The digitization of money and the “EM-ification” of developed markets could transform today’s systems Traditional currencies, central banks, capital markets, and the overall financial system are all poised for significant disruption.
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These innovations could transform money and financial systems as we know them. They have vast implications for the economy and society that could be as impactful as the invention of the internet.
Bitcoin and other cryptocurrencies represent a new US$2 trillion asset class that we believe will increasingly gain acceptance and participation of institutional investors.
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Ranjit Ramachandran, CFA, Equity Research Analyst and Portfolio Manager Alexandre Chau, Equity Portfolio Analyst
Have bitcoin and other cryptocurrencies entered the mainstream? Are institutional investors ready to view crypto as a distinct asset class? In this piece, we evaluate cryptoassets’ potential as an asset class as the topic dominates the headlines.
There are now thousands of cryptoassets globally. These assets have seen a rapid increase in interest in recent years from a broad spectrum of retail and institutional investors. Here, we focus on the leading cryptocurrency, bitcoin, which currently accounts for roughly 40% of the US$2.2 trillion crypto market.
Institutional participants like family offices, corporates, insurance companies, asset managers, and major university endowments are starting to make significant crypto-related investments. Bitcoin, in particular, has seen large institutional participation since 2020. Participants have been buying through CME futures, on the Grayscale Bitcoin Trust, and directly on exchanges.
Importantly, bitcoin was the first scarce digital asset ever created, with a fixed total supply of 21 million coins. Its new supply is cut in half every four years through the "halving" mechanism, until all 21 million coins are mined. Approximately 19 million coins have been mined to date, with around 5 million believed to be lost, 10 million stored in long-term cold storage, and close to 3 million on exchanges. This scarcity is critical to bitcoin’s potential as an asset class. Before bitcoin, the only known scarce assets (valued only for their scarcity as a store of value) were precious metals. With a growing number of cryptocurrencies, this environment is rapidly changing. In our view, compared to other cryptos, bitcoin benefits from having the highest network effects and the largest market cap, resulting in the highest investor confidence.
Institutional participants like family offices, corporates, insurance companies, asset managers, and major university endowments are starting to make significant crypto-related investments.
And just as investors believe in the value of gold because others believe in it, we think bitcoin is likely to benefit from this differentiated confidence. We believe these factors, along with growing institutional participation, currently make bitcoin less likely to be disrupted by other cryptos.
As we evaluate bitcoin as an asset class, one critical point is its role and history as a store of value. Global assets have gone through asset price inflation since quantitative easing started in 2008. Yet, when we look at how assets have performed relative to G4 central bank balance sheets, we can observe that equities have traded sideways since 2008. Global currencies, gold, and real estate, meanwhile, have depreciated in balance-sheet terms. Bitcoin is one of the only assets that has outperformed the G4 central bank balance sheets since 2008.1
1 Source: Bloomberg. Data from 30 September 2010 – 31 December 2021, monthly observations. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Notably, bitcoin’s weekly returns for the last 10 years are slightly positive on average and skewed slightly positive as well.2 Its volatility has also been in a more stable regime since 2014, hovering between 50% and 100% and lowering over time.3
Critically, bitcoin exhibits relatively low correlations (on average, approximately 0.1)4 to other main asset classes (Figure 1), so the impact of its higher volatility is more muted in a broader portfolio.
FIGURE 1: LOW CORRELATIONS TO TRADITIONAL ASSETS
Bitcoin
US equity
DM equity
EM equity
Global HY
Global I/L
Int corp IG
Int Treasury
US corp IG
US Treasury
Gold
Oil
1.00
0.16
0.20
0.98
0.24
0.77
0.81
0.15
0.83
0.85
0.74
0.08
0.47
0.52
0.44
0.67
0.07
0.39
0.43
0.38
0.87
0.09
0.35
0.40
0.37
0.58
0.82
0.95
0.03
0.53
0.41
0.78
0.76
0.84
0.66
-0.06
-0.24
-0.21
-0.25
-0.02
0.48
0.63
0.42
0.34
0.45
0.69
0.65
0.64
0.17
0.46
0.12
Sources: Bloomberg, Wellington Management | As of December 2021 for the three years prior, using weekly returns. | PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RETURNS. 2 Source: Bloomberg. Chart data: 1 January 2011 – 31 December 2021. | 3 Ibid | 4 Sources: Bloomberg, Wellington Management. As of December 2021 for the three years prior, using weekly returns. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RETURNS.
In our view, this performance history, stabilizing volatility, and low correlation to other assets make a strong case for bitcoin’s role as a store of value and crypto as its own distinct asset class.
