Constantin Kogan is a venture partner at BitBull Capital and has been a cryptocurrency investor since 2012. He has over 10 years of experience in corporate leadership, technology and finance.
Blockchain-based digital assets can be an alternative for investors hoping to reduce reliance on a failing traditional financial system. Because of this, institutions have kept a keen eye on happenings in the digital asset market – and wealthy investors, particularly family offices, could capitalize on the potential success story of blockchain’s ultimate breakthrough.
Many might say the over-discussed institutionalization of the digital asset market is a long way from fruition, and that may be true. However, current trends have spurred family offices, part of the institutional investor contingent, to increasingly adopt portfolio diversification strategies that support the allocation of funds to digital asset investments.
Although banks are much healthier than during the last crisis, lingering risks still exist within the financial sector (for example, nonbank mortgage servicers) during these unprecedented economic times. Because of this, investors can no longer depict cryptocurrency as a foray into the unknown but as an innovative financial tool. Because of this, there is increased focus from the family offices on digital assets as a good investment class.
What are family offices? Analysts estimate total family office assets under management is over $6 trillion. Among the investment activities of family offices is a preference to allocate to hedge funds, real estate and private equity. According to a UBS Global Family Office Report 2018, an average family office allocates 22% of its funds to private equities. Real estate is becoming popular (17%) and hedge funds have witnessed a slight decline to 5.7 percent.
A concept originated in Europe, family offices were first popularized by the House of Morgan (with a well-known investment titan named J.P.) and the Rockefeller family in the United States. Throughout the years, the growth rate of the family office industry has been unprecedented due to a constant influx of newly minted millionaires and billionaires. Today, there are more than 10,000 operational family offices globally.
A family office is an exclusive money management vehicle, allowing wealthy individuals or families to pull liquid assets together. The sole aim of family offices is managing, growing and preserving the wealth and legacies of such families. Recently, the concept has grown: It can now mean an organization that manages the wealth of two or more families, or multi-family offices.
Family offices and digital assets
The UBS Global Family Office Report indicates that 57% of family offices believe blockchain will transform investing strategies and behaviors in the future. This should come as no surprise. A recent Fidelity investment survey also revealed 22% of over 400 US-based institutional investors, including family offices and foundations, have explored investment products relating to digital assets.
This interesting revelation further drives the conversation about growing affinity for digital securities, blockchain-backed instruments that are tied to an underlying and tradable asset. This undoubtedly alters the perception that crypto has no future as a mainstream investment vehicle. Most striking is the fact that 72% of the investors in the Fidelity study declared no problems with buying digital asset-based investment products.
Perhaps the main reason for this is the low correlation to traditional assets attributed to blockchain-based digital investment products. While the correlation thesis is a strong one, liquidity is another credible reason why the influx of family office investment in the digital asset space is inevitable.
A blockchain antidote
The average family office holds up to 7% of its funds in cash, an investment strategy that guarantees unparalleled liquidity. However, the risks involved in long-term dependence on cash as a source of liquidity could eventually lead these entities to adopt digital assets.
For one, blockchain-based digital assets bypass the bureaucratic nature of traditional financial systems where middlemen feature prominently. There are also doubts surrounding the stability of fiat currencies, especially in today’s increasingly tension-stricken geopolitical landscape.
The cost of transacting and holding cash is indeed negligible in the short term. However, for an entity such as a family that values longevity and generational wealth, the long-term cost is not acceptable. An Accenture and McLagan report concludes blockchain technology could slash costs by 70% on central finance reporting; 50% on business and central operations; 50% on compliance; and more than 30% across the middle and back offices.
New investment technologies for family offices
Digital assets can give family offices access to the benefits of venture capitalism without the illiquid nature of conventional investment strategy. This approach will become viable as crypto custodial industries continue to innovate and mature as a sector within the blockchain industry.
Digital assets are destined to take up a more critical position in the portfolio of family offices. This narrative packs a punch because diversification, lack of correlation with other assets and liquidity remain paramount to the activities of this class of institutional investors. The blockchain ecosystem is still new, but its innovations will continue to capture the attention (and investment) of family offices.