Pension Funds & Bitcoin

eph-blog-bitcoin

A] Prelude*

* For more general information about retirement systems and finance, feel free to visit our dedicated webpages: 
•    https://expatpensionholland.nl/global-pillars-systems 
•    https://expatpensionholland.nl/global-investments-risks-0 

The State of Wisconsin Investment Board recently announced the purchase of $99 million worth of IBIT shares, BlackRock’s spot Bitcoin ETF. This marks the first investment in Bitcoin ETF shares by a public pension fund.

While this is the first time a state pension has bought shares of a Bitcoin ETF, it’s not the first bitcoin investment by a pension fund. In October 2021, the Houston Firefighters’ Relief and Retirement Fund acquired an undisclosed amount of BTC through institutional bitcoin services provider NYDIG. 

That was before spot ETFs were available. Now that a safer, easier alternative exists to buying bitcoin outright, it’s expected that many more large pension funds will follow.

B] Why Bitcoin?

The idea behind adding bitcoin to a balance sheet is simple. As Michael Saylor puts it, holding a large cash balance is akin to sitting atop a “melting ice cube.” Inflation steadily erodes the value of cash, resulting in guaranteed losses for investors.

Because they must balance the need for providing a guaranteed return to retirees with prudent risk management, the typical strategy of a pension fund would be to invest primarily in government bonds. 

Long-term and short-term Treasury bonds are considered to be the lowest-risk securities available, and they yield stable returns. Blue-chip stocks and investment-grade bonds are also viable options. For many years, these three asset classes were the only ones pension funds could expose themselves to by law.

But after the GFC and years of near-zero interest rates that followed, pensions have had to be more creative to generate returns, and the associated rules have relaxed. To make matters worse, bond yields have gone up dramatically since 2022. This makes shorter duration T-bills attractive for their higher interest rates, but it also means the value of bonds has gone down, resulting in losses for anyone holding long-duration government debt.

This situation plays a large role in why pension funds have begun investing in bitcoin.

C] Future Prospects: What This Means for Other Pension Funds

As far as what the future holds, no one has a crystal ball. However, we can look to what’s been happening with corporations as of late for clues to what might be in the works for pension funds.

Michael Saylor’s MicroStrategy was the first public company to adopt bitcoin as a treasury asset. The corporation currently holds over 210,000 BTC, or about 1% of the total supply. The strategy has been a monumental success. Not only has the company seen its balance sheet balloon to the tune of billions of dollars, but the share price has also skyrocketed.

As expected, other CEOs have taken notice. Many of them want to take a page out of Saylor’s playbook, and some have already begun to take action.

For example, two more companies have recently joined the list of those adopting a Bitcoin treasury strategy. Semler Scientific shares surged on 28 May 2024, as news of the company adding $40 million worth of bitcoin to its balance sheet broke. And on 9 April 2024, Japanese Web3 infrastructure provider Metaplanet saw its shares soar by 90% after announcing an acquisition of $6.5 million in BTC.

It might be possible or cannot be ruled out that a similar thing might happen for pension funds. It’s important to note that there tends to be a significant time delay between the first movers and further adoption, though. MicroStrategy began its process of acquiring Bitcoin in 2020. Four years later, corporate adoption has begun to gather momentum.

So, it may be a few years before we see other pension funds follow in the footsteps of the Wisconsin Investment Board. On the other hand, it’s also possible that such funds have been making preparations behind the scenes for many months. If so, a flurry of investments could be right around the corner.

D] Looking Ahead: The Role of Bitcoin in Institutional Investment Strategies

2024 appears to be the year that institutions of all kinds have begun accepting bitcoin and crypto as a legitimate asset class. The incentives have proven too large to ignore. Many in the space refer to this as game theory running its natural course: as the first movers see great success, others must follow, or they risk falling behind.

Corporations and pension funds have been the first institutions outside of asset managers to profit from the ongoing Bitcoin boom. Many have speculated that even larger entities, like sovereign wealth funds, nation-states, and perhaps even central banks, could be next.

E] A different perspective: EIOPA on Bitcoin

EIOPA is the central regulatory body for pensions and insurance within the EU and they have the following position on Bitcoin:

I. Intro
Blockchain is a subset of Distributed ledger technology (DLT), using ‘blocks’ of information to keep track of data transactions in a distributed network of multiple nodes or computers.

