The extent to which digital assets are likely to disrupt finance and other sectors is not widely understood. It’s lost in confusion and controversy. Yet blockchain technology’s potential makes it worth considering a small allocation to bitcoin or other digital currencies.
Rarely has the emergence of a new asset class polarised opinions so much. To the credit of crypto-sceptics, rarely had a new asset class been so innovative and difficult to understand. Moreover, bitcoin first-day evangelists have confused the picture, by preaching the end of US dollar hegemony and that the most famous crypto-assets are the natural hedge against this inevitable Armageddon.
In the meantime, bitcoin has achieved the status of digital gold: a store of value for a new generation of investors. Like the yellow metal, bitcoin has little use, is cause for environmental concerns and is challenging to store safely. It’s likely, however, to keep its role as a safe haven in the long term. In the meantime, its market capitalisation is still only a fraction of that of all gold mined to date. But when bitcoin eventually finds its equilibrium price, it seems likely to be a stable store of value, albeit underperforming in the long run the real productive asset: capitalist economies’ equities – as is the case with gold.
The rising digital ecosystem
Bitcoin and its controversy have obscured, at least for the uninitiated, the rise of the digital asset ecosystem. A decentralised financial system is being built alongside the more familiar historical financial system. Decentralised protocols (DeFi) operating at zero marginal cost allow the intermediation of these new assets. They can be traded, borrowed or lent (relatively) easily in this autonomous financial system.
As investors, we are faced with a double uncertainty: both of a technological and regulatory nature.
Banks without employees take deposits, which they remunerate, and make loans with the profit from which they buy back their digital capital. Until very recently, all these activities took place outside the supervision of our national regulators. But the regulators have now entered the picture and this is likely just the beginning of crypto assets supervision.
That’s hardly surprising. Governments have not put an end to bank secrecy for tax collection purposes only to see the internet and crypto-assets undo their good work. But, more importantly, the privileges arising from controlling the financial system are far too strategic for governments to even consider sharing.
As investors we are, therefore, faced with a double uncertainty: both of a technological and regulatory nature. We don’t yet know which applications will develop based on the crypto-asset infrastructure, and we don’t quite comprehend how countries will intervene to regulate them. That’s all it takes for these assets to be extremely volatile, as their potential intrinsic value is impossible to estimate – for now.
Allocating to the future
The fact that they are volatile does not mean they should be ignored or avoided. First, volatility is not inherently bad. In these times of financial repression, the suppression of volatility tends to foster the squeezing of returns towards zero, or below, after inflation. Second, while many understand crypto’s potential to disrupt the financial system and its historical players, fewer realise that finance is just one industry among many on the cusp of a radical paradox shift stemming from blockchain technology’s ability to digitise trust and contracts. Once one realises this, the consequence is self-evident. Crypto-assets cannot be ignored as they may severely disrupt the businesses underlying the traditional assets held in our portfolios – whether credit or equities.
Intermediaries and multi-family offices might consider allocating a small amount to digital assets. Intermediaries may wish to call on the experience and expertise of our in-house specialists. Each will appreciate the right weighting according to its own circumstances, but when we talk to those who have already taken the step, allocations typically vary between 0.5% and 5%. The resulting volatility (cryptos have proven to be highly correlated to traditional risky assets in down market episodes) is the price to pay for learning, capturing potential long-term opportunities and, more importantly, avoiding missing out on the potential future impact on the other assets in a portfolio. This is true risk management, the kind that hedges permanent losses of value rather than short-term volatility!