Cryptocurrencies fail as safe havens in a volatile market or as hedges against inflation, and there is no compelling reason for institutional investors to include them in their portfolios for diversification, according to a research paper published by PGIM yesterday (May 18).
Instead, they should be investing in the blockchain technology behind crypto, and its applications such as smart contracts; interoperability and fraud prevention solutions; and tokenisation, said Shehriyar Antia, vice president and head of thematic research at PGIM, in an exclusive interview with AsianInvestor.
CRYPTO: HOPE OR HYPE?
Antia said the PGIM report — focusing on Bitcoin, Ether, and Sol, which collectively represent close to 60% of the $1 trillion crypto market cap — found little real-world evidence that cryptocurrencies deliver diversification versus mainstream assets; are effective inflation hedges; possess the intrinsic characteristics of a safe-haven asset; or advance environmental, social and governance (ESG) objectives.
“During the Covid-driven global market turmoil in early 2020, Bitcoin was not a stabilising force at all. In fact, Bitcoin declined more steeply than equities, commodities, bonds, and any other asset class at that time,” he said.
In the past year, Bitcoin — once hailed as digital gold — has also failed to hold its value against rising inflation, he said. The wild price gyrations of many cryptocurrencies, including Bitcoin, have made them highly unattractive as a store of value – even in the short term.
Bitcoin has since 2020 been consistently, positively correlated with both equities and commodities, making it unsuitable as a reliable portfolio diversifier, said Antia.
The high electricity usage of crypto mining operations and the anonymised and decentralised nature of these currencies, which make them the preferred instrument in evading sanctions and other illicit activities, are incompatible with ESG objectives, he said.
“Long-term investors really need to maintain their discipline and not get swept up by the hype and relentless crypto enthusiasm out there,” he said, adding they must focus on strong data and analyses.
“They really need to [ask] what exactly a new asset class could do to institutional portfolios, and they really need to examine whether or not they're chasing returns or chasing a fad.”
SPOTLIGHT ON BLOCKCHAIN
The best investment opportunities may in fact lie in the blockchain technology that is the “real world changer” and not cryptocurrencies, which are “problematic” for investors, he said.
The PGIM report identified some of these opportunities as private blockchains and smart contracts; companies involved in solving issues around interoperability, due diligence, and fraud prevention; and tokenisation of real assets or fractionalising ownership into digital tokens on a distributed ledger.
Antia cited the Asian Development Bank Trade and Supply Chain Finance Program, which provides credit guarantee transactions using distributed ledger technology and smart contracts in countries such as Thailand and Vietnam, as an example of a real-world application that has solved a problem.
He said institutional investors should look at technology solution companies in the broader infrastructure and ecosystem, such as South Korea-based ICON and Polygon, major players in the blockchain communication and interoperability space, since they will have first-mover advantage as real-world applications such as digital currencies emerge.
The PGIM report said a slew of PE and VC-funded software firms like Chainalysis — for which GIC recently led a $170 million funding round — and Fireblocks in the US, currently provide services to exchanges, payment providers, and custodians to help them conduct due diligence on customers, track transactions, and manage risks such as money laundering and fraud.
“Chainalysis is actually a great example of companies that are bolstering the infrastructure and the broader crypto ecosystem… (as it) provides security services, risk management services, risk assessment services,” said Antia, adding that such companies will continue to play important roles in solving the problems that blockchains and distributed ledgers face today and in the future.
On the tokenisation of real assets, he said the application of this blockchain technology will substantially reduce frictional costs around financial services and reshape the current market for illiquid assets.
“Indeed, the prospect of fractionalised ownership and better liquidity under a tokenised real asset regime might allow investors and real estate managers to diversify or fine-tune portfolios with greater ease,” said the PGIM report, which contained the insights of over 30 PGIM investment professionals across fixed income, equity, real estate, and private alternatives as well as economists, venture capitalists, and crypto investors.