The world is undergoing a rapid digital transformation with digital assets and blockchain technology playing a vital role in this global shift.
While still in the early stages of adoption, blockchain is heralding a fundamental technological change that mirrors the importance of secular shifts similar to the dot.com era in the 90s. In addition to spawning countless exciting innovations, the emergence of this technology has given rise to a new digital asset class that is challenging investors to reassess their portfolio construction.
Since its inception in 2009, Bitcoin has been recognised for its potential to deliver remarkable returns as well as substantial drawdowns. Despite its renowned volatility, Bitcoin has consistently outperformed all major asset classes in seven out of the ten past years, making it the most successful asset of the decade. Furthermore, Bitcoin and the second-largest crypto asset, Ethereum, have demonstrated the best risk-return relationship of major asset classes based on Sharpe Ratio and Sortino. Thus, disregarding this space could mean missing out on a significant opportunity.
“The crypto economy is on track to revolutionise the financial industry. It’s no longer a matter of if, but when.” Carl Szantyr | Co-Founder, Blockstone Capital
The opportunity cost of not having crypto asset exposure is high
As the investment landscape continues to evolve, it is essential for investors to adapt their portfolios accordingly. Digital assets could become a key component owing to the following factors:
Growth potential: Digital assets present immense growth potential, enabling investors to capitalise on emerging trends and disruptive business models. The younger generations, entering their prime earning years, largely view Bitcoin as a positive financial innovation. The transfer of substantial wealth from ‘Boomers’ to digitally-native millennials and Gen Z will provide a demographic tailwind for the crypto economy.
Diversification and risk mitigation: Incorporating digital assets in an investment portfolio can provide diversification benefits, helping to mitigate risks and generate resilient returns. As a non-correlated asset class, digital assets can provide a degree of independence from traditional market fluctuations, enhancing portfolio resilience and returns.
Crypto markets offer inefficiencies that can be capitalised upon. Digital assets possess unique characteristics that differentiate them from traditional assets, including higher volatility and abundant arbitrage opportunities. In the current trading environment, where traditional assets are exhibiting greater market efficiency, generating excess returns has become increasingly challenging. Digital asset markets, on the other hand, have experienced significant volatility in recent years, providing potential avenues for leveraging market inefficiencies for capital gains.
Access to innovative digital innovations: The crypto market is in a constant state of evolution, continuously presenting new use cases. The rise of non-fungible tokens (NFTs), decentralised finance (DeFi), GameFi, decentralised social media, and other sub-sectors exemplify the transformative potential of digital assets across industries such as art, finance, gaming and social media. By participating in the crypto market, investors gain access to these innovative digital advancements that are reshaping traditional paradigms and creating novel opportunities for growth and engagement.
In a broader sense, the sector is becoming greener: Ethereum’s transition to a Proof-of-Stake consensus mechanism enhances its ESG score, addressing investor concerns regarding the sector’s carbon footprint. Moreover there is a growing momentum towards renewable energy in Bitcoin mining with recent reports indicating that around 60% of Bitcoin mining utilises renewable energy. Private companies are also investing in renewable energy production specifically for Bitcoin mining, exemplified by Tether’s recent investment into a sustainable Bitcoin mining operation in Uruguay powered by 100% clean energy sources.These developments signify a positive trend towards greener practices within the crypto industry.
Rising institutional participation during the ongoing market volatility highlights the growing conviction in the long-term value of digital assets
An April 2023 EY-Parthenon survey of 256 institutional investor decision-makers found that all institutional investor segments believe in the long-term value of blockchain and digital assets despite recent market activity. As per the survey, 38% of respondents expect to increase holdings over the course of 2023, while 52% expect to maintain their holdings unchanged.
The growing confidence in crypto markets is supported by crypto-native service providers rapidly maturing as well as traditional service providers launching new institutional-grade digital asset service offerings.
There are unique investment and operational risks that come with allocating to digital assets
For the institutional investor, this is a story of uncorrelated returns and portfolio maximisation in a volatile market. We have seen over six-fold volatility and three times the maximum drawdowns of global equities, but also a corresponding outperformance of other asset classes over the past decade. A modest digital asset allocation would have enhanced almost any traditional portfolio in the same period, especially if they were aware of the unique risks.
