Private View Blog: Embracing crypto-assets is both an opportunity and sound risk management

I read with interest the recent 'Great Debate' in PWM on whether bitcoin offers more of a risk or opportunity for investors. In fact this is not a binary choice and like many investments, it offers a mixture of both.

Rarely had the emergence of a new asset class polarised opinions so much. To the credit of crypto-skeptics, rarely has a new asset class been so innovative and complicated to understand. Moreover, bitcoin first day evangelists have overshadowed the basics by preaching the end of the dollar and the most famous of crypto-assets as the answer to this inevitable armageddon. 

In the meantime, bitcoin has achieved the status of digital gold for a new generation of investors. Like the precious metal, bitcoin has little use, is cause for environmental concerns and is challenging to store safely. We believe, however, that it will keep its role as a safe haven in the long term. Its market capitalisation is still only a fraction of that of mined gold to-date and eventually, when it will find its equilibrium price, we anticipate that it will underperform in the long run the real productive asset: capitalist economies’ equities – just like the yellow metal.

Bitcoin and its controversy have obscured, at least for the uninitiated, the rise of the digital asset ecosystem. A decentralised financial system being built alongside the more familiar historical financial system. Decentralised protocols (DeFi) operating at zero marginal cost allow the intermediation of these new assets. They can be traded, borrowed or lent (relatively) easily in this autonomous financial system. Banks without employees take deposits, which they remunerate, and make loans with the profit from which they buy back their digital capital.

Until very recently, all these activities took place outside the supervision of our national regulators. These have now entered the picture and this is likely just the beginning of crypto-assets supervision. On the one hand, governments have not put an end to bank secrecy for tax optimisation purposes only to see it carried over the internet and crypto-assets, but more importantly, the privileges granted by the control of the financial system is far too strategic for them to even consider sharing. 

As investors we are therefore faced with a double uncertainty, both of technological and regulatory nature. We don't yet know which applications will develop based on the crypto-asset infrastructure and we don't quite comprehend how countries will intervene to regulate them. That's all it takes for these assets to be extremely volatile as their potential intrinsic value is impossible to estimate – for now.

The fact that they are volatile does not mean they should be ignored or avoided. First, volatility is not inherently bad. In these times of financial repression, the suppression of volatility guarantees the suppression of returns to zero or below after inflation. Second, while many understand the disruptive potential of the financial system and its historical players, fewer realise that finance is just one industry among many on the cusp of a radical paradox shift stemming from the ability that blockchain offers to digitise trust and contracts. 

Once one realises this, the consequence is self-evident. Crypto-assets cannot be ignored as they are a severe disruptor of the traditional assets otherwise held in our portfolio, credit and equities.

For this reason, we suggest family offices to consider allocating a small amount to digital assets. Each will appreciate the right weighting according to its own circumstances, but when we talk to those who have already taken the step, the amounts allocated vary between 0.5 per cent and 5 per cent. The resulting volatility (cryptos have proven to be highly correlated to traditional risky assets in down market episodes) is the price to pay for learning, capturing potential long-term opportunities and more importantly avoiding missing the potential impact on other assets in their portfolio.

This is true risk management, the kind that manages permanent losses of value rather than short-term volatility.

Yves Bonzon is chief investment officer at Julius Baer