Bitcoin and ethereum are still drops in the ocean of financial markets
Alessandro Tentori and Ano Kuhanathan say the so-called cryptocurrencies are really crypto assets that even today form a relatively small part of global financial markets. Nevertheless, we can continue to expect them to attract investor and regulatory interest
Economists have quite a strict definition of what can be labelled “money” or “currency”. It must combine four attributes – it must be a medium of exchange, it should serve as a unit of account, it has to be able to store value and it must be legal tender.
At the moment, bitcoin and other cryptocurrencies meet none of these criteria. First, none have become a broadly accepted means of payment. Second, apart from crypto exchanges, only a handful of exchanges refer to value in bitcoin. Third, according to coindesk.com data, bitcoin price swings make it hard to consider it a stable store of value and lastly, it is not legal tender. Therefore, we prefer the term crypto assets.
According to our research, the total market capitalisation of the crypto space is currently around US$324 billion compared to US$10.5 billion in 2014. The bulk of the growth has been over the past year, with aggregate market capitalisation surging more than 2,500 per cent. Bitcoin, ethereum, ripple, bitcoin cash and litecoin make up over 70 per cent of the market. However, the market capitalisation is still smaller than traditional assets classes such as global equities (over US$80 trillion) and global bond markets (over US$100 trillion).
While several financial products have been developed around the crypto asset class, including investment funds, derivatives and alternative investment vehicles, the total assets under management is a relatively small US$2 billion to US$3 billion. The average daily traded value of bitcoin futures on the Chicago Board Options Exchange and Chicago Mercantile Exchange has been around US$150 million since inception in December 2017.
Generally, assets are classified as capital assets, consumable assets and stores of value. Bitcoin is a payment asset that can, to some extent, be related to a currency or to gold – hence it could be thought of as a store of value. Although like gold, bitcoin relies on a commonly agreed value among market participants, it is seven times more volatile than gold and unlike gold, is intangible.
Ethereum is a platform asset that can be used for other applications of the distributed ledger technology, beyond its function of transfer of value. Ethereum could be a store of value but also a capital asset (without cash flows) to the extent that its value is somewhat related to the usage volume of the underlying technology.
Next, we have application tokens, such as augur, which are designed for a specific use. Think of these tokens as the reward points you get from your airline. However, some also give the holder a stream of “dividends” based on revenues generated by the underlying business. Application tokens are convertible assets of sorts and some bear the characteristics of capital assets.
Another crypto asset class is linked to side chains; they lock their values in a parent chain. For example, counterparty allows users to create a cryptocurrency within the bitcoin blockchain.
Are crypto assets correlated with traditional financials assets? Most research focuses on bitcoin since it is the oldest crypto with the largest capitalisation. Some studies say bitcoin lies somewhere between gold and the US dollar and shows anti-correlation to UK equities in a portfolio, while others argue that bitcoin can be considered a diversifier with low or anti-correlation against some assets.
However, crypto investments are generally far less liquid than conventional financial assets. Traded volumes, transaction processing time and accessibility are still big hurdles.
Governments and international organisations are looking into privately issued crypto assets and reflecting on the regulatory environment necessary to prevent money laundering, terrorism financing and contraband trafficking.
A recent study from the Centre on Sanctions & Illicit Finance found that the amount of observed bitcoin laundering was rather small (less than 1 per cent of all transactions entering conversion services) but, more importantly, most of the laundering schemes occur through a handful of exchanges and gambling services.
Interestingly, some central banks have also been considering issuing their own cryptocurrencies. Looking forward, we expect regulators to continue to analyse the consequences of crypto assets.
Alessandro Tentori and Ano Kuhanathan are part of AXA Investment Managers’ research team. Varun Ghotgalkar also contributed to this article