Blockchain investing: A Family Office Memorandum
Navigating Inflation and Macro Risks: The Strategic Importance of Digital Assets for Family Office Wealth Preservation
As a family office committed to the principles of wealth preservation, our primary responsibility is to safeguard and grow the intergenerational wealth of our clients amidst an ever-changing economic landscape. The current environment, characterized by persistent inflation and myriad macroeconomic risks, underscores the importance of a diversified investment strategy. One increasingly vital component of such a strategy is the allocation to digital assets. This memorandum will explore the imperative of managing inflation, recognizing macro risks, and incorporating digital assets into a robust wealth preservation strategy for family offices.
Understanding the Cost of Inflation
Inflation, the gradual increase in prices and decrease in purchasing power, is a perennial concern for family offices. Historically, moderate inflation has been considered a sign of a healthy economy, reflecting growing demand and productivity. However, when inflation accelerates, it erodes the value of money, diminishes real returns on investments, and complicates long-term financial planning.
The past few years have seen a significant uptick in inflation rates globally, driven by a confluence of factors including expansive monetary policies, supply chain disruptions, and geopolitical tensions. In the United States, for instance, the Consumer Price Index (CPI) has frequently exceeded the Federal Reserve’s target rate, reflecting broad-based price increases.
For family offices, the cost of inflation is multi-faceted:
1. Erosion of Savings: Cash holdings lose value in real terms, as the purchasing power of money declines.
2. Real Returns on Investments: Fixed-income investments, such as bonds, offer returns that may not keep pace with inflation, leading to negative real returns.
3. Increased Volatility: Inflationary pressures often lead to increased market volatility, affecting equities and other asset classes.
To mitigate these effects, a well-rounded portfolio must include assets that have the potential to outpace inflation and provide real growth.
Macro Risks: A Broader Perspective
Inflation is but one of the numerous macroeconomic risks that can impact a family office’s investment portfolio. Other significant risks include:
1. Geopolitical Tensions: Conflicts and political instability can disrupt markets, affect trade flows, and lead to sudden shifts in asset prices.
2. Monetary Policy Shifts: Central bank policies, particularly in major economies like the United States and the Eurozone, significantly influence global financial markets. Interest rate hikes or cuts, quantitative easing, and other measures can lead to rapid market adjustments.
3. Economic Cycles: Boom and bust cycles, driven by factors such as consumer confidence, fiscal policy, and technological change, affect asset valuations and investment returns.
4. Environmental Risks: Climate change and associated regulatory responses pose long-term risks to certain industries and investments.
Given these risks, a defensive investment strategy must be adaptive, incorporating assets that can provide stability and growth across various economic scenarios.
The Role of Digital Assets in Wealth Preservation
1. Inflation Hedge: Much like gold, certain digital assets are seen as a hedge against inflation. Bitcoin, with its capped supply of 21 million coins, is designed to be deflationary. As fiat currencies lose value due to inflation, the relative scarcity of Bitcoin can enhance its value.
2. Diversification: Digital assets often have low correlation with traditional asset classes like stocks and bonds. This means they can provide diversification benefits, reducing overall portfolio risk.
3. Growth Potential: The blockchain technology underpinning digital assets is transformative, with the potential to revolutionize various industries. Early investments in digital assets can capture significant growth as adoption increases.
- Consumer Adoption: Global digital asset ownership reached 562 million people in 2024, which is a 34% increase from 2023 [1]. Digital currencies extend beyond investment vehicles and are being increasingly embraced by consumers and businesses as a reliable payment method for everyday transactions. Statista predicts that the number of crypto users could reach 992 million by 2028 [2].
- Institutional Adoption: America’s top public companies are busier onchain than ever. Onchain projects announced by Fortune 100 companies have increased 39% year-over-year and hit a record high in Q1 2024. A survey of Fortune 500 executives finds that 56% say their companies are working on onchain projects [3].
- Technology Adoption: Many of the most trusted names and products in finance are embracing blockchain technology and crypto, driving innovation and providing on-ramps for widespread adoption:some text
- Spot bitcoin ETFs: The total spot bitcoin ETF assets under management is more than $63 billion. On May 23, the SEC approved exchange applications to list and trade spot ether ETFs (pending S-1 approval), further scaling access to spot crypto trusted products and spurring adoption.
- Onchain government securities: are driving new interest in real-world asset tokenization. Recent high interest rates have boosted demand for safe, high-yielding T-bills onchain, sending the 1,000% since the start of 2023, to $1.29 billion [5]. By 2030, the tokenized asset market is expected to hit $16 trillion [6].
- Global Payments: giants PayPal and Stripe also are making stablecoins even easier to use. Merchants on Stripe (via Circle) can now accept payment in USDC via Ethereum, Solana, and Polygon [7]. These payments are then automatically converted into fiat currency. PayPal is supporting cross-border transfers for stablecoin users across about 160 countries – with no transaction fees. The annual settlement volume of stablecoins hit $10 trillion in 2023, more than 10x the amount of remittances worldwide [8].
- Small Business Adoption: the most trusted institutions in the US are small businesses who have been venturing into crypto. About seven in 10 (68%) believe crypto can help address at least one of their financial pain points, the biggest of which are transaction fees and processing times [9].
- Regulatory Clarity: The growth in adoption and increased activity underscores the urgency for clear rules for digital crypto developers and other talent in the US, fulfill crypto's promise of better access, and enable US leadership on crypto globally. The US continues to lose developer share, down 14 points in the past five years; only 26% of crypto developers are US-based today [10]. Among Fortune 500 (F500) executives, concern about available, trusted talent is now a top blocker to adoption.
