Future Themes — Systems — Evaluating cryptocurrencies as an asset class
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By: Alexandre Chau, Equity Portfolio Analyst; Ranjit Ramachandran, CFA, Equity Research Analyst
Have bitcoin and other cryptocurrencies entered the mainstream? Are institutional investors ready to view crypto as a distinct asset class? In this piece, we evaluate cryptoassets’ potential as an asset class as the topic dominates the headlines.
Crypto analysis: Supply and demand
There are now thousands of cryptoassets globally. These assets have seen a rapid increase in interest in recent years from a broad spectrum of retail and institutional investors. Here, we focus on the leading cryptocurrency, bitcoin, which currently is roughly 50% of the US$2.0 trillion crypto market.
Institutional participants like family offices, corporates, insurance companies, asset managers, and, allegedly, major university endowments are all starting to make significant cryptocurrency investments. Bitcoin, in particular, has seen large institutional participation since 2020. Participants have been buying through CME Futures, on the Grayscale Bitcoin Trust, and directly on exchanges.
Importantly, bitcoin was the first scarce digital asset ever created, with a fixed total supply of 21 million coins. Its new supply is cut in half every four years through the “halving” mechanism, until all 21 million coins are mined. Approximately 18 million coins have been mined to date, with around 5 million believed to be lost, 10 million stored in long-term cold storage, and close to 3 million on exchanges. This scarcity is critical to bitcoin’s potential as an asset class.
Before bitcoin, the only known scarce assets (valued only for their scarcity as a store of value) were precious metals. With a growing number of cryptocurrencies, this environment is rapidly changing. In our view, compared to other cryptos, bitcoin benefits from having the highest network effects and the largest market cap, resulting in the highest investor confidence. And just as investors believe in the value of gold because others believe in it, we think bitcoin is likely to benefit from this differentiated confidence. We believe these factors, along with growing institutional participation, currently make bitcoin less likely to be disrupted by other cryptos.
Bitcoin as a store of value (and other asset class characteristics)
As we evaluate bitcoin as an asset class, one critical point is its role and history as a store of value. Global assets have gone through asset price inflation since quantitative easing started in 2008. Yet, when we look at how assets have performed relative to G4 central bank balance sheets, we can observe that equities have traded sideways since 2008. Global currencies, gold, and real estate, meanwhile, have depreciated in balance sheets terms. Bitcoin is one of the only assets that has outperformed the G4 central bank balance sheets since 2008. 1
Notably, bitcoin’s weekly returns for the last 10 years are slightly positive on average and skewed slightly positive as well. 2 Its volatility has also been in a more stable regime since 2014, hovering between 50% and 100% and lowering over time. 3 Critically, bitcoin exhibits relatively low correlations (on average, approximately 0.1) 4 to other main asset classes (Figure 1) , so the impact of its higher volatility is more muted in a broader portfolio.
In our view, this performance history, stabilizing volatility, and low correlation to other assets make a strong case for bitcoin’s role as a store of value and crypto as its own distinct asset class.
Valuing the crypto asset class
Institutional investors may also wonder how to value assets like bitcoin. As bitcoin does not generate cash flows, there are several different methodologies for extrapolating potential future prices for the asset. Using four common methods for valuation — the gold valuation method, stock-to-flow method, institutional participation method, and high-net worth participation method — forecasted valuations range from US$100,000 to US$500,000 by 2025. 5 As this is a relatively new asset class, we believe investors need to consider a range of valuation metrics such as these to estimate its future potential.
The future of finance and ESG
In our view, not only is bitcoin a store of value akin to digital gold, but it is also a call option on the future of finance. Over the past year, there has been a surge in use cases for cryptos. We believe bitcoin opens the gates to the future of decentralized finance (DeFi), creating new tokens, use cases, and new economies. We believe DeFi has the potential to upend the existing financial system, remove the intermediary, and help develop new lending/borrowing protocols, decentralized exchanges, and new marketplaces.
But at the same time, these assets have often raised ESG concerns. We think the perceptions of cryptos facilitating illicit activity and being environmentally unfriendly are misleading. In our view, we should consider the utility that bitcoin can provide for societies that are experiencing inflation, where monetary regimes are not stable, and payment tools are unsafe. Ultimately, we do think bitcoin mining will continue to rely on renewable energies and future bitcoin buyers will be able to source their coins from ESG-compliant miners.
Bitcoin’s potential risks
Given how early in their lives both bitcoin and the whole crypto asset class are, it behooves us to note the substantial risks that exist. While the following list is not exhaustive, we believe regulation, government policy, leverage in parts of the ecosystem, changes in the macroeconomic environment, technological risks, and ESG concerns are all potential risks for the asset class.
Bottom line: Cryptocurrency investment implications
We believe bitcoin and other cryptoassets represent a new asset class that will increasingly gain acceptance and participation of institutional investors. In addition, we think there will likely be progressively more specialization, sophistication, and use cases (such as DeFi and nonfungible tokens). While many participants are just seeking to get bitcoin exposure today, we believe they may be looking to build a broader portfolio of digital assets in the future.
As bitcoin dominates today’s headlines and various valuation methods show its significant potential, we think the growing interest in cryptos is just beginning. At the same time, we need to be mindful of the considerable risks that still exist for the asset class.
1 Source: Real Vision, March 2021. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. | 2 Source: Eight Isle, December 2020. | 3 Source: Eight Isle, December 2020. | 4 Sources: Axioma, Eight Isle, December 2020. | 5 These valuation estimates are based on the gold valuation method, stock-to-flow method, institutional participation method, and high-net worth participation method from various publicly available sources such as Fidelity Digital Asset and ARK Investment. Data as of 2021. Actual results may vary significantly from forward looking estimates.
At the time of writing, all statements, other than historical facts, contained within this document that address activities, events or developments that will or may occur in the future are forward-looking statements. Such statements are subject to a number of assumptions, risks and uncertainties. Please note that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forward-looking statements.
