Bitcoin is infiltrating stock index funds

Index fund investors may have little interest in betting on cryptocurrencies, as they prefer to earn solid returns from well-known stock market benchmarks, but that doesn’t mean they don’t own Bitcoin.

Index funds were designed to allow investors to participate in the stock market, which generally rises over the long term — without having to bet on what will be the “next big thing.” Investing in cryptocurrencies is the cultural opposite, valuing bold speculation and trendy digital assets.

But recently, Bitcoin has found its way into many index fund portfolios through a sort of backdoor — courtesy of MicroStrategy, a former software company turned Bitcoin carrier. The company holds 592,100 Bitcoins, worth more than $62 billion, and is continually adding to that stash by issuing preferred shares, including $1.2 billion worth of them earlier this month. MicroStrategy’s market value hit $104 billion on Friday, making it large enough to be included in several popular stock market indices, including the Russell 1000, Russell 3000 and Nasdaq 100. (It’s worth noting that MicroStrategy isn’t included in the S&P 500, whose components are chosen by an index committee run by S&P Global Indices.) Still, MicroStrategy (and its bitcoin holdings) have made their way into the portfolios of several popular funds. The $337 billion Invesco QQQ Trust has about 0.53% of its assets invested in MicroStrategy, according to Morningstar. While that may not sound like much, it’s roughly in line with the fund’s holdings in well-known companies like Intel, Mondelez International and DoorDash.

Other funds, such as the $1.8 trillion Vanguard Total U.S. Stock Index ETF and the $15 billion iShares Russell 3000 ETF, also hold small amounts of MicroStrategy shares, accounting for less than 0.2% of fund assets.

Given the sheer size of these index funds, even a tiny allocation to their portfolios could bring billions of dollars of investment into MicroStrategy. A recent report from JPMorgan Chase's Global Market Strategy team showed that index funds collectively hold about $14 billion in MicroStrategy shares.

If you add in active mutual funds and institutional investors — investors that don't invest in index mutual funds but still use indexes as a performance benchmark — JPMorgan estimates that the total market value of MicroStrategy held by various funds is close to $50 billion.

One ​​potential problem for the stock is that the price of Bitcoin has been rising recently, and MicroStrategy has been increasing its holdings of Bitcoin. These two factors have together driven MicroStrategy's market value up. At the same time, the increase in market value has prompted index funds to further buy the company's shares.

However, this dynamic may one day reverse. If Bitcoin falls and MicroStrategy's market value shrinks, index funds may quickly turn from buyers to sellers, triggering a chain reaction.

“The more Bitcoin MicroStrategy buys, the higher the price of Bitcoin, which in turn drives up its market value and increases its weight in stock indexes,” wrote Nikolaos Panigirtzoglou, head of JPMorgan’s strategy team. “This self-reinforcing cycle increases the risk of bubble and crash cycles and makes MicroStrategy investors uneasy about buying its shares.”

MicroStrategy did not respond to a request for comment.

Investors in index funds may not be interested in Bitcoin or MicroStrategy itself. But buying an index fund means letting the market decide what to invest in. At least these investors can take comfort in the fact that MicroStrategy accounts for well under 1% of any given index fund portfolio, so even if there is a loss, the impact will not be significant.