Fidelity Research Report: Six Ways Institutional Investors Allocate Bitcoin

This article is from Fidelity Digital Assets and translated by Chain Catcher.

So far, most discussions in the institutional investor community have focused on "Why Bitcoin?" If someone indeed concludes that Bitcoin is suitable for their portfolio, the next logical question is often "How" to invest in Bitcoin.
In this article, we will discuss the advantages of different investment channels, including third-party custody, passive single-asset funds, futures contracts, and actively managed funds.
A core feature of Bitcoin (and digital assets in general) is that holders can self-custody their assets and have true ownership, thus eliminating the need to trust intermediaries that control the assets. However, many institutions with fiduciary duties face regulatory and operational constraints that prevent them from directly holding these assets. Additionally, self-custody currently requires robust security and risk management processes, which some institutions may be unwilling to undertake or may lack the time and resources to refine.
To adapt to this reality, as institutional interest in Bitcoin assets has increased, the channels for investing in Bitcoin have significantly expanded. In this article, we focus on the benefits and challenges of multi-channel investments that institutional investors may consider after deciding to allocate to this asset class.
1. Spot Trading and Custody
The early infrastructure for Bitcoin was largely built to meet trivial trading needs, with few strong and secure institutional custody solutions available. Historically, the lack of institutional-grade solutions has been a barrier for institutional investors looking to invest in Bitcoin. In recent years, this challenge has been positively addressed, as several digital asset-native service providers have launched custody solutions focused on institutions to protect client assets from loss and theft and help them meet regulatory and fiduciary obligations.
Today, the benefits of gaining Bitcoin exposure through partnerships with third-party custodians include the maturity of custody solutions, relatively low costs of maintaining spot exposure through custodians, and the potential capital efficiency benefits of holding underlying Bitcoin. Therefore, spot trading and custody are the most common risk exposure channels. In a 2019-2020 institutional investor survey, we found that about 60% of respondents with digital asset exposure held the underlying assets. Below, we outline the benefits and considerations investors need to keep in mind when considering gaining spot Bitcoin exposure.

1. Potential Benefits
   1) Institutional-Level Trading and Custody
   In recent years, the launch of integrated trading execution and custody solutions designed specifically for institutional clients has significantly matured the outlook for Bitcoin, facilitating the acquisition, long-term storage, and protection of Bitcoin by large, regulated investors. Today, digital asset custody operates under robust operational and regulatory frameworks. Many custodians regularly undergo operational and security (e.g., SOC) audits, adhering to standards similar to those of traditional service providers. They may also hold state trust licenses or national bank licenses.
   Meeting these standards, along with other requirements outlined in the Investment Advisers Act of 1940, has led some regulated entities to interpret certain Bitcoin custodians as qualified custodians. This is important for investors like registered funds, which must hold investment securities from qualified custodians. Note that Bitcoin is not classified as a security, but it is still important to match its characteristics appropriately with qualified custodian status.
   2) Low Costs
   Another advantage of spot Bitcoin exposure is that it is one of the lower-cost efficiency ways to acquire the asset, given that total fees (trading execution and custody costs) are relatively low compared to most other methods we discuss. Annual custody fees and fee schedules vary from one provider to another, but most providers have total custody assets below 50 basis points. Depending on the provider, custody fee rates may also expand as total assets on the platform grow. Trading execution costs include trading fees and slippage that investors may experience, especially when establishing large positions.
   In a hypothetical test, assuming each Bitcoin is priced at $50,000, Coin Metrics estimates that the total trading cost (trading fees plus slippage) for a $5 million order executed in one day is 0.175% (higher trading costs but lower slippage). The cost of executing a $1 billion order over approximately two weeks is 0.225% (higher latency but lower trading costs).
   
   3) Opportunities for Enhanced Capital Efficiency
   In addition to self-custody, depositing physical Bitcoin with a custodian is the most direct way to gain exposure to this asset class. A key advantage of accessing physical Bitcoin is capital efficiency. As Bitcoin becomes more widely accepted as an investable asset, borrowers may increasingly leverage Bitcoin as collateral to gain liquidity while maintaining their positions. Lenders may see the value of Bitcoin as collateral due to its attractive characteristics, such as high liquidity, borderless nature, ease of rapid final settlement, and real-time dynamic pricing.
2. Considerations
   1) Technical Due Diligence
   Given the relatively technical nature of digital asset custody, investors may feel they lack the capability to communicate effectively with due diligence service providers. For example, they may struggle to understand the differences between hardware security modules (HSM) and multi-party computation (MPC) models used to protect assets, or to grasp the pros and cons of integrated custody versus segregated custody, among other issues. Therefore, due to gaps in technical knowledge and experience, some institutions may prefer to choose tools that allow them to outsource the evaluation of service providers.
