How Traditional Finance Inadvertently Drives Up Bitcoin Prices

Author: @ManoppoMarco Compiler: Vernacular Blockchain

After eight consecutive weeks of gains, the crypto market has finally seen some pullbacks. However, I am more bullish on Bitcoin 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. The growth of passive funds

To understand TradFi, you need to first understand the development of passive funds in investing. Simply put, passive funds are investment products that aim to track and replicate the performance of a specific market index or market segment, rather than trying to outperform them. Such funds follow specific rules and methods to provide services for their target markets and risk preferences.

SPY (SPDR S&P 500 ETF Trust) and VTI (Vanguard Total Stock Market ETF) are examples of well-known passive funds. Your financial expert friend or uncle may have also recommended that you buy these funds instead of some "air coin", but you have proved them wrong with your actual actions! But I digress.

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

But please don't take those college classmates who are obsessed with WSB options as "the vast majority of people".

Going into all the details that drive the development of passive investing would require an entire article, but we can boil it down to a few simple factors:

1) Cost Efficiency

Passive funds (such as index funds and ETFs) typically have much lower expense ratios than actively managed funds because they do not require a lot of "active work" from the fund manager. Once the rules and methods are set, the rest of the work is done primarily by algorithms, with only a small amount of human intervention during quarterly adjustments. Lower costs generally mean higher net returns, which makes passive investing particularly attractive to cost-conscious investors.

2) Accessibility and Distribution

Put simply, passive funds are more accessible. You don’t have to go through the hassle of sifting through which active funds are worth investing in. There’s an entire industry dedicated to getting financial products into the hands of your grandparents, and passive funds are more deeply integrated into these distribution chains due to regulation. For example, most active funds are limited in terms of promotional materials, while passive investment products are truly integrated into many channels such as 401(k) systems and pension systems.

3) Consistent Performance

The “wisdom of the crowd” often leads to better results. The fact that most actively managed funds have underperformed their benchmarks over the past 15 years further highlights the advantages of passive funds. While you may not get a 10x return like buying Tesla or Shopify early, most people don’t bet 50% of their net worth on a single stock. High risk is not always a sexy choice.

4) Still not convinced? Here are some interesting statistics

In the US, 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, total assets under management (AUM) for passive funds exceeded those of active funds for the first time in history.

Data from October 2024 show that US equity index funds hold $13.13 trillion in global assets and $10.98 trillion in US assets, while actively managed equity funds hold $9.78 trillion and $7.26 trillion, respectively.

Index funds now account for 57% of US equity fund assets, up from just 36% in 2016.

In the first ten months of 2024, US stock index funds had inflows of $415.4 billion, while actively managed stock funds had outflows of $341.5 billion during the same period.

Because of this, the entire traditional financial sector and crypto fund managers with traditional financial backgrounds are paying close attention to the progress of Bitcoin ETFs (pun intended, they are indeed "investing" in them). They know that this will be the starting point of a larger torrent that will truly bring 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 on developing cryptocurrency indices, adoption has been relatively slow, starting with single-asset crypto products. Obviously, this is because these products are easier to launch, which is why everyone is scrambling to be the first to launch a Bitcoin ETF. Today, we have begun to see efforts to develop Ethereum-collateralized ETFs and more altcoin-based products.

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

Nevertheless, it will take time to launch and promote these products. Since they are new products, they cannot automatically enjoy the benefits of monthly fund inflows like the existing popular passive products.

MSTR promotes traditional finance

Next is MSTR: As MSTR is included in the Nasdaq 100 Index, passive funds (such as QQQ) will be forced to automatically buy MSTR, and MSTR will use these funds to buy more Bitcoin. In the future, new BTC-stock-gold hybrid passive products may emerge to replace the role of MSTR, but in the foreseeable 3-5 years, because MSTR is a mature US listed company, it is more likely to quickly meet the index inclusion qualifications of top passive funds than newly launched passive products, thus playing the role of "Bitcoin Treasury Company".

Therefore, as long as MSTR continues to use capital to buy more BTC, the demand for Bitcoin purchases will continue to increase.

No Better Choice

If this sounds too good to be true, that’s because there are still some minor hurdles that need to be addressed before MSTR can play this role more effectively. For example, MSTR is less likely to be included in the S&P 500 because the S&P 500 requires companies to have positive cumulative earnings in the most recent quarter and the past four quarters. However, new accounting rules starting in January 2025 will allow MSTR to include changes in the value of its BTC holdings in net income, which could make it eligible for inclusion in the S&P 500 index.

Essentially, this is the core of traditional finance.

5 Minutes of Calculation and Assumptions I literally only spent 5 minutes doing this calculation, if there are any errors or suggestions for assumptions, please leave a comment below!

In short, as MicroStrategy is incorporated into the supply chain of traditional finance, the entire traditional financial passive investment ecosystem will inadvertently buy more Bitcoin, just as they unknowingly hold Nvidia shares, which has a similar effect on the price of Bitcoin as traditional finance.