Crypto assets: Choose your words carefully
SCOTT KEFER, CFA 26-Oct-2021
In the mid-1990s, Bill Gates famously said that he saw “…little commercial potential for the internet for the next 10 years." Of course, that was before anyone really understood the internet, and he quickly redirected his entire company’s primary focus to this emerging technological platform that would ultimately reshape every industry in ways no one could have fathomed.
More recently, we’ve seen a similar debate with regard to the emerging crypto asset class. Some financial services pundits were initially dismissive of digital assets only to later advocate for their place in client portfolios.
This trajectory of belittling to acquiescing to embracing is not unusual. Anything new and so disruptive to the status quo is certain to attract naysayers. On top of that, new technologies (especially digital assets) use an entirely unfamiliar vocabulary and mind-bending concepts that are hard to grasp. Thus, being initially skeptical of crypto is only natural.
The parallels between the internet and the rapidly emerging digital asset class are striking, particularly when it comes to the underlying blockchain technology. The internet was first created as a crude communications platform with a narrow government (mostly defense) and academic focus. There was no real commercial use, and the notion of shopping or streaming movies and music was not even a fantasy when in the early days. Who could have imagined?
Think of how a similar situation might be unfolding with the digital asset class, which is built around a truly innovative technology. Today, investors may view crypto narrowly—either as a “gold replacement” or as a single anonymous currency that has yet to gain worldwide acceptance. Yet it’s vital to remember that crypto assets have the potential to be so much more. Remember, email was once virtually synonymous with the internet, but years later it turns out to be only one application on what was once a mysterious new platform.
Digital assets are based on blockchain technology—which is a means for recording transactional data that is verified across many users or computers—and they exist beyond the control of any single entity or governing body. Yet “currency” is only one application underpinned by the blockchain. What else will emerge is unknowable at this point, and these digital assets may end up disrupting many industries beyond finance.
In addition to its use as a currency alternative or for peer-to-peer transactions, the transparency and decentralized nature of the blockchain suggests that it may have far-reaching implications that could fundamentally alter things like: the entire derivatives market; insurance, title insurance and by extension real estate markets; personal identity security; music/arts rights and licensing; and even supply chain logistics and manufacturing.
Moreover, it’s hard not to marvel at the recent growth trajectory of digital assets. Consider that “the number of global crypto users reached 221 million in June 2021. It only took four months to double the global crypto population from 100 million to 200 million.* There’s a tremendous amount of developer activity looking for new blockchain applications and a great deal of money being raised for crypto-related ventures. And if that’s not enough, the country of El Salvador announced that it was using Bitcoin as its legal tender, and other nations may follow. It certainly seems like the fledgling crypto asset class is here to stay.
Diversification still rules
For those interested in participating, this leads to a bigger question on how to play this emerging investing theme. For individuals, what's most popular right now are single coins—the most common being Bitcoin. But is it wise to simply go after the proverbial first-mover in this space, or does a coin with less name recognition (or perhaps even a pending new coin) offer better value? It’s important to know that there are diversified ways to access the crypto asset class.
Before making any allocation, investors should understand that it is a volatile asset class that may not be appropriate for all. But those who are interested should carefully reflect on a few key considerations, including:
1. Diversification: Do you want to bet it all on a single coin, or is broad, multi-coin exposure a better fit for an initial allocation? And is that multi-coin approach dynamic with the ability to keep pace with innovation and include new viable coins (worthy of institutional investment) as they emerge?
2. Liquidity: If choosing a multi-coin approach, does the investment vehicle offer daily subscription and redemption requests, or does it only offer monthly or quarterly subscriptions? And if a fund offers the ability to trade over-the-counter, are there potential premiums and discounts to the actual NAV of the assets that one needs to take into account?
3. Cost: As ever, investors need to pay attention to fees. Existing fees associated with this emerging asset class span a wide range, so it’s important to understand what your expenses are (especially when acting as your own custodian for these types of assets).
4. Risk Tolerance: It’s important to understand that the crypto asset strategies will likely continue to be volatile, so investors need to size their allocation appropriately (if they choose to invest at all).
In the end, the digital asset class may be the next big thing, and it appears to offer an asymmetric return opportunity. The value creation potential of crypto is exciting, so we all should think twice before belittling this new technology that’s just in its infancy and has the potential to impact everyday lives in ways we have yet imagined.
1: Measuring Global Crypto Users : A Study to Measure Market Size Using On-Chain Metrics, July 2021, Kevin Wang