The risk of Bitcoin and the value proposition of other digital assets

Marco Manoppo is Head of Research at Digital Asset Research (DAR), where he examines hundreds of digital asset exchanges and digital assets as part of DAR FTSE’s methodology research process for Digital Asset Indices.

Russ Alan Princee: In a volatile market environment, is this a time to be cautious about crypto or is there a place for digital assets in client portfolios?

Marco Manoppo: Crypto is a nascent asset class that is still maturing from its technological and regulatory perspective. As such, it is often considered a risky asset. In today’s macro market environment, investors must be cautious when approaching asset risk. There will be an enormous opportunity for risk-based assets when the macro economy turns, but risk management and position sizing must be adjusted accordingly based on a personal portfolio outlook and time horizon.

The volatility that the digital asset market introduces and the multidisciplinary nature of the tokens themselves required a much more robust approach and understanding in terms of portfolio construction. There is definitely a place for digital assets in a client portfolio, but it needs to be done with care. Like other emerging technology assets in a well-diversified portfolio, there may be a place for crypto, but it should be considered on a case-by-case basis.

While the crypto winter of 2018 and 2019 was a long dry spell for crypto investors, there are many indications that this crypto winter will be different. There is a long pattern in crypto of winters leading to bright springs, as the continued investments build up and begin to show more fruit. The best timing for any investment is difficult to predict, but the patient investor will almost certainly see benefits from a well-managed approach.

Activities in the crypto industry have shown tremendous growth in recent years. Institutional involvement and continued technological innovation have enabled the creation of new sectors within the crypto industry such as DeFi and NFT. Legacy companies, both major financial institutions and tech giants, have also become much more involved in crypto – further proving the staying power of digital assets.

prince: Many RIAs have promoted Bitcoin as the only crypto asset worth considering. What kind of risk does that entail, and how should advisers think about managing this risk?

Manoppo: While Bitcoin is the largest digital asset market by capitalization, the technological growth that catalyzed the momentum of the crypto market’s growth in recent years was primarily driven by other digital assets. For example, technological advances around the scalability of smart contracts have enabled a booming DeFi market that reached $200 billion+ in Total Value Locked at its peak; and the growth of NFT infrastructure enabled artists and musicians to monetize their work and intellectual property in a digitally native way.

Bitcoin’s narrative and market treatment has historically also been much closer to a macro asset, moving in tandem with decisions on gold and central bank policy. While other digital assets that have demonstrated their technological prowess have been treated more like tech stocks or venture investments. This fact alone indicates that there are multiple ways for advisors to think about the risks associated with various digital assets.

As such, it is critical to understand the value proposition of other digital assets and how they may differ from Bitcoin. A proper understanding of codebase construction, maintenance, community engagement, security practices, market liquidity, and regulatory compliance is important to help advisors think about the different risk vectors that exist in the crypto market. The multidisciplinary nature of these tokens and the complexity of having a fully digital, 24/7 global market introduced both risks and opportunities. For advisors, it is critical to understand all the different dimensions of a digital asset before deciding how to manage the risk.

prince: Ethereum has undergone a transition from Proof of Work to Proof of Stake. Instead of crypto miners getting rewards for settling transactions, ETH holders can earn rewards through stakes. What role does return play in crypto portfolios?

Manoppo: Yield in digital assets has been around for quite some time. The sources of these returns vary from investing in blockchain networks to liquidity extraction and lending returns. That said, one of the crypto-native ways to earn returns is via stake. Unlike other sources of returns that are derived from financial mechanisms, staking is a way to earn returns by participating in the underlying blockchain network.

Stakers receive returns by allocating and locking their tokens for a certain period of time to help the underlying blockchain network process transactions and achieve consensus. In a Proof-of-Stake—PoS—a type of blockchain network, the existence of stakers is critical to the integrity and functionality of the network.

As the number of blockchain networks implementing a PoS consensus mechanism increased over the past couple of years, stake rewards have slowly become more popular. However, the majority of digital assets that have a return on investment have been relatively lower in market value, limiting institutional investors’ ability to participate due to liquidity constraints. That is until Ethereum moved to PoS.

As the second largest digital asset by market capitalization, Ethereum’s move to PoS is a big deal because it is also the largest blockchain network by the number of applications built on top of it, as well as the value it holds across its DeFi ecosystem. Unfortunately, institutional investors now have a way to meaningfully participate in a staking yield strategy for their crypto portfolio. Compounded over the years, the extra single-digit, and sometimes low-double-digit percentage returns that crypto investing provides will significantly change investors’ portfolio returns.

Digital Asset Research (DAR) is a specialist provider of ‘pure’ digital asset data, insights and research for institutional clients. Since 2017, DAR has led the way by carefully reviewing noisy inputs for flagship clients such as Bloomberg, FTSE Russell and Wilshire. Every day, DAR processes 250+ million trades to price 7,000+ institutional-grade digital assets and deliver a variety of product solutions to navigate the crypto landscape.

RUSSIAN ALAN PRINCE is CEO of Private Wealth magazine (pw-mag.com) and Chief Content Officer of High-Net-Worth Genius (hnwgenius.com). He consults with family offices, the wealthy entrepreneurs on fast track and select professionals.