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Bitcoin and Ethereum cryptocurrency ETFs are set to hit the Australian market as soon as tomorrow. With the markets as volatile as they are, and with more choice soon available for crypto-oriented investors, does it make sense to hold both crypto equities exposures and cryptocurrency exposures in the same portfolio?
In this article, we revisit the case for crypto equities alongside cryptocurrency exposure. We explore the attractive fundamentals of the crypto equities market and analyse what the recent positive sentiment towards the crypto space expressed by a number of governments could mean for a sector that has been beaten down heavily of late.
The current macro environment has not been kind to growth exposures. Investors have been going ‘risk-off’ and, year-to-date, the Nasdaq, S&P500, and bitcoin are down 25.1%, 15.9% and 31.7% respectively. Rising interest rates increase the cost of capital, draining liquidity from all financial markets, cryptocurrency markets included.
One of the major issues with cryptocurrency exposure is the difficulty in placing a value on the cryptocurrency itself. Whilst we are confident that Bitcoin and Ethereum are here to stay, there are many direct competitors to Ethereum such as Solana, Cardano, and Polkadot which also use smart contracts, can create NFTs, may transact faster, already use proof of stake and are cheaper to use.
Bitcoin does not have many direct competitors, however it is being lumped in with, and traded like, tech stocks, and correlations between bitcoin and equity markets have been near all-time highs, likely because of macroeconomic factors and the changing investor base from retail to institutional.
Crypto equities historically have been correlated to Bitcoin’s (BTC) spot price to varying degrees, and a weak BTC should lead to weakness in crypto-focused stocks. While overall we continue to expect a relatively strong correlation between cryptocurrencies and crypto equities, there is a case for something of a decoupling over time, particularly with more institutional money coming, and an increasing realisation that a number of these crypto equities companies potentially can make money regardless of the price of BTC.
Fundamentals look cheap compared to broader benchmarks
An advantage of looking at crypto equities is that you can value them based on current financials. Whilst market fundamentals don’t always tell the full story, the metrics of a portfolio of crypto equities (using the Bitwise Crypto Innovators Index) look appealing in a number of ways. For example, the index looks attractive compared to a number of broader benchmarks on median revenue growth estimate, profit margin estimate and P/E estimate.
Source: FactSet data as at 6 May 2022. Estimates shown are subject to change over time. Actual outcomes may differ materially from estimated outcomes. A crypto equities index can be expected to be substantially more volatile than a broader global equities index.
Regions around the world are deciding how to deal with crypto and trying to get their regulatory settings right. Many countries such as the U.S, U.K., Singapore, U.A.E and Australia have declared they want to be leaders in crypto but are moving forward cautiously. Regulations still to be written can affect individual protocols in sectors such as DeFi, stablecoins, and protocols that may be considered a ‘security’. Whilst regulation can have an impact on specific coins and various crypto sectors, publicly traded companies that are a leveraged play on crypto are relatively insulated, offering general services such as banking, investment and mining services, mining hardware, exchanges, and trading platforms.
It’s not about ‘which crypto’ but the thematic as a whole
There are currently over 17,000 cryptocurrencies, with the number increasing every day. There are also many sectors within crypto which become ‘hot or not’ during different parts of the cycle including NFTs, DeFi, Metaverse, GameFi, Web3, memecoins and more.
Whilst it is impossible to predict the outcomes of government regulation, or market returns over the short or long term, crypto and blockchain technology are here to stay. Crypto is changing the way business is done, disrupting industries, and is expected to continue to garner retail and institutional investment.
Whilst it is still too early to know which specific cryptocurrencies will ‘win’ over time, the companies providing the ‘picks and shovels’ and laying down the infrastructure for the crypto economy to thrive have the potential to be the ultimate winners.
If the entire sector grows and adoption continues, whether through more cryptocurrencies being created, more investors entering the market, or more hash power joining the Bitcoin network, then crypto equities could stand to benefit apart from individual cryptocurrencies themselves. We favour a market-cap weighted approach to investing in crypto equities, as such an approach has the advantage of increasing exposure to the companies that grow and come to dominate the asset class, and reducing exposure to the companies that falter.
We believe that crypto equities can be used alongside cryptocurrency exposure because of the potential for the sector to increasingly decouple from cryptocurrency from a valuation perspective, not being subject to specific protocol or sector regulation, and because the success of crypto equities is tied to the entire asset class growing, rather than relying on one specific coin or token.
Australian investors can gain exposure to the growth of the crypto economy through the BetaShares Crypto Innovators ETF which provides exposure to the largest companies laying down the infrastructure for the crypto economy to thrive.
Investing in crypto assets or companies servicing crypto asset markets should be considered very high risk. Exposure to crypto assets involves substantially higher risk when compared to traditional investments due to their speculative nature and the very high volatility of crypto asset markets.
Investing in crypto assets or crypto-focused companies is not suitable for all investors and should only be considered by investors who (i) fully understand their features and risks or after consulting a professional financial adviser, and (ii) who have a very high tolerance for risk and the capacity to absorb a rapid loss of some or all of their investment.
Any investment in crypto assets or crypto-focused companies should only be considered as a very small component of an investor’s overall portfolio.