Welcome to Thoughts on the Market.
I'm Mike Cypress, head of U.S.
Brokers, Asset Managers, and Exchanges for Morgan Stanley Research.
And I'm Denny Galindo, investment strategist for Morgan Stanley Wealth Management.
Today we break down the forces making crypto more accessible and what this shift means for investors everywhere.
It's Tuesday, November 11th at 10 a.m. in New York.
We've seen cryptocurrencies move from the fringes of finance to being considered a legitimate part of mainstream asset allocation.
Financial platforms, especially those serving institutional clients, are starting to integrate crypto more than ever.
Denny, you've written extensively about the crypto market for some time now among your many jobs here at Morris Yelling.
So, from your perspective in wealth management, what are you hearing from retail clients about their growing interest in crypto?
Yeah, we actually started writing about crypto back in 2017.
We had our first explainer deck and we started writing extensive educational reports in 2021.
So we've covered it for a while.
Advisors who dabble in crypto typically had this one client.
He asked a lot of questions about when they could do more.
We also had some clients who were curious.
Maybe their neighbor made a lot of money, bought a new boat and they were wondering what is this Bitcoin thing?
Now, this year, we've seen a sea change.
I think it was the election really started it.
The Genius Act and some of the legislation also kind of added to it.
Almost all this interest is really on Bitcoin only, although we also have gotten a decent amount of interest about stablecoins and how those might impact things.
But it's really just the beginning, and I think it's an area that's not going to go away.
Mike, on the institutional side, what trends are you seeing among asset managers and brokers in terms of crypto adoption and integration?
Big move into the ETF space as large money managers make crypto easier to access for both retail and institutional investors.
Now this comes on the back of the SEC approving the first spot Bitcoin and Ethereum ETFs back in 2024.
And since then, we've seen firms from BlackRock to Fidelity Franklin Invesco, many others, including crypto native firms, having launched spot Bitcoin ETFs and spot Ethereum ETFs.
And these steps in the minds of many investors have legitimized crypto as an investable asset class.
Most recently, we've seen the SEC adopt generic ETF listing standards for crypto ETFs that can make it easier to accelerate ETF launches and reduce regulatory frictions.
And today the crypto ETF space is about 200 billion of assets under management and saw inflows of over 40 billion last year, over 45 billion so far this year, despite some of the near-term volatility.
And most of the asset class today is in Bitcoin.
Single token ETFs, with BlackRock and Fidelity managing the largest ETFs in the space.
Speaking of products, what types of crypto are retail investors most curious about?
And why do those particular ones make sense for their portfolios?
Yeah, I think you hit the nail on the head.
The most popular products are really the Bitcoin products.
We as a firm allowed solicitation in Bitcoin ETPs more than a year ago in brokerage accounts.
We just expanded them to allow them in advisory in October, so we're still early days here.
There really hasn't been that much interest in the other crypto products.
Now, when people think about this, there's three buckets here.
There are some people that think of it like digital gold.
And they're worried about inflation.
They're worried about government deficits.
And that's kind of the angle that they're pushing crypto from.
A second group.
Think of it like a venture capital, like a disruptive innovation in tech that's going after this big, addressable market.
And hopefully the penetration will rise in the future.
And then the third bucket is really thinking about it as a diversifier.
So they're saying, hey, this thing is volatile.
It doesn't match stocks, bonds, other assets.
And so I kind of want to use it for diversification.
Now Mike, when you have these discussions with institutional clients, how do they view the risk and potential of these different cryptocurrencies?
What's interesting with the crypto space is adoption started on the retail side, with institutions now slowly beginning to explore allocations.
And that's the opposite of what we've seen historically, with institutions leaning in ahead of retail in areas whether it's commodities or private markets.
But it's still early days on the institutional side.
We're starting to see some pensions endowments foundations begin to make some small allocations to Bitcoin as they long-term inflation hedge.
But keep in mind institutions tend to make investments in the context of strategic asset allocations, often with a broader macro framework.
Denny, you've written quite a bit about the four-year crypto cycle.
Could you explain what that is and where you think we are in the current crypto cycle?
Yeah, if you look at the data, you see a pretty clear trend of four-year cycles.
So there's three up years and one down year.
And it's been like clockwork since Bitcoin was invented.
Now, when you see something like that, you always try to explain, like, why is this happening?
So there's two kind of dominant explanations that we've seen.
So one's macro, one's micro.
Now, the macro version for crypto is really the M2 cycle.
So we see that global M2 money supply has kind of accelerated and decelerated in four year cycles.
And Bitcoin tends to really match that cycle.
It tends to accelerate when M2 is accelerating and it tends to decline when it's decelerating or declining.
But there's also this bottoms up way of looking at it.