As an emerging asset class, the digital asset ecosystem is exposed to a variety of specialised and unique risks. These include technological, counterparty risk, fraud, liquidity challenges, volatility and regulation, among others. Security remains a major challenge for the entire sector. According to a report from blockchain research firm Chainalysis, crypto crime accounted for a record-setting $3.8bn in 2022, encompassing user wallets, DeFi protocols and centralised services.
These risk factors underscore the importance of conducting thorough due diligence, implementing effective risk management strategies, and gaining a comprehensive understanding of the complexities associated with the digital asset landscape before venturing into crypto investments or engaging in the crypto market.
“In the middle of difficulty lies opportunity.” Albert Einstein
It’s important to note that since the downfall of Terra-Luna, 3AC and FTX in 2022, the entire market has displayed a significant focus on risk management. Additionally, regulatory authorities have intensified their scrutiny of market practices and participants. We perceive this increased scrutiny as a positive outcome of the market downturn.
Furthermore,, the ongoing regulatory uncertainty in the United States, partly triggered by the Securities and Exchange Commission’s (SEC) lawsuits against major industry players , Coinbase and Binance, holds the potential for favourable developments. We believe that this uncertainty may ultimately lead to enhanced transparency and clearer regulatory guidelines, fostering increased trust and confidence in the long-term viability of the crypto economy.
How to best invest in this asset class
When it comes to allocating to digital assets, diversification is vital. By spreading investments across a range of assets, investors can mitigate risk and maximise potential returns. This is why we firmly believe that for risk-averse investors, an actively managed strategy through a fund of funds (FoF) is the optimal approach for investing in this emerging asset class.
In addition to providing the benefits of professional management, a FoF provides access to a broader range of investment opportunities whilst mitigating single-manager risk given the nascent stage of crypto hedge funds and the challenges posed by a volatile asset class and uncertain regulatory environment, it is expected that failures may occur. By leveraging a FoF, investors can benefit from the expertise and experience of multiple fund managers, rather than relying on the performance of a single manager. Often, single-manager funds can be heavily influenced by the manager’s investment views, leading to highly correlated ideas and holdings.
Access to a wider range of investment opportunities is especially important in the rapidly evolving world of digital assets, where new opportunities are continuously emerging – making discerning where to invest especially challenging. Analysing the hundreds of liquid crypto funds requires both in-depth financial and crypto-native knowledge. With a FoF, investors can bypass the need for individual research and selection of specific digital assets. Instead, the FoF manager assumes the responsibility of carefully curating and balancing a range of investments to align with your investment goals.
“Fees aren’t as costly as bad investments.” Vegard Iversen | Partner, Blockstone Capital
The focus on FoFs as an ideal way to access proven managers has gained significant traction since the May 2023 announcement that Syz Bank is becoming the first banking group to launch a crypto fund of funds. The $23bn Swiss private bank is best renowned for being the first to give Swiss HNW access to Wall Street hedge funds, which at the time were returning 25%. Syz Bank's latest initiative demonstrates its recognition of a FoF as an excellent entry point into the growing digital asset class.
Why Blockstone Capital
Blockstone Capital (trading name for Meliora Capital LLP) is a London-based investment manager operating as a digital asset fund of hedge funds, authorised and regulated by the Financial Conduct Authority (FCA). Our aim is to make the emerging crypto asset class investable by adhering to institutional-grade standards and to provide qualified investors with superior risk-adjusted returns over the long term.
Recognising that no single approach can excel in all market conditions when it comes to digital asset investing, we apply multiple approaches into a coherent strategy. This enables our fund to overcome some of the risks associated with crypto and to offer consistent and attractive returns throughout different market conditions.
Blockstone Capital leverages the expertise of our multidisciplinary team, consisting of professionals with extensive experience in active portfolio management and capital markets. Our team possesses a profound understanding and enthusiasm for digital assets, enabling us to navigate this dynamic landscape effectively.
To find out more about us, visit https://www.blockstonecapital.io/.
To speak with us directly, contact ir@blockstonecapital.io to request a meeting with Carl Szantyr.