Crypto assets: Testing the waters
MANNIK S. DHILLON, CFA, CAIA 16-Aug-2021
The world of crypto assets is still relatively foreign to most investors, even some sophisticated institutions. Admittedly, it’s a dynamic and potentially disruptive asset class that can be hard to comprehend. Concepts like distributed ledgers, blockchain and digital coins are both intriguing and confounding. And while there are constantly new crypto assets entering this space—some with great fanfare and others more dubious—one thing seems certain: digital assets may merit serious consideration for inclusion in a broadly diversified investment portfolio for certain investors.
Consider the trajectory of digital assets, which now have grown to an estimated market capitalization of $1.4 trillion, as of mid-year 2021*. Even anecdotally, it has become clear that digital assets are becoming mainstream.
- Legacy financial institutions—albeit some more willingly than others—are beginning to acknowledge consumer desires to use in crypto through existing banking portals.
- A growing list of merchants—both domestic and overseas—are accepting forms of digital currency, and there is evidence to suggest that the largest online marketplaces are mulling ways to allow people to shop with digital currency.
- Even today there are crypto debit cards (even rewards cards!) that can be used anywhere that certain legacy cards are accepted.
Simply put, a trend toward digital currencies appears to be real and lasting because it offers convenience, anonymity, security and other benefits. History has shown us that new technologies and tools that can enhance efficiency, transparency and help move the economy faster have eventually taken hold. It wasn’t that long ago that some pundits dismissed the internet as narrow form of communication that would always be relegated to the academic world. And let’s not forget the potential benefits of cryptocurrencies to an estimated 1.7 billion currently unbanked consumers around the world, which suggests that it has the potential to make a positive social impact globally.
How should investors allocate?
As consumer demand for crypto grows, it’s easy to understand why it’s gaining traction from an investor perspective. Digital assets can bring added diversification benefits to an investment portfolio and, potentially, provide an opportunity to capture returns with low correlation to other assets. Some investors view crypto as offering a new source of potential long-term growth as it gains a lasting foothold. And, of course, there’s the notion that various digital coins may be an effective store of value and a possible hedge against future inflation. All this explains its rapid growth as an asset class, which in turn has brought greater liquidity, an emerging regulatory framework, and rising institutional interest.
Yet there are almost 11,000** cryptocurrencies in existence today, which naturally begs the questions: Which coins will prove to be the long-term winners? Which ones should investors consider buying today? How might investors allocate?
These are tricky questions. Some of the early movers in this space now have name recognition to even the most casual investors. Yet there will no doubt be new viable crypto assets to emerge in the future. Think back to which dot-com companies were the big winners in the late 1990s and early 2000s? Do these companies continue to hold dominant market positions or even continue to exist?
Another analogy can be drawn with the emerging markets asset class. As recently as the mid-1990s, emerging markets were considered too risky or too unstable or too unusual for some investors. Today, however, they are a permanent portfolio allocation for every institutional portfolio and an important source of potential growth and diversification.
Thus, for this new digital asset class, perhaps an old-school approach is warranted. An indexed allocation—one that diversifies across a basket of digital currencies—might be the best way to gain long-term exposure to crypto. We believe an indexed approach should offer:
- True broad market representation across a basket of crypto assets that are vetted by a globally recognized indexing expert, with strict selection criteria and an eye toward index governance.
- Ample liquidity with the ability to request subscriptions and redemptions daily
- Regular rebalancing and reconstitution, which allows the index to include new entrants in the field assuming the coins meet the necessary criteria. This ensures that the basket retains those coins with a higher probability of being a lasting store of value.
- Currencies listed on multiple approved exchanges and held at the most reputable cryptocurrency custodians.
The digital asset landscape is exciting but still new for many investors. However, utilizing experts to vet specific digital assets broadly, with a rigorous and disciplined process, seems like a smart way to gain exposure while also seeking to manage the risk and volatility inherent to any emerging asset class.
* Source: Coinmarketcap.com
** 10,799 as of July 8, 2021, according to Coinmarketcap.com