II. How does it work?
•    A transaction with party B is requested by party A, such as transferring money, setting up a contract, or sharing records;
•    This transaction is broadcasted to a distributed network of ‘nodes’ or computers which will validate it according to an agreed set of rules called ‘consensus’ mechanism;
•    When the transaction is validated, a new ‘block’ will be added to the Blockchain and is timestamped, a pointer to the previous block in the chain is provided and the transaction data entered;
•    The new block is processed by the cryptographic technique of hashing where a hash is calculated on the hash of the previous block plus the data contents of the new block. The result then becomes the hash of the new block.

Crypto-assets can be defined as a digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology.

III. How does it apply in insurance and pension sectors?
The adoption of Blockchain and smart contracts in the insurance industry is still at an early stage compared to other technologies such as IoT and AI. However, it could theoretically be used throughout the entire insurance value chain.

Some examples:
•    client on-boarding: by using a Blockchain-enabled shared database, insurers can streamline and reduce the cost of their KYC/AML compliance. On-boarding of a customer needs to be done only once by one insurer/intermediary. When the customer wishes to engage a new insurer/intermediary, the latter can request access to documentation already on-chain in order to confirm due diligence.
•    underwriting process: the use of Blockchain in the underwriting process could result in improvements could result in improvements in efficiency and cost reduction as a result of the inherent trust and transparency within Blockchain, particularly when combined with automated processes collating and assimilating information (e.g. external data can be included to decrease risk and provide semi-automatic pricing).
•    development of new products and services such as completely decentralized P2P insurance or parametric insurance products.
•    Crypto assets can be used as a means of payments of insurance premiums or claims compensation in some jurisdictions. Some unit-linked life insurance products can also have crypto-assets as an underlying investment. Insurance undertakings could also potentially raise capital via Initial Coin Offerings. The increasing tokenization of assets such as in the area of real estate transactions could also be relevant for the insurance sector.

IV. Risks and opportunities for the markets
Blockchain has the potential to reduce duplication of processes, increase process automation, help cut costs, and improve data management within organizations.

It could also enable the development of new products and services, for instance by facilitating the uptake of insurance platforms and ecosystems, improving the interaction with third parties or by enabling completely decentralized peer-topeer (P2P) insurance business models.

However the adoption of Blockchain may also trigger new risks to insurance undertakings, supervisors, and consumers. As Blockchain technology is still evolving, several challenges are emerging, such as the complexity of the technology, data protection and privacy issues, cyber risks, integration with legacy infrastructures, or interoperability and standardization issues between different Blockchain. Concerns about the legal status of smart contracts also have been reported.

Specifically concerning crypto-assets, potential benefits include more efficient and cheaper transactions when purchasing insurance products, a  wider range of investment opportunities for consumers with different risk profiles, or to foster financial inclusion (e.g. amongst those populations that do not have easy access to banking institutions). 

Concerning the risks of crypto assets, their high volatility, the fact that they don’t have any underlying intrinsic value and that they are mostly unregulated, make them unsuitable for most retail consumers.

V. How is EIOPA addressing Blockchain?
EIOPA published a discussion paper and launched public consultation on Blockchain and smart contracts in insurance in 2021. The outcome of this discussion paper will help to better understand the developments and risks and benefits for the insurance industry.

EIOPA’s work in the area of Blockchain and smart contracts aims to:

  • facilitate information sharing;
  • identify the main use cases, best practices, as well as risks and opportunities;
  • monitor future developments and trends;
  • promote level playing field and convergence of supervisory and regulatory approaches in the EU.

Moreover, in cooperation with national competent authorities EIOPA regularly monitors the developments of crypto assets markets and their impact on the insurance sector from a consumer protection and prudential perspective. This includes using Solvency II data to assess the evolution of investments of insurance undertakings on crypto assets, which are relatively limited to date and commonly take place via unit-linked life insurance products.

In September 2020, the European Commission presented a legislative proposal for a regulation on markets in crypto-assets (MICA).  The proposal provides a comprehensive framework with a view to protect consumers and the integrity and stability of the financial system. However the proposal remains subject to the outcome of the co-legislative process and therefore consumers still don’t benefit from the safeguards foreseen in that proposal.

As the application of the legislative proposal is still at a distant stage, the European Securities and Markets Authority (ESMA), the European Banking Authority (EBA) and  EIOPA have issued two warnings to consumers on the risks of crypto-assets:

  • 1] 2022: EU financial regulators warn consumers on the risks of crypto-assets 
  • 2] 2021: Crypto-assets: ESAs remind consumers about risks