Cryptocurrencies: a new asset class?

Cryptocurrencies are a subset of digital currency that is decentralized, and based on a set of algorithms and protocols that enable a peer-to-peer, cryptographically based payment mechanism, medium of exchange and store of value (Gartner).

The first cryptocurrency - the Bitcoin - was created in 2009. Since, others have been developed, with various success. According to Coinmarketcap.com, more than 1337 cryptocurrencies are available and new ones are created every day.

Cryptocurrencies’ capitalization increased 30-fold in one year

The value of each crypto-currency is basically determined according to the cost of the resources needed to validate a new block (hardware, electricity) in a blockchain. Then, this value evolves with the supply and the demand, the technical developments, the method of compensation, but also with external factors:

• Slowing supply growth of quantity of Bitcoins;
• Geopolitics and capital control (Brexit, election of Trump, devaluation of the Chinese currency, regulation of Chinese capital...);
• Anticipation of demand (interest of asset managers, financial intermediaries and central banks on the use of crypto-currencies);
• Increasing acceptance of consumers and suppliers of products and services (such as the recognition of Bitcoin as a legal currency by Japan in April 2017).

The global capitalization of crypto-currencies reached a peak of $425Bn in December 8, 2017, with a volume of daily transactions amounting to $13-15 billion. The market remains dominated by Bitcoin, which represents 55% of the capitalization. Ether (15%), Bitcoin Cash and Ripple complete the podium. Litecoin, Dash, IOTA or NEM can also be mentioned, each representing 1 to 3% of the market.

Are cryptocurrencies an investment opportunity?

Beyond a means of payment, crypto-currencies are now becoming investment vehicles. they represent a high growth potential with a pent-up demand and a high volatility that creates investment opportunities. But it’s not their only merit:

• they constitute a universe of diversification of portfolios. DLT Financial estimates the correlation between the DLT10 Index (a cryptocurrency financial index based on 10 major digital currencies) and the S&P 500 at 4.7%.
• they might be an anti-inflationary store of value, since coins issues are generally limited in volume.
• they could be safe haven security, thanks to its independence to central banks’ control and economic incertitude.

Of course, as any investment with high potential of performance, it involves risks. Because it is based on an ongoing technology, with a relatively low number of users, without – for the moment – central regulation, cryptocurrencies may show high volatility. Some – such as CEOs of major banks - have loudly expressed their fears and believe that a bubble is close to blow up. It is true that there are similarities with the Internet bubble, with opportunistic and irrelevant offers that override investors’ enthusiasm. Cyber threats have also tarnished their image, even though hacking and scams have never been linked to the protocol but to “wallets” and exchange platforms (see below).

From the bursting of the Internet bubble emerged the today’s biggest companies, which have deeply changed the economy and our lifestyle. The same could be true for blockchains and cryptocurrencies, whose potential applications are innumerable. Not considering them as a potential investment universe might be the biggest risk.

How to invest?

Except to become "minor", the two main ways of investing directly in crypto-currencies consist in:

• acquiring « coins » via purchase platforms (Coinbase, Coinmkt, Hivewallet…) or exchange platforms (Bithumb, Poloniex, Kraken, Bitfinex, OKCoin, etc.) ;
• participating in Initial Coin Offering (ICO), which aims to raise funds to finance projects on a blockchain. In the first half of 2017, more than $1 billion was raised through ICO.

With so much lucrative potential at stake, asset managers and financial institutions have begun to focus on electronic currencies. First investment solutions have been proposed since 2015 and other investment offerings as well are services have been announced recently:

• In September 2015, ARK Web x.0 ETF (ARKW), managed by Ark Investment Management, became the first ETF to invest in bitcoins by purchasing shares of Bitcoin Investment Trust. ARKW is invested on next-generation Internet-linked companies and now offers Bitcoin exposure to the tune of 9,7%.
• The Bitcoin Investment Trust now owned by Grayscale Investments LLC, was launched as a publicly traded ETF in 2015, quoted on OTC market. Its objective is to track the underlying value of bitcoin and to enable investors to gain exposure to the price movement of bitcoin, without buying, storing, and safekeeping bitcoins. In April 2017, Grayscale launched a similar ETF benchmarked on Ether: Ethereum Classic Investment Trust. 
• In Europe, XBT Provider, a Swedish issuer, launched a publicly listed bitcoin Exchange Traded Note (ETN) in April 2015 the Bitcoin Tracker One and its euro-denominated version: Bitcoin Tracker Euros (total AUM: $190M (07/31/2017)). Since June 2017, Hargreaves Lansdown allows its customers to invest in this ETN through their self-invested personal pension (Sipp) or their normal broking account. For its part, Vontobel proposes Voncert, a tracker tradable at the SIX Structured Products, which expires in July 2018.
• Crypto Fund AG, headed by Jan Brzezek, previously chairman of the Asset Management division at UBS, announced they schedule to introduce the “world’s first diversified cryptocurrency fund”, based on the Cryptocurrency Index (CRIX).  The fund is expected to be launched in Q4 2017 and the fund provider aims at a volume of 100 million Swiss francs in the first year.
• In July 2017, Falcon Private Bank became the first Swiss private bank to provide blockchain asset management solutions for its clients, in partnership with Bitcoin Suisse AG. In August, it expanded to Bitcoin Cash, Ether and Litecoin the cryptocurrencies which could be trade and store via their cash holdings.
• In August 2017, Fidelity Investments implemented on its website the option to display holdings in Bitcoin, Litecoin and Ethereum held through the digital wallet provider Coinbase.
• TOBAM launched the first Bitcoin mutual in Europe in November 2017. The same month, Swissquote launched a bitcoin Actively Managed Certificate which claims it will decrease the cryptocurrency’s volatility.

To be continued...

Author: Pascal Buisson