   2) Fragmented Liquidity
   The liquidity of the digital asset market is fragmented. Digital assets like Bitcoin trade across multiple exchanges globally, with varying levels of volume, transparency, security, and regulatory status. This contrasts sharply with traditional capital markets, where trades occur on a single exchange, and laws require the provision of the national best bid and offer (NBBO) or the best available purchase (lowest) and sale (highest) prices for clients. Bitcoin exchanges are not bound by such requirements, and given the degree of fragmentation, it is less likely to guarantee "best execution" across all platforms.
   However, an increasing number of institutional service providers are launching integrated execution services and smart order routing solutions that will allow clients to fund a single account and access multiple liquidity providers to attempt better price execution and enhance capital efficiency.
   3) Lack of Integration with Traditional Assets
   To a large extent, institutional investors cannot access Bitcoin through the same accounts or platforms they use to acquire traditional asset classes, resulting in a fragmented experience in managing risk exposure across different asset classes and creating operational challenges (such as tax and reporting). For investors, the ability to integrate Bitcoin assets into a traditional portfolio and view these assets in a single interface would be a win. If traditional banks and custodians begin to offer digital assets alongside traditional assets by establishing, acquiring, or partnering with sub-custodians, this concern may diminish. Factors supporting this trend include interest from institutional clients and potential clients, regulatory support from key agencies like the OCC, and competitive pressure.
   2. Private Placements of Passive Funds
   Private placements of passive funds provide another channel for qualified institutional investors to gain long-only Bitcoin exposure. Passive funds are popular because they abstract the complexities of Bitcoin trading and custody and present the assets to investors in a familiar structure. The convenience comes at a cost, as funds charge management fees in addition to transaction and custody fees to investors. This fee is used not only for the fund manager and operations but also for the costs incurred by the fund through its chosen custodian.
3. Potential Benefits
   1) Convenience and Readability
   Passive Bitcoin funds used by recognized institutional investors offer a convenient fund structure. Generally, fund distributors can provide physical assets or fiat assets and allow the fund to execute trades on their behalf. Fund managers who may be more capable of analyzing service provider prospects are also responsible for due diligence and the selection of custody and trading partners. Therefore, allocators must have a high level of trust in the fund management company to make appropriate decisions related to security, counterparty risk, and more. Passive funds can also provide simplified and easily readable tax and reporting benefits.
   2) Fair Value Accounting Treatment
   An increasing number of corporate finance teams are allocating Bitcoin to their balance sheets. One challenge companies face when directly investing in Bitcoin is the accounting treatment of the allocation. On the financial statements of public companies, direct investments in Bitcoin are treated as indefinite intangible assets. As a result, this investment is marked down to the lowest trading price of Bitcoin in each accounting period, which poses a potential adverse impact on GAAP results—current market value is not reflected in the financial statements for each accounting period. By establishing Bitcoin exposure through passive funds, companies can achieve preferential accounting treatment, as Bitcoin may be classified as "equity investments," valued at market value in each fiscal period, along with other potential tax and accounting benefits.
4. Considerations
   Passive funds typically charge annual management fees ranging from 50 to 200 basis points, in addition to costs associated with trading execution, custody, and/or fund management. Therefore, given that fund managers do not provide significant advantages in purchasing and holding Bitcoin, private placements are a relatively higher-cost investment method. However, several new entrants are entering the passive fund space, creating healthy competition and downward pressure on fees.
   Investors should also evaluate the differences in redemption frequency and mechanisms of passive Bitcoin funds. Investors should determine whether the fund allows daily, weekly, or other frequency redemptions. Additionally, they should understand whether they can redeem physical Bitcoin, cash, or shares on the secondary market, which we will discuss below.
   3. Publicly Traded Stocks
   Investors can also gain exposure to potential price movements of Bitcoin through publicly traded stocks. For example, the Grayscale Bitcoin Trust (GBTC) provides investors with an opportunity to gain Bitcoin exposure through an open-ended private trust. The trust issues shares that trade as securities on the public market. These shares represent ownership of the trust, which has the sole purpose of holding Bitcoin and tracking its underlying price movements.
   Although secondary market shares are available to both retail and institutional investors, accredited investors can also participate in daily directed placements at net asset value (NAV) and sell shares on the secondary market after a six-month lock-up period.