Institutional investors may also wonder how to value assets like bitcoin. As bitcoin does not generate cash flows, there are several different methodologies for extrapolating potential future prices for the asset. Using four common methods for valuation — the gold valuation method, stock-to-flow method, institutional participation method, and high-net-worth participation method — forecasted valuations range from US$100,000 to more than US$500,000 by 2026.5 Notably, the stock-to-flow model has recently failed to accurately track the bitcoin price.
As this is a relatively new asset class, we believe investors need to consider a range of valuation metrics such as these to estimate its future potential.
5 These valuation estimates are based on the gold valuation method, stock-to-flow method, institutional participation method, and high-net-worth participation method from various publicly available sources such as Fidelity Digital Assets and ARK Investment. Data as of 2021. Actual results may vary significantly from forward-looking estimates.
Below are a few key terms that investors may come across as they evaluate the investment potential of the cryptocurrency asset class.
Blockchain — A blockchain is a decentralized peer-to-peer electronic network that relies on computational proof instead of a central authority to authenticate transactions. In other words, software replaces a central authority as the source of trusted validation. Proof of work — PoW is a consensus mechanism, most prominently used in bitcoin, that has the participants in a network solve a cryptographic proof to validate transactions on the network or when mining new coins. Proof of stake — PoS is a consensus mechanism in other cryptocurrencies — such as Ethereum — that is used to validate transactions and when mining new coins. This methodology is based on the size of the cryptocurrency holdings (or “stake”) and uses far less energy than proof of work. Altcoins — Altcoins are all other cryptocurrencies other than bitcoin, including Ethereum, Solana, stablecoins, and meme coins. Stablecoins — Stablecoins are cryptocurrencies that have values pegged to other assets — such as the US dollar, a commodity, or another cryptocurrency. Meme coins — Meme coins like Dogecoin and Shiba Inu are cryptocurrencies that originated from internet memes. They are considered significantly more speculative than bitcoin by institutional investors. NFTs — Non-fungible tokens (NFTs) are unique digital assets stored on a blockchain. These include digital art and music.
In our view, not only is bitcoin a store of value akin to digital gold, but it is also a call option on the future of finance. Over the past year, there has been a surge in use cases for cryptos. We believe bitcoin opens the gates to the future of decentralized finance (DeFi), creating new tokens, use cases, and new economies. We believe DeFi has the potential to upend the existing financial system, remove the intermediary, and help develop new lending/borrowing protocols, decentralized exchanges, and new marketplaces.
But at the same time, these assets have often raised ESG concerns. We think the perceptions of cryptos facilitating illicit activity and being environmentally unfriendly are misleading. In our view, we should consider the utility that bitcoin can provide for societies that are experiencing inflation, where monetary regimes are not stable, and where payment tools are unsafe.
We believe bitcoin opens the gates to the future of decentralized finance (DeFi), creating new tokens, use cases, and new economies.
Ultimately, we think bitcoin mining will increasingly rely on renewable energies and future bitcoin buyers will be able to source their coins from ESG-compliant miners.
Given how early in their lives both bitcoin and the whole crypto asset class are, it behooves us to note the substantial risks that exist. While the following list is not exhaustive, we believe regulation, government policy, leverage in parts of the ecosystem, changes in the macroeconomic environment, technological risks, and ESG concerns are all potential risks for the asset class.
Ether — the cryptocurrency of the decentralized Ethereum blockchain network — is the second-largest cryptocurrency, making up around 20% of the total crypto market cap. Ethereum enables smart contracts and uses a proof-of-stake consensus mechanism.
We believe bitcoin and other cryptoassets represent a new asset class that will increasingly gain the acceptance and participation of institutional investors. In addition, we think there will likely be progressively more specialization, sophistication, and use cases (such as DeFi and NFTs). While many participants are just seeking to get bitcoin exposure today, we believe they may be looking to build a broader portfolio of digital assets in the future.
As bitcoin dominates today’s headlines and various valuation methods show its significant potential, we think the growing interest in cryptos is just beginning. At the same time, we need to be mindful of the considerable risks that still exist for the asset class.
At the time of writing, all statements, other than historical facts, contained within this document that address activities, events, or developments that will or may occur in the future are forward-looking statements. Such statements are subject to a number of assumptions, risks, and uncertainties. Please note that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forward-looking statements.
Please refer to the investment risks page for information about each of the following risks: • Capital risk • Manager risk • Regulatory risk • Volatility risk Please see the important disclosure page for more information.
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1 Wellington Management, company meetings, January 2021.
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