Commodities are really the place we go to for that analysis.
So a lot of commodities you know could be coffee, could be oil.
If something disrupts supply, you tend to get the shortage.
You get the price moving up, then you get commodity speculators piling in adding leverage and it'll just kind of go parabolic.
At some point something pops the bubble usually more supply and then you get like a great depression.
You get like an 80 drawdown, all the leverage comes out and the whole thing crashes.
So crypto has also followed that.
Now we break the four-year cycle into four seasons spring summer, fall and winter.
And each season has a different characteristic about which parts of the market work which don't work, what things look like.
We're in the fall season right now, and that tends to last about a year.
We wrote a note last year on this.
Fall is the time for harvest, so it's the time you want to take your gains.
But the debate is, how long will this fall last?
When will the next winter start?
Or maybe this pattern won't even hold in the future.
And so this is the big debate in the crypto circles these days.
And Mike, given the volatility, given the Great Depressions we talked about in Bitcoin, with these 70-80 drawdowns, how do you see it fitting into institutional portfolios compared to other cryptocurrencies?
Compared to other cryptocurrencies, Bitcoin is still viewed as the flagship asset within the crypto space.
Just given higher adoption, greater liquidity this year, market value it's longer history and better regulatory clarity as compared to other tokens.
But, given the volatility, as you mentioned, and the early days nature of cryptocurrencies, adoption is still quite nascent amongst institutional investors.
Some institutional investors view Bitcoin as digital gold or macro hedge against inflation and monetary debasement.
It's also sometimes viewed as a low correlation diversifier within multi-asset portfolios.
But even that's also been a debate. in the marketplace too.
As we look forward from here, crypto adoption within institutional portfolios could potentially expand, as regulatory clarity establishes a clear framework for digital assets right.
We had the Genius Act recently that focused on stablecoins.
Next up is market structure.
There's a bill working its way through Congress.
We've also had developments on the ETF side that lower barriers for institutions to gain exposure there.
Not only is it more accessible within traditional portfolios, but the ETF fits nicely into day-to-day workflows.
So bottom line is institutional views on Bitcoin and crypto are evolving, and how firms view Bitcoin, we think will depend upon the institution's objectives, their risk tolerance and portfolio context.
And keep in mind that institutional allocations don't turn on a dime.
They tend to be slower moving.
Denny, do retail clients take a similar approach, or are they more likely to take bigger bets?
Our clients struggle with this question.
And so we get a lot of questions like, okay, I don't want to miss this.
I'm a little nervous about it.
What allocation should I use here?
And so we go back to our three kind of typical investors when we try to answer this question.
We really try and help people figure out where is equal weight.
So we were to note in February called, are you underweight Bitcoin?
And we have three different answers depending on how you're thinking of it.
And, you know, there's a big debate.
There's no clear answer.
And that's not really where we want our clients.
We want them to be smaller, where they can have some exposure if they want it.
Not everyone wants it, but if you do want it, you can have it.
And it won't really dominate the volatility of the portfolio.
Now, on another note, Mike, are you seeing legacy platforms start to offer crypto as well?
So crypto ETFs are generally available in self-directed brokerage accounts across the industry today.
Schwab, for example, commented that their customers hold 25 billion in crypto ETFs, which is about call it 20 share the etf space.
But access to these crypto etfs is a bit more restricted within the advisor-led channel.
But we're starting to see that broaden out for etfs and eventually might see model portfolios with allocations toward crypto etfs.
But when you look at spot crypto trading though, that generally remains out of reach of most legacy platforms.
The key hurdle for that has been regulatory clarity And with a more crypto-friendly administration, that is changing here.
So Schwab, for example, acknowledged that they have the regulatory clarity needed and they're working towards launching their spot crypto trading platform in the first half of next year.
On that topic, Denny how do you view the merits of holding crypto directly versus through an exchange-traded product like ETFs?
Yeah, I mean, our clients are mostly not day trading this product and kind of moving it back and forth.
So The ETPs have been a pretty good answer for them.
The one issue is liquidity.
And so we're not used to thinking of this in U.S. equity markets that the most liquid markets.
But in crypto, the crypto markets, the spot markets, are actually more liquid than the equity markets.
So you get a lot of liquidity even after hours, even 24-7, as other markets around the world kind of take the lead.
But most of our investors aren't treating it that way.
They're not day trading it.
And they're really keeping it more like the digital gold market allocation and so they just need to adjust the position size.
You know, once a month, once a year maybe just kind of buy and hold.
But i wonder, you know, as more people get more comfortable, it could become more important in the future.
So it's an open question, but for now the etps have been a pretty good answer here.
Fascinating space, denny.
Thanks so much for taking the time to talk.
It was great speaking with you mike, and thanks for listening.
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