B&B Analytics (Digital Assets Research)

From a rise of over 3200% in 2017 to a dramatic correction of 78% in 2018 to a rebound of 210% in 2019, the crypto asset market has been through an incredibly bumpy ride.  The 2017-18 period shared much resemblance to the Dot-Com bubble when rampant stock speculation resulted in a significant correction. However, amidst all the price uncertainty, the silver lining has been that the underlying crypto economy remains robust.  Several factors such as user growth rates, user activity, and blockchain application growth indicate a positive trend towards sustained crypto acceptance.

Institutional Interest gathers momentum in 2019

The digital assets industry has seen a remarkable revival in 2019. End-use cases and regulatory frameworks have become clearer allowing large institutions such as Fidelity, J.P. Morgan, Vontobel, Facebook and more entering the space. Institutional interest is expected to accelerate strongly in the days to come, either in the form of accepting the blockchain as means to enhance efficiency or through investments in crypto assets and blockchain companies.

It is against this backdrop of new-found institutional interest, that the crypto-assets market rallied 210% in 2019. Independent research also suggests that median crypto hedge fund assets under management (AuM) per asset manager grew from USD 1.2 mn to USD 4.3 mn during the bear market period of Q1 2018 to Q1 2019 as new capital entered into these funds. As institutions line up their plans to exploit these new market opportunities, crypto assets such as Bitcoin, Ethereum, etc. will play a crucial role in reshaping the future of global finance. 

Crypto Assets in Traditional Portfolio can improve risk adjusted returns

In a world of negative interest rates and inverted yield curves, crypto assets play the role of a new alternative asset class. Their low correlation with traditional asset classes such as equities and fixed income can help investors diversify investment portfolios. This holds true despite the high volatility crypto assets have endured historically as only a small allocation to crypto assests can improve portfolio risk adjusted return materially. The chart below shows the expected portfolio return of traditional asset portfolios with and without crypto exposures, optimized for various risk levels. The key message here is that a portfolio with 1% allocation to crypto assets either improves the expected return for the same risk level or allows for a lower risk budget for the same expected return level.

Bitcoin as a store of value

For many centuries and even today, Gold has been considered a store of value. The main reason is that no central authority controls Gold, its supply is limited, and it is backed by the trust of the people, resulting in its widespread acceptance. We believe that these same factors also apply to Bitcoin. Bitcoin is decentralised, not controlled by a central authority, its supply is limited by the mathematics built into the Bitcoin protocol, is easy to store and highly divisible (each Bitcoin is divisible into 100 mn satoshis). These store of value characteristics are essential for building trust amongst users and making a case for its wider acceptance. It is therefore not surprising that Bitcoin holds vital importance in the crypto assets space, with a market share of more than 50%.

As Bitcoin’s use cases increase over time, it will stabilise, benefitting from a lower volatility versus its track record thus far. The increased stability should result in a positive feedback loop further enhancing its popularity as a store of value. According to the World Gold Council, the total value of gold ever mined is estimated at approx. USD 8.5 tn. A transfer of wealth from Gold to Bitcoin amounting to just one per cent of Gold, would more than double Bitcoin’s current value.

Tokenisation: The next key milestone

ICOs or Initial Coin Offerings (the digital assets equivalent of Initial Public Offerings) saw a massive influx of investment in 2017, with more than USD 6.2 bn invested in various blockchain and crypto projects. With little or virtually no regulation before 2018, most of these ICOs turned out to be non-compliant offerings or frauds, reminding the market of a need for regulation. As a result, regulators across the world tightened ICO norms (or banned them altogether) while working towards defining the regulatory framework governing these offerings. Despite the ICO debacle, tokenisation of assets using blockchain remains a vital innovation. Dematerialised securities have been around for a long time, but their implementation is susceptible to higher setup costs, higher administration costs and slower settlement times. Moreover, they have so far not included alternative assets like real estate, art and more. Tokenisation using blockchain technology offers several benefits such as improved efficiency, faster settlement times and enhanced transparency, and can be applied to digitalise any underlying value, thereby increasing their liquidity, accessibility and enhancing price discovery.

Tokenisation can be subdivided based on their underlying into the following categories:

  • Security token offerings – Tokens represent an underlying of equity or debt
  • Fiat backed tokens – Tokens are pegged to a fiat currency making it a stable coin
  • Precious Metal backed tokens – Tokens pegged to a precious metal
  • Alternative asset backed tokens – Includes tokens that represent a share of an alternate asset such as property, art or commodity

Security tokens may improve the ability to keep account of transactions, monitor ownership and facilitate settlement in real-time. Stable coins, on the other hand, are a building block for a fully functional digital ecosystem with the potential of becoming a medium of exchange for other tokens on the blockchain. Exchanges like NASDAQ and SIX (Swiss stock exchange) are banking on the possibility of tokenising financial assets and are actively developing products for tokenising existing securities and building new products for their clients.

Many countries are still working towards defining the legal ground for security tokens and other such digital assets. Tokenisation is expected to play a critical role in re-shaping the future of global finance – reducing the barrier to entry for SME’s and digitalising different asset classes, making them more accessible to investors.

Final Thoughts

In spite of the scepticism surrounding digital assets, the industry continues to evolve and adapt in a direction that is more compatible with traditional markets. Many banks and institutions are actively implementing projects to capture this newfound market opportunity to either improve operational efficiency by using blockchain or to develop a new financial product for investment purposes. Several such developments are creating a foundation for blockchain and digital assets to revolutionise modern-day finance.