Mention the words cryptocurrency or bitcoin today, and a few thoughts likely come to mind: stupendous growth, volatility, risk, and speculation.

This combination of perceptions explains why institutional investors are proving reluctant to add the digital quasi-currencies into their portfolios. This reticence is notable, coming as it does at a time when the asset owners are seeking to diversify away from their traditional institutional portfolios and into uncorrelated assets. 

Academics claim early institutional investors adopters will benefit while pro-digital currency quantitative experts argue that the quasi-currency assets can be analysed methodologically. But they are yet to convince the institutional investor world at large. 

“We are not paying attention to it for now, because pension funds want stability [of returns],” Tsay Feng-Ching, director general at Bureau of Labour Funds (BLF) in Taiwan, told AsianInvestor.

It’s a point underlined by other institutional investor experts. 

“A few very large clients have experimental portfolios that are less than 1% of their total portfolios…[but] I haven’t seen a single institutional investor do that yet (invest into cryptocurrencies),”Jayne Bok, head of investments at consultancy firm Willis Towers Watson, told AsianInvestor.

For all the excitement—and more recent shock—surrounding cryptocurrencies, the fledgling asset class has a lot to do before it can get the trust of some of the world’s deepest-pocketed investors. 

A NEW ASSET CLASS

In essence, a cryptocurrency is a digital asset designed to work as a medium of exchange that uses cryptography to secure its transactions. Buyers and sellers exchange these virtual tokens using the distributed ledger technology blockchain—a list of transactions that are instantaneously replicated across a number of computers rather than being stored on a central server. 

One key feature of all cryptocurrencies is decentralisation. Central banks or regulators don’t directly regulate virtual currencies, in contrast to regular cash. Instead, the cryptocurrencies rely on internet users to confirm transactions and thus become a public record.

Bitcoin was the first cryptocurrency, and it is by far the most famous. It was created in 2009, and was only worth $0.09 per unit as of July 2010. But it rose quickly after that, gaining worldwide attention when its value pierced $1,000 in 2013. More cryptocurrencies quickly followed. Coinmarketcap, a cryptocurrency information provider, estimates 1,514 cryptocurrencies now exist. 

But bitcoin remains the bellwether. For many years its value hovered just under $1,000. And then in January 2017 it skyrocketed, hitting an all-time high of $19,783 on December 17. 

But then, the bust. Bitcoin’s value collapsed by more than 62% over eight weeks, dropping to $6,500 on February 6. The weeks since have seen a partial recovery; bitcoin was trading at $11,328 on Tuesday (March 6). 

The pitches and yaws of bitcoin’s valuation have led many (including AsianInvestor in our December 2017/January 2018 edition) to assert that the cryptocurrency was at the centre of a speculative bubble. Added to that, news headlines of cryptocurrency scams surface from time to time, while the quasi-currencies still have something of an unsavoury reputation for being used by some criminals to make untraceable payments. This combination has led more potential investors to become wary of buying cryptocurrencies without more knowledge of the risks involved.  

Yet despite these concerns, interest in cryptocurrencies has rapidly grown. The total market capitalisation in cryptocurrencies was $345 billion as of February 2018, of which bitcoin alone was worth $124 billion. Other biggest cryptocurrencies include ethereum (20.60%), ripple (8.17%) and bitcoin cash (4.44%)—a differentiated version of bitcoin, Coinmarketcap data shows. 

REGULATORY CLAMPDOWN

The plummet in bitcoin’s value during late January and early February offered a brutal reminder that rapidly escalating assets can experience equally sharp drops. In part the fall was a result of a string of concerning headlines, including toughening regulations in many countries. 

Across Asia, central banks and financial watchdogs have begun adopting different stances towards the digital assets. In August 2017, the Monetary Authority of Singapore (MAS) said that it would regulate initial coin offerings (ICOs), which use cryptocurrencies as the medium of exchange. The next month, in September, People’s Bank of China and Korea’s Financial Services Commission (FSC) banned ICOs. But in the same month, Japan’s Financial Services Agency (FSA) issued licences to 11 cryptocurrency exchanges.

The China ruling in particular concerned people. The country is believed to produce the most bitcoins in the world (a process called ‘bitcoin mining’), so a tougher regulatory stance could impact the currency’s appeal. 

Even social networking site Facebook is turning against them. On January 31 it said it had banned cryptocurrency advertisements from its platform as they were “frequently associated with misleading or deceptive promotional practices”.

Part of the problem facing bitcoin and its brethren is regulators lack a unified view towards cryptocurrencies. Investment tools can only flourish when most major countries recognise them and regulate their usage by investors in a similar fashion, said BLF’s Tsay. 

Without this governments may lack policies on effective consumer protection, while investors are left exposed in the case of investment dispute. This is enough to put many off taking the risk.

“Institutional investors like us consider whether an asset class has a legal status in a country, what the position is like and whether it is recognised,” said Tsay.

It's an attitude that is understandable for institutinonal investors focused on retaining capital, and making money over the long-term. But it's not one that everybody agrees with. 

Look out for part two of this feature story, which originally featured in AsianInvestor's February/March edition, in which we look at the proponents for cryptocurrency investments in portfolios.