Crypto as an Asset Class? Yes and Maybe

With more and more institutional and individual money moving into cryptocurrency, how should you treat the emerging technology?

First, here are the three traditional asset classes according to Investopedia:

Equities — Stock

2. Fixed Income — Bonds

3. Cash and Cash Equivalents

These three asset classes have served as the pillars of a diversified portfolio for decades, but financial products and investors have evolved to broaden the range of asset classes.

In the past few decades, alternative asset classes like private equity, real estate, timber, hedge funds and others have become a part of a diversified portfolio due to their low correlation to traditional equities and fixed income. This low correlation — yet high return — asset class helps to balance an investors overall portfolio.

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Alternative Assets

What is an alternative asset? According to pioneers on cryptocurrency portfolio management Chris Burniske and Adam White, an alternative asset:

“…must be sufficiently investable, providing ample liquidity and opportunity to invest. Second, it should have a distinct politico-economic profile that arises from its basis of value, governance, and use cases. Third, an asset’s market value should fluctuate independently of other assets in the marketplace, exhibiting low correlation of returns. Lastly, the prior three characteristics should lead to a differentiated risk-reward profile, which can be broken down into absolute returns and volatility. Combined, these four characteristics clarify which assets belong in each class.” — Chris Burniske and Adam White

Sufficiently Investable and ample liquidity — there are more than 500 cryptocurrency exchanges as of writing this (Bitcoin.com). ✅

— there are more than 500 cryptocurrency exchanges as of writing this (Bitcoin.com). ✅ Politico-economic profile arising from its basis of value, governance, and use cases — Bitcoin is owned by no one and open to everyone, governed by its incorruptible code, abides by economic laws like supply and demand and has many use cases like cheap and quick remittance payments, and as a store of value. Many use cases of alternative cryptocurrencies’s like Steemit and Siacoin have real value as well. ✅

— Bitcoin is owned by no one and open to everyone, governed by its incorruptible code, abides by economic laws like supply and demand and has many use cases like cheap and quick remittance payments, and as a store of value. Many use cases of alternative cryptocurrencies’s like Steemit and Siacoin have real value as well. ✅ Asset’s market value should fluctuate independently of other assets in the marketplace — In the figure below, the top 16 cryptocurrencies exhibit a correlation to the S&P500 ranging from 0.14 to -0.10. This means the top 16 cryptos are barely, if at all, correlated to the main index of the U.S. equities markets. Most coins even have a lower correlation to the S&P500 than gold - meaning digital gold has more diversification benefits in your overall portfolio than old-school gold. ✅

Finally, an asset class must have a differentiated risk-reward profile — Cryptocurrencies have become notorious for their volatility as nightly news stations, the WSJ and others covered the huge bull market of 2017 that saw a 1000% increase in value for bitcoin. But 2018 has been a different story. Bitcoin and other cryptos like Ethereum, Bitcoin Cash, Litecoin, Ripple, Dash and Monero have plummeted. Bitcoin itself has lost around 70% of its value. The volatility of the market contributes to the risk-reward profile, making cryptocurrency a very high risk investment when standing alone. ✅

High volatility of cryptocurrency contributes to the risk-reward profile of the asset class. Credit CNN

Conclusion: Crypto is a viable asset class, with high risk-reward due to volatility. This may turn some asset managers and investors away from large allocations of crypto, I don’t blame them. But this does not negate the notion that crypto belongs in your overall portfolio as a high risk-high reward, diversifying investment.