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Cryptocurrency is the Pascal’s wager of finance

Cryptocurrency is the Pascal’s wager of finance
French philosopher and mathematician Blaise Pascal argued: "if you have nothing to lose vs infinite gains then why wait to wager?!"
By bne IntelliNews May 27, 2019

The upside for crypto is enormous. It could grow ten-fold to catch up with something like the gold market, which is already $1.4 trillion in market capitalization. The cryptocurrency market capitalization is around $240mn and it has growth prospects. If you invest a little now you have very little downside. But if it takes off the returns will be astronomical.”

That's the argument put forward by Gleb Yakolev, the CEO of ITI Funds that has recently launched the first cryptocurrency index fund. It is very similar to the wager proposed by the famous seventeenth-century French philosopher, mathematician and physicist, Blaise Pascal: human’s bet with the way they live their lives that God exists or not. He argue bet on God’s existence because if you get it wrong the downside is limited: oblivion. But if you get it right, the upside is infinite: an eternity in heaven.

It is the asymmetrical risk/reward nature of in an investment into crypto that is so appealing, argues Yakolev. It could be the step up in the digital revolutionary ladder that began with the internet. It has the potential to change the way we live our lives. But unlike the internet, which has already disrupted many industries, crypto has yet to make its mark: there are no widely used applications that is used by a large number of people. This revolution is still on the first rung of the ladder.

Going institutional

Most crypto analysts expect the next bull-run to eclipse all gains witnessed during the first 2016-2017 bull-cycle. Crypto has already completed the its first cycle, and now at the end late 2018 some experts were talking about institutional adoption in the second.

The idea is simple: in this phase every additional $1mn invested in crypto will increase the cryptocurrency market capitalization by $20mn. Retail investors who saw investments into vehicles like bitcoin as a get-rich-quick scheme dominated the first phase. The next phase should be dominated by institutional crypto investors – but where are they?

Recent survey published by fund manager Fidelity found about a half of institutional investors are investing or going to invest in digital assets. However, these investments are limited by a dearth of institutional grade investment products for them to invest into.

For a would be institutional crypto-investor, it is not clear how to enter and exit the market, where to store assets, how to manage risks, what taxes should be paid and so on. ITI Funds claims its team has found answers to most of these questions.

“We have developed our crypto platform to make digital assets available to institutional investors in a regulatory compliant framework. I know everybody is talking just like that today. But ITI Funds has launched the first EU crypto index fund with professional custody and 100% insurance. It is based on principles similar to general exchange-traded funds (ETFs) and the legal structure is familiar to both institutional and private investors. It is a “fiat-to-crypto” fund domiciled in Luxembourg, so there is no problems with Know Your Customer (KYC), taxes and so on. Also index tracking approach is transparent and clear,” says Yakolev.

The ITI Fund is domiciled in Luxembourg where it is held to the highest regulatory standards. The group has set up several platforms that lower the cost of entry to would-be fund managers offering more traditional products from the fiat-world. Using the same infrastructure, ITI Funds have also set up a crypto-version that is identical to the more familiar fiat-backed assets, except the underlying assets are cryptocurrencies rather than the most usual stocks and bonds.

“When ITI Funds started working with crypto we realized we had to become an innovator to bring fiat world rules to crypto space. You have to invent a way to unite custody, insurance company, index provider, etc. One of our key demands was to have real professional custody to escape crypto exchange risks and also offer 100% fund insurance,” Yakolev said in an interview with bne IntelliNews. “Insurance companies just do not deal with it as they do not know how to estimate risks. Its too new. You have to convince a custodian to show its inner structure, backend processes, to an insurance company. Only after that an insurance company will decide if this custody is safe enough to cooperate with. Who wants to share its secrets? Blockchain is a new world.”

The number of custodians willing and able to cater to a cryptofund are few as storing coins instead of stocks remains a novel request. Most coins traded on regulated exchanges are available for professional custody and insurance are included in the index.

The ITI Fund is not unique in offering an index that tracks a basket fo cryptocurrencies, but it is unique in being the only one set up to be able to cater to institutional investors.

“Other indexes have other purposes. Some track the market in general. Some calculate the average Bitcoin price. Our logic is different. We want to track the most developed part of the market. We choose top cryptocurrencies. The coins have to fulfil several conditions such as liquidity, recognition and availability of an insured cold storage solution,” Yakolev says.

As part of the index methodology there is a 15% cap on any component, which ensures constant diversification.

“Without 15% cap the index will be 50%+ Bitcoin. We’d like to think we created a perfect index for investing,” says Yakolev.

In addition as part of the package to appeal to institutional investors ITI Fund partnered with top index professionals: the methodology of ITI Funds Crypto Index has been checked and approved by MV Index Solutions, a subsidiary of the US fund giant VanEck.

Spring is coming

After the first round of enthusiasm passed cryptocurrencies have suffered a crypto winter as investors into the scams and more crazy ideas have taken their losses and have been licking their wounds. But just as in the aftermath of the dot-com bubble the interest in crypto is reviving again as the professionals move in.

ITI Funds Crypto Index Fund has doubled in value YTD and should benefit from the rise of “altcoins” – new coins that are joining the bitcoin family. The ITI Fund is now listed on Bloomberg terminals (ticker: ITIFC) and currently consists of nine crypto assets: Bitcoin, Ripple, Ethereum, Litecoin, Bitcoin Cash, Zcash, Stellar, Ethereum Classic and Bitcoin Gold.

“We are going the extend this number to 30 as soon as other coins meet all index criteria,” says Yakolev. “Bond yields are typically around 5%. The risk is that the issuer will default on the bond and you will lose the whole amount you invested. But you are careful and pick a strong issuer and you can be fairly sure they won’t default. In crypto it is wise to invest only small amount, as the chance of default in this case is a lot higher. But if it comes off the returns are in triple, not single, digits,” says Yakolev.

Gold was trading at $1,277 as of the end of April and flat for the year. The wider MSCI EM index, that tracks all emerging markets, had done a lot better and was up 12% over the same period, with Russia’s dollar denominated Russia Trading System (RTS) index is returning 20% YTD as of the time of writing, making Russia the second best performing market in the world. Oil prices have also soared by 37% over the first four months of the year. But the ITI Funds Crypto index fund, is up by more than 90% in the same period.

Young markets are the ones that return the big gains, but they also carry the most uncertainty. However, as the “crypto winter” is now coming to an end Yakolev says the growth in institutional investors stepping into the market are increasingly driving crypto-funds.

Institutional investors bring some solidness to crypto. Their longer horizon means they will not sell as quickly after taking a hit. The ticket size will go up. And there will be more people in the game doing compliance and risk management, which will make it easier to identify the scams from the winners. And a balanced crypto index fund appeals to this more conservative class of investor.

“You don't get the alpha that you would get from and actively managed fund. You only get the beta. But if you want to invest into crypto now it's the beta that is the reason you should be, not chasing the short-term alpha gains. Investors who are doing it now are preparing for a huge surge in the whole market,” says Yakolev.

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This article is part of bne IntelliNews’s coverage of technology, blockchain, fintech, cryptocurrencies and the new economy. Sign up for the free monthly newsletter bneTech here, or read more tech stories on the website here.

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