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May 2022

Red dogs, stump tails and blue pups were just some of the creative names for the ultimately doomed currencies issued by poorly capitalized state-chartered banks during the wildcat banking era in U.S. monetary history from 1837 to 1863 – until Congress finally passed legislation that created a single centrally backed national U.S. currency.

For institutional investors, cryptocurrencies also offer the allure of extraordinary and diversified returns in a market that is now of sufficient size and liquidity for meaningful institutional positions. Indeed, some market participants estimate that about 5% of total Bitcoin supply are now held by institutional investors via custodial intermediaries.

To understand the investment implications of the evolving cryptocurrency landscape, we have drawn on the insights of more than 30 investment professionals across PGIM’s fixed income, equity and private alternatives managers – as well as leading economists, venture capitalists and crypto investors. Our resulting conclusions:

While a few cryptocurrencies will endure on the fringes of the monetary system, the broad replacement of fiat currencies globally by cryptocurrencies is unlikely to materialize. Functionally, cryptocurrencies are unable to meet the basic prerequisites of either a currency or a precious-metal substitute – shortcomings exacerbated by the powerful headwinds from increasing regulatory scrutiny and the growing likelihood of central bank digital currencies (CBDCs) which provide almost all the functional benefits of fiat-linked cryptocurrencies, but with no liquidity or credit risk.
Beyond hedge funds exploiting inefficiencies to generate alpha on the other side of “FOMO”- driven, largely retail and speculative flows, there is currently no compelling case for direct ownership of cryptocurrencies as a meaningful share of an institutional portfolio. Theoretically, cryptocurrencies have no ex-ante foundational underpinnings for delivering robust risk- adjusted returns in the future. Empirically, after examining the brief historical data available on crypto, we find little real-world evidence that cryptocurrencies deliver diversification vs. mainstream assets, are effective inflation hedges, possess the intrinsic characteristics of a safe-haven asset, or advance ESG objectives. Of course, it goes without saying that bitcoin and many other cryptocurrencies have delivered awe-inspiring returns over the last decade – albeit with frequent and substantial drawdowns – and this speculative momentum could continue for some time.
In contrast to direct cryptocurrency ownership,there are attractive institutional investment opportunities in the broader crypto ecosystem and the incidental innovation that has flourished in the creation of bitcoin and other cryptocurrencies. These include private applications of distributed ledger technology and smart contracts used in financial services (like clearing and settlement of securities and international payment systems) as well as

It is clear vy landscape, immature infrastructure and problematic ESG impact, investing directly in bitcoin and other cryptocurrencies is currently quite unattractive for institutional investors.

Of course, investors will want to monitor developments in the cryptocurrency space in the unlikely event that conditions arise for the mainstreaming of private cryptocurrencies. But regardless of how cryptocurrencies themselves endure, savvy long-term investors will certainly want to capture the emerging constellation of investment opportunities in the broader ecosystem of innovation surrounding cryptocurrencies – many of which will power new trading platforms, smart contracts, central bank digital currencies and next-generation securitization technologies in the years and decades ahead.

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