Translation: Plain language blockchain
After eight consecutive weeks of gains, the crypto market has finally seen some pullback. However, my bullish sentiment on Bitcoin is stronger than ever, even though we are currently in a price exploration zone. The reason is simple: as an asset class, Bitcoin is gradually entering the (3,3) system of traditional finance (TradFi).
1) Growth of passive funds
To understand TradFi, one must first understand the development of passive funds in investing. Simply put, passive funds are investment products designed to track and replicate the performance of a specific market index or segment, rather than trying to outperform them. These funds follow specific rules and methods, serving their target market and risk preferences.
SPY (SPDR S&P 500 ETF Trust) and VTI (Vanguard Total Stock Market ETF) are well-known examples of passive funds. Your financial advisor friend or older relative may have suggested that you buy these funds instead of some 'meme coin', but you have proven with your actions that their advice was wrong! But I digress.
Most investment enthusiasts may still remember that Buffett once bet with a hedge fund manager that the S&P 500 would outperform the vast majority of actively managed funds, and indeed, history has proven Buffett right. Since 2009, passive funds have rapidly risen to become the preferred investment method for the vast majority.
But please don't take those college classmates addicted to WSB options as the 'vast majority'.
Delving into all the details driving the growth of passive investing requires an entire article, but we can summarize it into a few simple factors:
1) Cost efficiency
The expense ratios of passive funds (such as index funds and ETFs) are usually far lower than those of actively managed funds because they do not require fund managers to engage in a lot of 'active management'. Once the rules and methods are established, the subsequent work is mainly performed by algorithms, requiring only minimal human intervention during quarterly adjustments. Lower costs generally mean higher net returns, making passive investing particularly attractive to cost-conscious investors.
2) Accessibility and distribution channels
In simple terms, passive funds are easier to access. You don't have to sift through which active funds are worth investing in. There is an entire industry dedicated to delivering financial products to your grandparents, and due to regulatory influences, passive funds have more deeply integrated into these distribution chains. For example, most actively managed funds face restrictions on promotional materials, while passive investment products have truly integrated into 401(k), pension systems, and many other channels.
3) Stable performance
'The wisdom of the crowd' often leads to better outcomes. Over the past 15 years, most actively managed funds have underperformed their benchmarks, further highlighting the advantages of passive funds. While you may not achieve 10x returns like early investors in Tesla or Shopify, most people also wouldn't bet 50% of their net worth on a single stock. High risk is not always the sexy choice.
4) Still not convinced? Here are some interesting data points.
In the U.S., assets in passive funds have quadrupled over the past decade, from $3.2 trillion at the end of 2013 to $15 trillion at the end of 2023.
As of December 2023, the total assets under management (AUM) of passive funds exceeded those of actively managed funds for the first time in history.
Data from October 2024 shows that U.S. stock index funds held $13.13 trillion in global assets and $10.98 trillion in U.S. assets, while actively managed stock funds held $9.78 trillion and $7.26 trillion, respectively.
Index funds now account for 57% of U.S. stock fund assets, compared to just 36% in 2016.
In the first ten months of 2024, U.S. stock index funds saw inflows of $415.4 billion, while actively managed stock funds experienced outflows of $341.5 billion during the same period.
Because of this, the entire traditional finance sector and those crypto fund managers with traditional finance backgrounds are closely monitoring the progress of Bitcoin ETFs (double entendre, indeed 'investing' in them). They know this will be the starting point of a larger tide, truly bringing Bitcoin into the retirement portfolios of ordinary people.
2. Crypto investment products
What is the relationship between Bitcoin ETFs and passive funds? While the three major index providers (S&P, FTSE, MSCI) have been working to develop cryptocurrency indices, their adoption has been relatively slow, currently starting only from single-asset crypto products. Clearly, this is because these products are easier to launch, which is also why everyone is rushing to be the first to launch a Bitcoin ETF. Today, we are beginning to see the development efforts for Ethereum staking ETFs and more products based on altcoins.
However, the real killer product is BTC hybrid products. Imagine a portfolio with 95% in the S&P 500 and 5% in BTC, or 50% in gold and 50% in BTC. These types of products are what financial advisors would feel more comfortable recommending, and they would also be integrated into the supply chain of investment products, thus expanding their distribution channels.
Nevertheless, launching and promoting these products still takes time. As they are introduced as new products, they cannot automatically enjoy the monthly inflow advantages that existing popular passive products do.
MSTR drives traditional finance
Next is MSTR: as MSTR is included in the Nasdaq-100 index, passive funds (like QQQ) will be compelled to automatically buy MSTR, while MSTR will use that capital to purchase more Bitcoin. In the future, new BTC-stock-gold hybrid passive products may emerge to replace MSTR's role, but in the foreseeable 3-5 years, due to MSTR being a mature publicly traded U.S. company, it is more likely to quickly meet the index inclusion qualifications of top passive funds compared to newly launched passive products, thus playing the role of 'Bitcoin treasury company'.
Therefore, as long as MSTR continues to use capital to purchase more BTC, the demand for Bitcoin purchases will keep increasing.
No better choice
If this sounds too good to be true, it's because there are still some small hurdles to overcome for MSTR to play this role more effectively. For example, MSTR has a lower chance of being included in the S&P 500 because the index requires positive cumulative earnings for the most recent quarter and the past four quarters. However, new accounting rules set to take effect in January 2025 will allow MSTR to account for changes in the value of its BTC holdings in net income, which may make it eligible for inclusion in the S&P 500 index.
Essentially, this is the core of traditional finance.
Five minutes of rough calculations and assumptions; if I actually spent just five minutes on this calculation, please leave comments below if there are any errors or suggestions on the assumptions!
In summary, as MicroStrategy is integrated into the supply chain of traditional finance, the entire ecosystem of passive investment in traditional finance will inadvertently purchase more Bitcoin, just as they unknowingly hold Nvidia stock, which has a similar effect on Bitcoin's price as traditional finance.
