Buy-side firms should stop waiting on blockchain. It’s only a matter of time before Bitcoin becomes a popular investment option.

Blockchain technology has generated significant interest in the financial sector and it is impossible not to be aware of a new technology for the industry that is at the forefront of technological innovation.

However, if you dig deeper into the sources of this interest, you will find that many sell-side financial institutions and settlement institutions are working on prototypes of this technology. For example, most of the members of the R3 blockchain consortium are sell-side banks. There is a clear lack of buy-side companies ( buy-side companies, which are made up of pension funds, mutual funds, hedge funds, private equity funds and other money management companies ).

Buy-side firms have different structures and mandates, but ultimately, investor risk-adjusted returns are a major concern, and blockchain technology can help.

Settlement institutions are interested in blockchain technology because of its ability to simplify the settlement process, provide data coordination between different institutions, and eliminate the need to explicitly move and verify data across organizational boundaries. This saves the need to check the validity of data at all entry and exit points because participants can collectively access the consensus mechanism.

But interest in blockchain from buy-side firms has waned, likely due to their neglect of blockchain.

Cost reduction

The obvious benefit for buy-side firms is the potential for increased efficiency that can be achieved by using a clearing house’s blockchain solution for custody and settlement.

The asset custodian is responsible for a few clients' assets at a few points, which can be added quickly. By increasing efficiency, the overall cost to the buyer to service the assets should go down.

Other long-term benefits may be regulatory costs.

Buy-side firms today invest a lot of money in compliance and subsequent oversight. Markets that adopt blockchain could potentially encode many of these regulations into the blockchain as smart contracts, reducing the need for human intervention and oversight.

The CFTC is particularly interested in these initiatives to improve the efficiency of futures markets, which can provide investors with safer markets while providing better market transparency.

Entering different markets

The benefits of global diversification in enhancing risk-adjusted returns are well known in the industry.

However, many fund managers and buy-side firms struggle to invest in a truly globally diversified portfolio because of friction in the management process. Global exchange-traded funds (ETFs) address this problem to some extent, but managers who look at specific securities find it difficult to invest economically.

If blockchain is widely adopted around the world, the current model of global custody and expensive asset custody fees could become a thing of the past. Such a move would benefit smaller investors the most, but would make it easier for buy-side firms to invest across borders. In such a system, human intervention would be rarely required—for example, issues such as corporate actions could one day be automated in smart contracts, eliminating the need for financial intermediaries.

Digital Assets

One of the more exciting trends in the blockchain space is around the use of public blockchains not as a settlement layer, but simply as an asset and settlement layer. Bitcoin was created as a peer-to-peer electronic currency system, but is also being used as an asset.

Large market players like CME Group see a future for the space, as do investment management firm Ark Invest and blockchain startup Coinbase in recent reports.

Digital assets offer buy-side firms an entirely new investment class with the potential to improve the risk-adjusted returns of existing portfolios. Some firms are already leading the way.

Hedgeable, a New York-based robo-advisory firm, has been recommending that clients invest in Bitcoin as an asset class. Last year, Bitcoin averaged more than 60% at the firm, contributing 0.96% to its annual return, even though Bitcoin accounts for less than 2% of the firm’s assets.

Hedgeable co-founder Matthew Kane said 30% of their customers have opened a Bitcoin wallet through Coinbase to invest in Bitcoin.

The average Hedgeable user owns 1 BTC each. Kane also said that his company sees Bitcoin as a long-term asset class that can help improve risk-adjusted returns.

Looking ahead, with two Bitcoin ETCs now seeking SEC approval (Winklevoss Bitcoin Trust and SolidX Bitcoin Trust), it seems like it’s only a matter of time before Bitcoin and other digital assets become an investment option available to the average investor.