Panama’s sovereign fund mulls the future of digital assets

Most institutional investors continue to steer well clear of cryptocurrencies. The prospect of fraud and theft, wild volatility and more high-profile failures like crypto exchange FTX raise too many red flags to invest in crypto, blockchain, and the wider digital asset ecosystem.

But Abdiel Santiago, CEO and chief investment officer of the Fondo de Ahorro de Panama, Panama’s $1.5 billion sovereign wealth fund, is one of many CIOs watching the market develop from the sidelines.

Investment strategy at the young sovereign fund is still cautious and conservative. The fund began allocating to cash, fixed income and a little equity when it was set up six years ago and has only recently started to develop an allocation to private equity and infrastructure. Santiago is also exploring opportunities in core and opportunistic private debt with the fund’s investment managers although he says the asset class remains too frothy to invest in right now.

But he believes long-term investors are well positioned to embrace new opportunities in digital assets as the market develops, and signs of its evolution are evident. For example, the market capitalisation of Bitcoin already accounts for about 3 per cent of the S&P500: add in all the other cryptocurrencies and that reaches about 5 per cent.

Maturation is also visible in the emergence of Bitcoin and Ethereum exchange-traded funds which Santiago believes could provide a good entry point for more institutional investment. A range of ETFs has been approved in the last year and a half in the US, Europe and Australia, and he reflects that these products provide a more reliable wrapper, regulatory clarity, and have helped reduce the mystery around digital assets that could signpost wider adoption.

“ETFs are providing a sanitised method of investing in cryptocurrencies,” he says.

Some pension funds have already stepped into the market, such as the State of Wisconsin’s Investment Board which manages $156 billion in assets for the Wisconsin Retirement System. Elsewhere, $143 million State of Michigan Retirement System has invested in Bitcoin ETFs. Last May, Jersey City mayor Steven Fulop wrote on X that he planned to allocate part of the city’s pension to ETFs.

Correlation risks

Exactly how an allocation to digital assets would fit alongside other assets investors hold remains a key unknown. Bitcoin and Ethereum fell more sharply than equities, commodities and fixed income when markets crashed at the beginning of the pandemic; and Bitcoin shattered the idea that it was an inflation hedge when it plummeted as inflation soared around the world in 2022.

However, Santiago suggests that although the diversification benefits aren’t present today, that doesn’t mean digital assets are not an investable asset class and that they will not be a source of diversification in the future. Only time, data, and analysis will tell.

“It is still too early to see how digital assets will offer diversification in a portfolio in the future,” he says.

“Exploration of the basic correlation between bitcoin, the biggest cryptocurrency, and gold, averages around 0.5 to 0.6 in a positive correlation. Gold goes up and Bitcoin also goes up. Similarly, when the S&P500 goes up, Bitcoin also spikes. Although analysis of Bitcoin against a bond index sees less correlation, there is not enough history in the data to say if digital assets do or don’t act as a ballast against risk assets.”

He adds that it is similarly unclear whether digital assets will even grow as an opportunity set.

“It may be that it doesn’t grow, but just remains the same size for a long time.”

Regulatory clarity

What is clear, however, is the need for regulation. Santiago argues that a strategic shift toward clearer and more consistent regulatory frameworks would protect early investors and support sector growth.

“The stability of blockchain investments and, by extension, digital assets, significantly hinges on future regulatory clarity,” he says.

He describes the current landscape as “regulation through enforcement” whereby regulation is unclear but punishments and penalties are meted out for misdemeanours. For example, little viable regulatory progress ensued the collapse of FTX.

“The industry would benefit from and is asking for a regulatory regime in which serious players can operate,” Santiago says. “We are really looking for a catalyst that would allow people to start moving away from this punitive approach.”

Santiago is no more wary of the risk in digital assets than he is of the risk inherent in any other asset class. He traces much of the risk to the sector’s “bad birth” and thinks it is probable digital assets hold more headline than fundamental risk.

However, he says post-trade and custody concerns are particularly pressing for investors because of unknowns around how the assets would be held or protected.

“It would be about getting comfortable around the custody angle for institutions like us,” he says. Positively, he notes emerging solutions like cold storage, taking the investment offline and putting it with a reputable bank.

“It comes down to risk measurement,” Santiago says.

“Just because something is riskier doesn’t make it a bad investment.”

But he observes that many investors struggle to understand digital assets. The idea that their investment sits on a computer server is a difficult concept to grasp.

“For good reasons, investors want to see the asset they invest in,” he says.

“Even if it just a computer, we need to know there is something standing behind it.”

For this reason, he suggests the most compelling opportunities in digital assets will lie in blockchain technology and the real-world applications it offers, such as collecting and securing patient data; supporting money transfers; and logistics and supply chain management, for example.

“When we can see applications utilising this infrastructure for real applications in the real world our level of comfort develops,” he says.

Despite transparency in blockchain infrastructure, from an ESG perspective, cryptocurrencies are also problematic. Cryptocurrencies have uses for nefarious actors in evading sanctions and taxes and Santiago concludes the race to secure power for mining means owning power infrastructure is becoming as valuable as the cryptocurrencies themselves.

“This isn’t just mining,” he says.

“It’s a strategic bet on the future of power.”