   The main benefit of gaining Bitcoin exposure through publicly traded stocks is that investors do not need to deal with the logistics associated with custody, transferring, and receiving Bitcoin. They can access the risk as easily and conveniently as any other publicly traded security.
   Unlike private passive funds, publicly traded Bitcoin exposure requires paying a relatively high management fee of 2%, but the secondary market may also trade at a premium or discount due to the lack of redemption mechanisms between the secondary market and traditional Bitcoin exchanges, asynchronous trading times, and poor liquidity. In the past, the closing price of GBTC was twice the underlying price of Bitcoin. Since reaching a peak premium of 137% at the end of 2017, GBTC's premium has recently seen a discount to net asset value. As competition heats up among structurally similar products, it may become increasingly difficult for products like GBTC to achieve premiums as they once did.
   4. Bitcoin Futures
   Investors can also use Bitcoin futures to establish long exposure, hedge spot exposure, or create neutral risk Bitcoin exposure. Bitcoin futures come in various forms and sizes, from highly regulated products offered on familiar platforms to less regulated products with significant leverage available on overseas platforms.
   1. Regulated Cash-Settled Futures
   1) Potential Benefits
   Cash-settled Bitcoin futures offered on platforms regulated by the Commodity Futures Trading Commission (CFTC), such as CME, have become one of the primary products meeting institutional interests. CME's cash-settled futures attract financial institutions because they trade on the same platform as futures contracts for other assets. They are regulated by the same agency (CFTC) that oversees traditional commodity contracts, creating a familiar arena.
   Another advantage of trading on the Chicago Mercantile Exchange is that it has established relationships with futures commission merchants (FCMs), which institutions use to obtain and clear other futures contracts. More than 24 FCMs support Bitcoin futures settlement, including E*Trade, Macquarie, TD Ameritrade, and Wedbush. Since FCMs are already integrated, they can easily trade new cash-settled products offered on the platform. The fact that futures are cash-settled adds another convenience factor, as exchanges, FCMs, and clients do not have to worry about custody issues during physical delivery.
   2) Considerations
   The settlement price of cash-settled futures relies on the spot price index. Platforms offering cash-settled futures must reference a robust, regulated, and non-manipulated set of exchanges.
   Additionally, cash-settled Bitcoin futures typically trade at a premium compared to spot, meaning futures trade at a premium over spot, and longer-dated futures trade at a higher premium than shorter-dated futures. Therefore, holding Bitcoin long-term through futures may be a relatively expensive option, depending on the level of futures premium. Maintaining long exposure to Bitcoin through cash-settled futures also requires rolling contracts before expiration, adding trading costs on top of the premium.
   In general, futures contracts tend to trade at a premium to account for the storage costs of holding the underlying asset (such as physical commodities like gold or oil). Therefore, Bitcoin futures may trade at a premium to offset custody costs. A more likely explanation is that institutions facing regulatory or operational constraints in acquiring spot Bitcoin are willing to pay a premium to gain Bitcoin futures.
   While this premium may be unfavorable for participants establishing long positions, it may also be a feature for traders to lock in risk-neutral rolling returns by going long spot Bitcoin (or shorter-dated futures) and shorting longer-dated futures.
   2. Regulated Physically Settled Futures
   1) Potential Benefits
   Physically settled futures deliver Bitcoin to the contract buyer at expiration (if the contract is not rolled), which is attractive for institutions that ultimately want to invest in the underlying asset, especially if the contract is offered by a regulated entity. Additionally, stakeholders do not have to worry about potential manipulation of the spot exchange at settlement, as they might with cash-settled futures.
   2) Considerations
   Regulated physically settled futures (in terms of volume and open interest) have not yet achieved the same level of adoption as regulated cash-settled futures. This may be because FCMs are reluctant to support these contracts to avoid clearing and settling physical Bitcoin transactions. This poses a barrier for institutions whose counterparties may not support these contracts.
   5. Actively Managed Trading Funds
   Investors may also find value in gaining Bitcoin exposure through actively managed tools. As a transparent, liquid, volatile, 24/7 traded asset, Bitcoin presents an attractive opportunity for active managers to generate "alpha" above regular price behavior. Although Bitcoin does not lend itself to traditional active management, which has led institutional investors to abandon active management strategies, Bitcoin offers a unique set of tools that investors can leverage to assess its fundamentals.
   Specifically, market participants can analyze Bitcoin data more deeply than any other traditional asset. Just as government statistical agencies release a country's population and economic data, or public companies disclose growth rates and earnings in quarterly financial statements, Bitcoin provides a real-time global ledger that publishes data on network activity and internal economics.
