after news story about how yet another crypto exchange was hacked and millions of dollars' worth of crypto stolen.

You wouldn't feel too confident about exposing your pension fund to that kind of risk.

But in the world of institutional investing, there is an answer to this - professional custodians.

Custodians offer protection for investments that require some level of security, such as physical gold. And Wall Street has no shortage of them. Some of the major names include State Street Corp. (NYSE: STT), Bank of New York Mellon Corp. (NYSE: BK), and JPMorgan Chase & Co. (NYSE: JPM).

See Why Bitcoin Is Far from Dead: Cryptocurrency legend Michael Robinson just revealed why Bitcoin could be poised for a record-breaking rebound. Before the mainstream public gets any wiser, you need to see this now.

But none of these most trusted custodians have moved into cryptocurrencies yet. And especially with an investment as tricky to properly secure as crypto, institutional investors like pension funds won't settle for anything less than a top-notch custodian.

A few crypto companies, most notably Coinbase and the Winklevoss twins' Gemini Trust Co., do offer custodial services for institutional investors. But for pension fund managers, the trust factor isn't there yet.

Part of that is due to the lack of a track record.

Gemini's service launched in 2016; the Coinbase service is brand-new, having launched July 2.

Pension fund managers are also wary of cryptocurrency as an asset. The volatility, in addition to the frequent stories of crypto exchanges getting hacked, has made fund managers especially cautious about investing in cryptocurrencies.

But the lack of custodial services is by far the biggest roadblock right now...

Custodians Hold the Key

"So much of the security of Bitcoin and other cryptocurrencies rests with who stores that private key, who controls the vault," Blake Estes, counsel, financial services, and co-leader of blockchain and distributed-ledger technology at Alston & Bird LLP told Pension & Investments.

"Blockchain (the technology behind the transfer of assets) itself can't be hacked, but it all still boils down to who ends up holding the keys," Estes continued. "I'd tend to think that pension funds will not venture into uncharted territory until they're certain about the security of who has custody of the keys."

It's unclear exactly what the big-name custodians are doing with regard to cryptocurrency - they haven't disclosed their plans.

But Jonathan Benassaya, founder and CEO of IronChain Capital, suggested to Pensions & Investments that major custodians aren't ignoring crypto.

"The level of custody in crypto is the same as with other assets, except that crypto is self-cleared through the blockchain," Benassaya said. "Custodians are not so far away from making this happen."

And they certainly have the incentive. The market cap of all cryptocurrencies right now is more than $300 billion, even with prices down more than 50% from their December highs. Significant interest from institutional investors would represent substantial new business for them.

"If custodians expand their business model to take care of cryptocurrencies, the same as with classic securities, there could be quite some space in terms of revenue growth. They can bring the experience and reliability of classic custodian work to this asset class," Matthias Voelkel wrote in a March report from McKinsey & Co.

Of course, the major custodians also want to be sure they will have customers when they do decide to launch crypto custodial services.

That means more pension funds and institutional investors will need to express a desire to invest in crypto.

The thing is, the pension funds have a strong incentive of their own to take the leap into Bitcoin and other cryptocurrencies...

What Will Drive Pension Funds to Start Investing in Bitcoin

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What will draw pension funds to crypto is a combination of two related things: the promise of outsized returns from crypto assets and the pressure to maintain their own returns.

Crypto has delivered amazing returns over the past few years, even taking the recent pullback into account.

Remember, Bitcoin was trading at under $1,000 on Jan. 1, 2017. Today it trades at over $8,000 - a return of over 700% over a 19-month span. If you go back just one more year, Bitcoin was trading at $435. It's up about 1,800% since then.

Meanwhile, concern is growing in the pension fund industry that annual returns will start to drop over the next few years.

In recent years, pension funds have managed annual returns of about 8%. But the median assumed rate of return for the 130 public pension funds tracked by Wilshire Consulting has fallen to 7.25%.

That may not sound like much of a drop, but in the world of pension funds, even a small reduction in the annual return can mean a shortfall of billions of dollars.

The reduction of the California State Teachers' Retirement System's and California Public Employees' Retirement System's assumed rate of return from 8% to 7% by 2021 translates to $15 billion less for the fund over 20 years.

That's money that will have to be made up by higher contributions from governments or employees. And that's the sort of thing pension fund managers strive to avoid.

It makes investing in crypto all the more tempting. A study of the impact of crypto on a hypothetical pension fund shows just how temping...

These Returns Will Prove Hard to Resist

A December study by the Johns Hopkins' Carey Business School showed that just a 2% investment in Bitcoin over a seven-year span would made a dramatic difference in the returns of a hypothetical fund.

The fund had a fairly typical 60-40 mix of stocks and bonds. Switching just 2% into Bitcoin resulted in a 50% increase in the fund's gains.

bitcoin and stocks"For those CIOs who are lagging behind industry peers and need to add riskier, and thus more rewarding, investments to their portfolio, cryptocurrencies are an investment worth considering," wrote Jim Kyung-Soo Liew, the Johns Hopkins finance professor who authored the study.

Now don't expect pension funds to jump into Bitcoin overnight. This is a trend that will start with a few brave pioneers.

But once it starts, it wills snowball. The billions flowing into cryptos will fuel a massive rally that will at minimum double the prices of many of the top coins.

The only question is when.

"I do think it's inevitable from a few angles," Ari Paul, a former portfolio manager at the University of Chicago and current CIO of cryptocurrency investment firm BlockTower Capital told CNBC in April. "They're comfortable with the investment thesis but not the investment vehicles yet. My guess is that you won't have meaningful pension money for about a year."

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About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

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