The term cryptocurrency may evoke a number of different images, from lightning-fast computers fuelling get-rich-quick schemes to shady rooms where hackers plot multi-million dollar digital heists.

And while there may be some truth to those perceptions, cryptocurrency is a growing sector that many institutional investors are eyeing with increasing interest. Indeed, in mid-December 2020 Bitcoin’s value soared past US$20,000 for the first time, throwing more fuel on the cryptocurrency fire.

Read: Are institutional investors moving into cryptocurrency?

Although digital currency is a relatively recent development, the concept is rooted in the idea of a central trust, albeit one that can be viewed and verified by all involved parties, said Michael Casey, chief content officer at news site CoinDesk, during the Canadian Investment Review’s 2020 Investment Innovation Conference. “Despite all of the hype, dismissiveness and the occasional crime or security breach, the concept of trust is why digital currency and blockchain matter and how we can approach this issue in a decentralized manner.”

So how does it all work? Simply put, the majority of cryptocurrencies are based on a shared decentralized ledger known as blockchain, where individual transactions, or blocks, are added to the ever-growing sequence. In order to ensure a blockchain network’s accuracy, each new block must be verified through a complex series of mathematical equations, or mining, in which the first correct solution — often determined by the fastest computers — is rewarded with a new and unique piece of cryptocurrency, referred to as a coin.

Timeline of cryptocurrency

Cryptographer David Chaum conceives the idea of cryptographically secured electronic money.

Chaum launches Digicash, an early form of electronic currency involving encrypted software.

Bitcoin launches as open-source software by pseudonymous developer Satoshi Nakamoto.

Only 3.89% of Canadians use Bitcoin, while less than 1% use Ether, another cryptocurrency.

In addition to allowing for more transparency, the blockchain concept also sidesteps the “cost of trust,” said Casey, specifically the money spent on accounting and record keeping to ensure all transactions are correct. “That process of reconciliation, to ensure that we trust each other, imposes an enormous cost. It factors into quarterly reviews and audits. It’s centred around the system we created to solve the trust problem, around multiple disparate ledgers that we all keep.”

Institutional investors and crypto

Wei Xie, co-head of multi-strategy investments in the capital markets group at the OPSEU Pension Trust, says while institutional investors are unlikely to invest directly in a cryptocurrency, many already have indirect exposure through investments made in companies that work with the currencies, such
as Paypal Holdings Inc.

Read: Cryptocurrency exchange failure highlights due diligence in investment decisions

And with the sector ever evolving and affecting all asset classes, he suggests potential investors get up to speed on cryptocurrency. “The way this technology develops is moving so fast that, at some point, it may have such a high barrier to entry that you’ll be more and more discouraged to getting involved. That will ultimately be to the detriment of institutions, because this is going to have implications across your portfolio in one way or another.”

In addition to investor education, increased regulation of the sector will also fuel investments as the likelihood of security breaches, thefts and fraud continues to decline, says Xie, noting cryptocurrency legislation is starting to reach critical mass. Financial analysts believe the so-called cryptocurrency bubble of 2017 was partially due to price manipulation through co-ordinated buys of cryptocurrencies as they declined in value.

And while the OPTrust isn’t currently investing in cryptocurrency, either directly or indirectly, the plan is actively monitoring the space. “You have to do the work and get comfortable that you’re covering off the risk from a fiduciary perspective,” says Xie. “Ultimately, you need the right partner to guide you through the process. I think, subject to those conditions being met, an investment will be the natural outcome.”

Blake Wolfe is an associate editor at Benefits Canada.