The world needs alternative asset investment and cryptocurrencies fit the bill

Cryptocurrency has become an unignorable phenomenon in the world of finance today. We are observing a lot of institutional investment coming into cryptocurrencies, especially Bitcoin. The world is divided on their opinions whether it’s a good move or not. The results are locked in the future, but we can make an attempt to understand the logic behind it. We start with understanding what cryptocurrencies are, and whether they are suitable as an alternate asset class or not.

Are cryptocurrency, coin or paper currencies?

In our honest opinion we feel that it’s a misnomer.

Cryptocurrencies are not currencies. They are digital assets. We can group them into the intangible asset category as per classical finance definitions. However, the advantage being that they are not wasting assets which depreciate over time or even bulky valuables which require storage and other security costs.

Holding these assets may require usual interest costs (opportunity cost for holding any asset), insurance (if one wishes to insure their digital assets from digital theft, etc.) and custodial charges. So, cryptocurrencies are digital assets with low maintenance cost and zero depreciation.

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What are alternative investments?

Alternative investments are any other investment asset class which are not traditional. By traditional, the world of finance means public equities and corporate and government bonds. Any other asset class, namely private equity, venture capital, real estate, hedge funds, leveraged buyouts, risky debts, land, art, commodities, real estate, structured products and many more such can be termed as alternate investments.

Why alternate investments?

Since the great financial crisis of 2007-08, institutions are looking at alternate investments in a big way and have been making larger allocations in order to meet their returns expectations while attempting to diversify the risks. The traditional investment avenues coupled in their low return phase for a significant amount of time after the crisis which made it necessary to include alternate investments into the portfolio.

Are cryptocurrencies good alternate investment?

Our research shows that cryptocurrencies exhibit very low correlation with both traditional and alternate asset classes namely stocks, bonds, real estate, gold, emerging markets. This makes them a very good diversification and risk mitigation tools. Also various research shows that the digital assets are not driven by the price drivers of the traditional investments which makes their inclusion in the portfolio very favourable for overall risk-reward profile of the portfolio.

Separate studies show that allocation of just 1%, 2% or 3% of the total investment into digital assets enhances the long term excess returns of the portfolio while bringing down the Sharpe ratio significantly enhancing the investment efficiency in terms of risk adjusted returns on capital employed.

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Institutional investments moving into cryptocurrencies

Institutional investors are gradually moving in to the cryptocurrency space and Bitcoin seems to be the current choice of investment.

Given the economic uncertainty triggered by the pandemic-induced lockdowns and total closure of economic activities across the globe, it seems that alternate investments in digital assets are tailor-made for providing any portfolio with the risk mitigation and yield generation that Bitcoin has exhibited.

Some of the reasons why one would consider having cryptocurrencies as an alternate asset class in their portfolio are enumerated succinctly by the MicroStrategy CEO Mr. Michel J Saylor. But I think that there are a lot of narratives which are the additional reasons for considering such an allocation. Some of them are:

Bitcoin system is fault-tolerant

Hardcoded mathematical algorithms driving the crypto protocols are unchangeable over time, change of regime, pandemic or any such socio-economic disruptions.

Bitcoin is a retail-driven phenomenon

Already a broad-based phenomenon, the adoption of Bitcoin as a mainstream asset is just a matter of time.

Finite Supply – Deflationary

One of the most important features of Bitcoin and many other cryptocurrencies are that the supply of them is Finite and deflationary by nature.

Emerging store of value

Bitcoin investments are more driven by the “store of value” in times of economic uncertainty.

Liquidity

Cryptocurrency transactions are comparatively liquid to many other asset classes.

Accessibility

The most lucrative of alternate asset classes, viz., venture capital, private equity, art, real estate and similar such investments are process-oriented and restrictive to certain specific channels.

Compared to them, Bitcoin and cryptocurrencies are open networks, digitally available, global in nature without any geographical restrictions and egalitarian in nature as it does not differentiate between the economic status of the willing participants.

Low fees

Most other alternative investments come with a huge price tag in the form of Advisory fees or Management fees – cryptocurrencies on the other hand are open protocols with direct access with the cost to trade being the only possible fees involved.

Bitcoin-induced demonetisation

With more and more governments moving towards CBDCs, we are very well witnessing a categoric demonetisation of fiat currencies from physical notes and coins to digital currencies or stable coins. This phenomenon would in turn help the adoption and proliferation of Bitcoin and other limited supply cryptocurrencies.

All these features makes cryptocurrencies a very suitable alternate asset class, but at the same time in India we need policy intervention to regulate this industry by a legitimate financial institutions to check on any potential unlawful activities. Hope that the industry and all stakeholders can work in this direction.