Strategic Allocation to Digital Assets
While the benefits of digital assets are compelling, their integration into a portfolio should be approached with caution and a strategic mindset. Here are key considerations for allocating digital assets within a wealth preservation framework:
1. Moderate Exposure: Given their volatility, digital assets should constitute a moderate portion of the portfolio. A typical allocation might range from 1% to 5%, sufficient to gain exposure while mitigating risk.
2. Diversified Digital Holdings: Within the digital asset class, diversification is crucial. This might include a mix of established digital assets like Bitcoin and Ethereum, as well as promising altcoins and blockchain-based projects.
3. Risk Management: Employing risk management techniques such as stop-loss orders, regular portfolio rebalancing, and adherence to a disciplined investment thesis is essential.
4. Staying Informed: The digital asset space is rapidly evolving. Staying informed about regulatory changes, technological advancements, and market trends is vital for making informed investment decisions.
5. Portfolio Construction and Diversification in Venture Capital: The Lightning Venture Fund focuses on the businesses that are adding the next billion users to web3, blockchain and digital assets by investing in the teams that are solving critical challenges in digital asset technology and infrastructure. The companies must be institutionalizing and/or improving the UX of the digital asset ecosystem. We moderated exposure and diversified digital assets across the follow sectors of Web3, giving our venture fund comprehensive total exposure:
The Broader Portfolio Context
Incorporating digital assets is part of a broader strategy that should also consider traditional inflation hedges and risk mitigation techniques:
1. Real Assets: Investments in real estate, commodities, and infrastructure can provide tangible value and income streams that outpace inflation.
2. Equities: Stocks, particularly in sectors like technology and healthcare, offer growth potential. Dividend-paying stocks can provide income and serve as a buffer against inflation.
3. Fixed Income: While traditional bonds may struggle in an inflationary environment, inflation-protected securities (e.g., TIPS) and high-yield bonds can offer better protection.
4. Alternative Investments: Hedge funds, private equity, and venture capital can provide uncorrelated returns and enhance portfolio resilience.
Adapting to a Dynamic Environment
The economic environment is dynamic, and investment strategies must adapt accordingly. Here are some practices that underpin successful wealth preservation for family offices:
1. Regular Review and Rebalancing: Periodic portfolio reviews and rebalancing are crucial to maintain alignment with investment goals and risk tolerance.
2. Scenario Analysis: Conducting scenario analysis to understand potential impacts of various economic conditions (e.g., stagflation, recession) on the portfolio.
3. Emphasis on Quality: Prioritizing high-quality assets with strong fundamentals and resilient cash flows can provide stability during turbulent times.
4. Flexibility and Agility: Maintaining a flexible approach that allows for quick adjustments in response to new information and market conditions.
Some Missed Opportunities in Blockchain Investing
Targeted Web3 investments have proven to return high multiples of invested capital. Here are two concrete examples of how Digital Assets have outperformed most traditional assets:
- Ethereum launched in 2015 after an ICO raising $18 Million with tokens priced at $0.35 [11]. Over the last seven years Vitalik Buterin has continuously adapted to market conditions and remains the dominant smart contract platform, with over 3,000 decentralized applications (dApps) and a market cap exceeding $400 billion. With a $1,000 investment in Ethereum’s ICO back in 2015 an investor could have purchased 2,857 ETH at $0.35. That $1,000 investment would be worth ~$9,010,263.75 (*Price of ETH at $3,153.75 on 7/11/24)
- Solana, launched in 2020, raised approximately $336 million from ICO and venture capital, and represents a blockchain network that has embraced flexibility and rapid innovation. Known for its high-speed transactions and low fees, Solana quickly adapted to market demands, supporting a wide range of dApps and attracting significant attention. Solana's market cap has soared past $59 billion, largely due to its ability to evolve and cater to the needs of its growing community. Investing $1,000 in Solana’s ICO in 2020 and investors could have purchased 4,545 SOL at $0.22. That investment would be worth ~$655,031.85. (SOL price of $143.49 on 7/11//24)
Conclusion
In a world where inflation and macro risks pose significant challenges, wealth preservation for family offices demands a nuanced and forward-looking approach. Digital assets, despite their volatility, offer compelling advantages as part of a diversified investment strategy. By carefully incorporating digital assets alongside traditional investments, family offices can enhance their ability to preserve and grow wealth over the long term.
As stewards of intergenerational wealth, our role is to navigate these complexities with diligence, informed judgment, and a commitment to financial security. The strategic inclusion of digital assets is not just an acknowledgment of their growth potential, but a proactive step in building a resilient portfolio capable of withstanding the vicissitudes of the economic landscape.
Footnotes:
[1] Triple A: Global Crypto Ownership
[2] Crypto users to reach almost one billion in 2024, analysts predict
[3] The State of Crypto: The Fortune 500 Moving Onchain
[4] US SEC approves exchange application to list Spot Ether ETF
[5] Tokenization of Government Securities
[6] Relevance of Onchain Asset Allocation in ‘Crypto Winter’
[7] Stripe enables Merchants To Accept Payments on Ethereum, Solana, and Polygon.
[9] The Institutions America Trusts Most and Least
[10] 2023 Crypto Developer Report
[11] History of Crypto and ICO Boom: Ethereum’s Evolution
[12] All You Need to Know About Solana and Where to Buy It
Image Footnotes:
[1] The State of Crypto: The Fortune 500 Moving Onchain
[2] Lightning Capital Venture Fund I Presentation p.12