   The structure of actively managed Bitcoin tools typically takes the form of hedge funds. Fees usually include a management fee (1-2%) and a performance fee (10-20%). Lock-up periods are longer than for other risk investment tools, typically ranging from 1 to 3 years, with quarterly redemptions. Strategies vary, including neutral/hedging and arbitrage strategies. For investors seeking quality Bitcoin investments, actively managed strategies may be the optimal path.
   6. Exchange-Traded Funds (ETFs)
   So far, several Bitcoin ETF applications, including those from Canada and Brazil, have been approved internationally. However, the U.S. Securities and Exchange Commission (SEC) has not yet approved any Bitcoin ETF applications. While the SEC has previously raised a series of questions when rejecting Bitcoin applications, the maturation and institutionalization of Bitcoin custody and trading have led to a new wave of Bitcoin ETF applications in the U.S.
5. Potential Benefits of ETFs
   1) Redemption Mechanism
   Publicly traded trusts are securities that typically trade at a premium or discount because shares from private placements have a lock-up period of 6 to 12 months, during which they must be locked, creating a disconnect between supply and demand in the secondary market. In contrast, Bitcoin ETFs can allow real-time redemptions and creations through authorized participants, whose role is to arbitrage ETF shares when the value of shares in the secondary market deviates from the net asset value (NAV) of the fund's held assets.
   2) Approved Products
   Certain trustees, such as registered investment advisors, seek to obtain regulated products that can address operational constraints they may face (e.g., products that simplify reporting and trading on behalf of many clients). As we discussed, one of the best options currently available is typically over-the-counter publicly traded trusts that deviate from net asset value. However, some companies may only obtain authorization or prefer to trade on exchanges in countries with strict reporting requirements, providing more visibility and transparency. A Bitcoin ETF approved by the SEC and traded on a national exchange would offer greater protection and transparency than the tools currently available.
   3) Ease of Use
   Additionally, Bitcoin ETFs would allow retail and institutional investors to gain Bitcoin through a low-cost, secure wrapper, and for the reasons mentioned above, the share price may closely approximate the asset's net asset value, accessible through traditional brokerage platforms and financial institutions without dealing with digital asset exchanges and wallets. Greater transparency and ease of use could attract more retail and institutional investor capital.
   ETFs would provide a tool for more conservative retail investors who may feel uneasy or concerned about appropriately vetted digital asset service providers, while institutional investors may have similar concerns or face restrictions on the available options for acquiring Bitcoin through current means.
   2) Potential Challenges to ETF Approval
   The SEC has raised multiple questions regarding previously submitted Bitcoin ETF applications, including concerns about Bitcoin custody, market manipulation, and regulation, as well as whether there exists a sufficiently large Bitcoin market regulated by the U.S. The rapid advancements in the digital asset space warrant a reevaluation of these concerns.
   1) Bitcoin Custody
   The secure custody and trading of Bitcoin has been a key focus for regulators. In recent years, the necessary time has been provided to establish high-quality, robust, and secure digital asset custody suitable for institutional participation. Institutions now have a variety of reputable custodians to choose from, who are continuously demonstrating, iterating, and improving their security and robustness.
   2) Manipulation, Monitoring, and Scale of the Bitcoin Market
   Bitcoin trading is extremely fragmented, as exchanges are trading globally at all times, but lack the interconnectedness experienced in traditional markets. The development of mature trading venues for both the spot and derivatives markets has helped establish a reliable, regulated, and sufficiently large market. As this space continues to grow, we have seen improvements in pricing efficiency, as large traditional market makers have begun to view this space as worthy of their participation.
   The SEC has yet to comment on the increasing number of ETF filings. When the time is right, relevant decisions will help clarify whether regulators believe the previously raised concerns have been adequately addressed.
   7. Conclusion
   As a truly anonymous asset, the custody structure of Bitcoin presents unique challenges for delegated asset managers. This provides a variety of investment tools for allocators to consider leveraging to gain exposure to Bitcoin. Each option has its unique trade-offs in terms of custody, costs, and operational burdens, along with other features that need to be considered.
   Over time, these products have become cheaper, easier to use, and increasingly efficient. If regulators ultimately approve a more traditional investment product, such as an exchange-traded fund (ETF), it could create a more competitive landscape that could greatly benefit end investors.
   The lack of regulatory transparency and the less-than-ideal nature of some existing investment tools create barriers to investment, preventing certain potential investors from owning these assets. For those capable of analyzing the various trade-offs associated with the currently available risk exposure channels and potentially allocating, the current situation presents an opportunity to get ahead of their peers.