A Hedge for the Future (3 min read)
There is a reason that 94% of surveyed endowments gained exposure to blockchain investments during 2018. It is unlikely that 94% of endowments CIOs have had all their concerns about blockchain investments resolved. So why are they gaining exposure to this emerging and nascent asset class? One major reason is that blockchain investments have continued to serve as a strong hedge against political and economic instability.
The effectiveness of a hedge in portfolio construction can be estimated using correlations between the assets. We compared active and passive benchmarks for blockchain investments to broad traditional market benchmarks such as Vanguard Total World Stock Index Fund (VT), Vanguard Total Bond Market Index Fund (BND), and SPDR Gold Shares (GLD). As expected, we found that blockchain investments had some of the weakest correlations to traditional market benchmarks making a strong case for this liquid alternative investment:
The most important question is whether these correlations will persist in risk-off environments and liquidity crises so that they can be relied upon for portfolio construction. We argue that the correlations will maintain and the asset class will continue to act as a hedge given the following reasons:
- Unique supply and demand drivers: Traditional markets are driven by factors such as interest rates, economic growth, trade relationships, company profitability, and political stability. Whereas blockchain assets are driven by factors such as network adoption, product development, general technology adoption, and regulatory actions.
- Inflation resistant: As economies around the world experience record low interest rates, enormous government and corporate debt, and increased political tensions, investors are seeking store-of-value assets to protect their portfolios. Blockchain investments are getting attention as the new store of value assets given their features of scarcity, efficiency, censorship resistance, mobility, and utility.
- Network effects: Blockchain projects have stronger network effects than what we have seen in the past, even in other network-based technologies. A censorship-resistant network that is open-source and decentralized can support more profound applications of networks such as digital currencies and autonomous lending. These value networks over the internet result in a speed of adoption and stickiness of platform that we have not seen before. Blockchain networks grow particularly fast in regions where there are capital controls, oppressive regimes, and fears of economic instability.
- History of low correlations: There have been multiple examples of strong performance and uncorrelated movements in blockchain investments during times of stress in local and global markets. The weak correlations for blockchain assets were battle-tested during the escalation of the US-China trade war, Brexit fears, and hyperinflation in countries like Venezuela.
- Aligned incentives of users and investors: Blockchain business models may use tokens that are demanded by product users and by investors, aligning stakeholders. Often users and investors are indistinguishable from one another. This new relationship has caused a massive change in how utility seekers and financial investors interact with and help promote businesses. Prices are less likely to fall in tough market conditions as users continue to demand the assets to extract utility from it regardless of financial performance. This insight helped us get early exposure to what may be the world’s fastest-growing, most-profitable startup.
Basing our conclusions solely on past information would be a mistake. We are strong believers that businesses and capital markets are undergoing a paradigm shift with the introduction of blockchain assets into everything from payments to supply chain management. These new assets are so vastly different and separated from the status quo that market participants are likely to realize them as hedges both in stable and turbulent times.
Sources: Grayscale Investments, Coin Dance, CCI30, Hedge Fund Research, Yahoo Finance, CoinMarketCap
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Disclaimer: This is not an offering or solicitation. This is not investment, tax, legal, financial or any other type of advice. Please perform your independent research and due diligence.