Blockchain technology and digital assets; Am I a “neutral” investor?

Written by Javier Colás Gomez de Barreda, Founding Partner of Whale Capital.

DISCLAIMER: The content of this article does not constitute under any circumstances an investment recommendation nor an offer of any investment product. The opinions expressed therein are solely for educational purposes.

On January 10th, a significant event took place concerning the normalization of digital assets within the financial world. A decade after the first request and following a lengthy legal process, the U.S. Securities and Exchange Commission (SEC) authorized the launch of 11 spot bitcoin (BTC) exchange-traded funds (ETFs). Therefore, very well-known and recognized asset managers such as Blackrock, Valkyrie, Grayscale, Bitwise, Hashdex, ARK 21Shares, Invesco Galaxy, Fidelity, Franklin Templeton, VanEck, and WisdomTree have been acting as issuers of these ETFs since that date.

However, beyond the commercialized volumes of these products since their launch (~USD 249bn), this approval represents, in our opinion, a significant step towards the legitimization of digital assets, elevating bitcoin to the level of any other conventional financial asset. It is also big step as well towards the recognition of the crypto assets as a new “asset class” from the perspective of a new investment financial opportunity.?

A new “asset class” whose intrinsic value relies in the blockchain technology itself. A technology that has continuously evolved in terms of investments, capital allocation, resources, professionalization, design, decentralization, security, speed, and scalability of multiple projects or blockchain networks. And where are increasingly seeing more “use cases” for its adoption across various processes in multiple industries and sectors of the economy.

Market Size and Liquidity

Currently, the market capitalization of all crypto assets combined is USD 2.27T, meaning 1% of the total liquid asset market. As for its liquidity, the average daily volume over the past 12 months has been EUR 40bn, very similar to that traded in the American tech index Nasdaq100.

Performance

While it is true that past returns do not guarantee future retuns, it is useful to analyse the evolution of the crypto market’s market capitalization over the past 10 years. Despite its volatility, which we will discuss later, the CAGR over the last ten years has been 98%, significantly higher compared to any conventional asset class including any equity, fixed income, or commodities index.

Volatility and Risk

One main characteristic of crypto assets is their high volatility. Indeed, the realized volatility of BTC over the last 12 months (47%) is undoubtedly much higher compared to any other type of conventional asset. However, a report by Fidelity highlights that by the end of 2023, bitcoin was less volatile than 92 of the 500 companies in the index when measured using 90-day historical realized volatility figures and its 1Y volatility last year is comparable to that of the "big seven."

In any case, it is important to measure the return of an asset not by itself but in relation to the degree of risk assumed with that investment, i.e., the return per unit of risk (Sharpe Ratio). And as can be seen in the table below, over the last 6 years, the crypto market has behaved as the best “asset class” compared to other conventional assets.

Why should I invest in crypto assets?

As I mentioned earlier, investing in blockchain provides access to this disruptive technology that is beginning to be used in multiple industries. The decentralization and transparency it provides can reduce costs and increase the security and traceability in transactions. And offer us the possibility of owning any digital asset.

Unlike the internet, where the value of the network lies in the companies built on it – like Amazon, Facebook, Apple – in blockchain, the networks capture and aggregate the value of what is built on them. Therefore, the more applications a blockchain supports, the greater value the network will have and its native tokens - what we usually call cryptoassets.

As regarding its development and potential, it's worth noting that we are in a very early stage with enormous growth potential. Its adoption rate is comparable to what the internet had in 1997, with its growth trajectory historically very similar.

I am a 'neutral' investor in cryptoassets?

But how much should I invest in blockchain through cryptoassets? Once analysed that the size of the crypto market relative to the total global liquid assets, and in order to replicate said asset allocation, we could conclude that the necessary exposure to replicate this neutral position should be 1%.

And what is the impact of that 1% exposure to cryptoassets?

A global portfolio composed of 50% investment in equities (S&P 500), 40% in fixed income (bond index), 9% in alternative assets (hedge fund index), and 1% in bitcoin (as a “proxy” for crypto assets) would have had a total return of 70% (versus 45% for a portfolio without exposure to crypto assets) over the last 6 years (2017-2023). And most importantly; with only a 1% increase in the total portfolio volatility.(12% vs 11%).

Conclusion

Investing in digital assets means investing in the potential of the blockchain technology itself. A unique opportunity to invest directly in a disruptive and transformative technology that is still in its early years of development. An investment not without uncertainties and challenges, but with risk-return characteristics that have enormous potential and must be considered when making professional financial investments.