Crypto differs markedly from traditional asset classes in many ways, including the decentralised legal structures underpinning the tokens and highly controversial methods of valuation. A notable list of critics from Warren Buffett and Vanguard Group to local industry super fund UniSuper believes the asset class is not something to invest in because of the inherent volatility and prevalence of scams and cybercrime, among myriad concerns.
But clearly many investors are unfazed, given the Treasury data and the large number of people who do not own crypto but describe themselves as “crypto curious”.
Diversification rules
Galvin’s argument is that despite the unique characteristics of crypto investing, the old school rules of portfolio construction apply, including diversification.
And that means having an exposure to “altcoins” – the thousands of digital tokens other than the original bitcoin. Given many are in their very early stages, that is where the “alpha”, or ability to generate an above-market return, really lies, he says.
As a financial adviser, Cody Harmon says diversification matters, adding that doesn’t mean crypto investors need to go too far down the rabbit hole deploying their capital to obscure altcoins, which are sometimes disparagingly called “shitcoins” by critics.
That’s because ethereum, which, at a market share of about 20 per cent, is almost four times the size of the next biggest token tether, and is among the most important “layer one” blockchain ecosystems on which other tokens are built. Blockchain is the technology underpinning crypto assets – a networked public ledger that records transactions.
There is widespread confusion among investors about the difference between these “layer one” assets and other tokens, says Harmon, who runs the Cruz Family Office and takes an active interest in digital asset markets.
Some tokens such as ethereum, solana, terra, cardano and lunar represent separate and alternative blockchain ecosystems, meaning they are “competing for the attention of developers and miners and entrepreneurial capital”. Many other altcoins represent applications and businesses built on top of those blockchain networks.
Richard Galvin of Digital Asset Capital Management says crypto investors must diversify. Rhett Wyman
“Ethereum is already very diversified,” Harmon says. He likens buying its native currency, known as ether, to buying an exchange-traded fund (ETF) that tracks the technology-heavy Nasdaq index.
It is broader than an individual stock holding but still slightly more niche than a broad-based national market like the Australian Securities Exchange or New York Stock Exchange.
Since many altcoins are linked to applications built on ethereum, buying them while also holding units in the ether token is a bit like buying an ASX 200 ETF but also holding a blue-chip ASX stock such as BHP, Harmon adds, borrowing Galvin’s analogy.
Investors can also access an emerging range of tokens that give an exposure to a broader range of tokens, not dissimilar to the way an ETF is listed on an exchange but also invests in companies listed on that same exchange.
Harmon gives the example of the DeFi Pulse Index, a token that tracks the performance of decentralised finance (DeFi) assets across the crypto market. DeFi applications seek to cut banks and other financial intermediaries out of transactions through use of blockchain technology.
For investors who want to take on more risk, however, and try their hand at active altcoin-picking, Harmon has two pieces of advice. First, they should read the “white paper” associated with each token. Second, they should think about “utility”.
Coin-picking ain’t easy
While many tokens are very early stage and either do not have any obvious real-world use cases or are very “crypto-native” in that they largely service other blockchain-based operations, Harmon suggests assessing whether their stated purpose is likely to make sense as the market matures.
For example, SushiSwap is an application that allows users to swap one digital token for another – a function Harmon says is no different to the multitrillion-dollar foreign exchange (FX) market for fiat currencies, with which many investors will be familiar. “Is this an idea that has legs?” he asks. “Absolutely.”
But Galvin says that, just like stock picking, selecting individual coins is a tough business – and arguably much more so, since the assets are in infancy and there is little in the way of reliable, third-party, investment research and access can be difficult.
“The challenge for the individual investor is which coins or tokens to own and then how to buy them as they are not all on centralised exchanges like Coinbase or Independent Reserve,” he says.
Unsurprisingly, Galvin’s solution is to instead invest in a fund managed by seasoned, crypto-specialist portfolio managers. But most are only open to wholesale and sophisticated investors with at least $2.5 million in assets and have minimum buy-ins north of $200,000.
That’s why Mark Monfort, a data analyst and co-founder of the Australian DeFi Association, would like to see mainstream sharemarket-listed ETFs play a role in providing retail investors with access to altcoins.
Australia’s first crypto ETFs are set to begin trading on the Cboe Australia exchange later this week after a delay, and will also commence trading on the main ASX exchange in coming months as well.
But the corporate regulator ASIC restricted the market to bitcoin and ether, ruling that only the two large-cap crypto tokens have the requisite scale, pricing mechanisms and mainstream institutional investors to be eligible as underlying assets for ETFs.
“If ASIC had broadened the scope it would have made for a wider range of options for existing and new ETF issuers to bring choices to the ETF investing public,” says Monfort, who also founded the ETFtracker analysis tool.
“Instead we’ll have to watch how others innovate, and hopefully, we won’t be too late to play catch up.”