How does traditional finance inadvertently drive up the price of Bitcoin?

MicroStrategy has been continuously increasing its Bitcoin holdings due to the inflow of funds from passive investment systems, inadvertently creating a traditional finance-style amplification mechanism for Bitcoin prices.

Author: @ManoppoMarco

Translation: Blockchain in Plain Language

After eight consecutive weeks of gains, the crypto market has finally seen some pullback. However, my bullish sentiment towards Bitcoin is stronger than ever, even as 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 grasp the development of passive funds in investing. In simple terms, passive funds are investment products designed to track and replicate the performance of a specific market index or segment, rather than attempting to outperform them. These funds follow specific rules and methods, catering to 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 relatives may have suggested you buy these funds instead of some "meme coin," but you have proven their advice wrong with your actions! But I digress.

Most investment enthusiasts may remember that Buffett once bet a hedge fund manager that the S&P 500 index would outperform the vast majority of actively managed funds, and indeed, Buffett was right. Since 2009, passive funds have rapidly risen to become the preferred investment method for the majority.

But please don't take those college classmates obsessed with WSB options as "the majority."

A deep dive into all the details driving the growth of passive investing would require an entire article, but we can summarize it into a few simple factors:

1) Cost Efficiency

Passive funds (like index funds and ETFs) typically have much lower expense ratios than actively managed funds because they do not require fund managers to engage in extensive "active management." Once the rules and methods are set, the subsequent work is mainly done by algorithms, with only minimal human intervention during quarterly adjustments. Lower costs usually mean higher net returns, making passive investing particularly attractive to cost-conscious investors.

2) Accessibility and Distribution Channels

Simply put, passive funds are easier to access. You don't have to struggle to sift through which active funds are worth investing in. There is an entire industry dedicated to delivering financial products to your grandparents, and passive funds have become more deeply integrated into these distribution chains due to regulatory influences. For example, most active funds are limited in their promotional materials, while passive investment products have genuinely integrated into various channels like 401(k) plans and pension systems.

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 United States, the assets of passive funds have quadrupled over the past decade, growing from $3.2 trillion at the end of 2013 to $15 trillion by the end of 2023.

As of December 2023, the total assets under management (AUM) of passive funds have historically surpassed those of active funds for the first time.
Data from October 2024 shows that U.S. stock index funds hold $13.13 trillion in global assets and $10.98 trillion in U.S. assets, while actively managed stock funds hold $9.78 trillion and $7.26 trillion, respectively.
Index funds now account for 57% of U.S. stock fund assets, up from 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.

Because of this, the entire traditional finance sector and crypto fund managers with traditional finance backgrounds are highly focused on the progress of Bitcoin ETFs (pun intended, they are indeed "investing" in it). They understand that 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 with single-asset crypto products. Clearly, this is because these products are easier to launch, which is why everyone is rushing to be the first to launch a Bitcoin ETF. Today, we are beginning to see efforts to develop Ethereum staking ETFs and more products based on altcoins.

However, the real killer product is BTC hybrid products. Imagine a portfolio that is 95% S&P 500 and 5% BTC, or 50% gold and 50% BTC. These types of products are ones that financial advisors would feel more comfortable recommending and would also be integrated into the supply chain of investment products, thereby expanding their distribution channels.

Nevertheless, launching and promoting these products will still take time. 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 forced to automatically buy MSTR, which MSTR will then use 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 company, it is more likely to quickly qualify for inclusion in top passive fund indices compared to newly launched passive products, thus playing the role of a "Bitcoin treasury company."

Therefore, as long as MSTR continues to use capital to purchase more BTC, the demand for Bitcoin will keep increasing.

No Better Option

If this sounds too good to be true, it's because there are still some small obstacles to overcome for MSTR to play this role more effectively. For example, due to the S&P 500's requirement for companies to have positive earnings in the most recent quarter and over the past four quarters, the likelihood of MSTR being included in the S&P 500 is low. However, the 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.

A 5-minute rough calculation and assumption I really only spent 5 minutes on this calculation, so if there are any errors or suggestions regarding the assumptions, please leave a comment below!

In short, because MicroStrategy is integrated into the supply chain of traditional finance, the entire traditional finance passive investment ecosystem will inadvertently purchase more Bitcoin, just as they unknowingly hold Nvidia stock, creating a similar effect on Bitcoin's price as seen in traditional finance.

Article link: https://www.hellobtc.com/kp/du/12/5602.html

Source: https://x.com/ManoppoMarco/status/1871106620165665076