Crypto markets are arguably one of the most volatile asset classes on the market currently. Despite their volatility, or perhaps because of it, investors continue to flock to the space looking to make money and invest in the promising future of digital transactions. With so many options available for how to gain exposure to cryptoassets, Bitwise makes a very convincing argument in a white paper on the potential that crypto equity investing can offer as a less volatile option still able to harness the gains that the space experiences.
Bitcoin is the most popular cryptocurrency on the market, as well as the most established, and yet it continues to experience giant fluctuations in price. In the past five years alone, while the cryptocurrency has risen over 80 times its value, it has also experienced 10 drawdowns greater than 20%. Also, as there are currently no bitcoin ETFs available in the U.S., investors are relegated to alternate means when seeking bitcoin exposure.
An Analysis on Correlation
For investors that are focused on seeking similar returns to crypoassets, crypto equities can often offer very similar correlations. Bitwise tracked the correlation between the 10 largest pure-play crypto equities that are publicly traded (MicroStrategy, Galaxy Digital Holdings, and Riot Blockchain to name a few) against its own Bitwise 10 Large Cap Crypto Index, which contains the 10 largest cryptoassets by free float market cap, with bitcoin making up over half the allocation of the index as of print.
Correlations between the most popular crypto equities and cryptoassets ranged, on average, between 0.50 (which is considered moderate) and 0.75 (which is considered significant). MicroStrategy had the highest correlation at 0.74 — not a surprising finding as most of its market cap is derived from the bitcoin on its balance sheets — while Silvergate, a traditional bank that has business branches that are unrelated to crypto, had the lowest correlation at 0.43.
Tracking Beta and Leveraged Returns
When approaching investing within the crypto markets from a leveraged standpoint, different subsectors of crypto equities relate differently to the price cycles because of the various ways in which they have exposure to crypto. The same 10 crypto equity companies were tracked against the slope of the regression of returns on a crypto stock versus the broader crypto market, otherwise known as the beta.
Coinbase, which was only introduced to markets in April, had a beta of 0.41, while Argo Blockchain’s beta was 1.52. This makes sense when you consider how these companies are gaining their exposure, as some subsectors are directly driving the prices of cryptocurrencies, while others are harnessing the transactional power of trading in cryptoassets.
Crypto miners “tend to have significant operating leverage to crypto prices and therefore their share prices tend to exacerbate the crypto price cycles,” wrote David Lawant, Matt Hougan, and Juan Leon, the authors of the paper. Of the six crypto mining companies included in the analysis, five of them had betas that exceeded 1.00, which reflects leveraged exposure, and the sixth, Hut 8, was approaching the 1.00 mark at 0.97.
MicroStrategy, for which market cap is directly reflected in its bitcoin holdings and price is derived from the bitcoin exposure, unsurprisingly has a beta of 0.98, also nearly 1.00.
Investing in crypto exchanges is where the leverages tend to deviate more often, as these companies rely largely on trading volume for their revenue, not the prices of the cryptocurrencies and cryptoassets they trade. Falls in prices in those assets, like a bitcoin pullback, can often result in spikes in trading volume, and the exchange’s value is therefore not reflective of or reliant on the value of the cryptoassets they deal in. Coinbase, although only tracked since its IPO in April, has the lowest beta at 0.41. As an important note, exchanges are also pulling on other factors and services that make up their revenue, such as custody, lending, staking, and so on.
Downside Volatility Deviation
The biggest argument that advisors and critics often have regarding crypto investment is that it opens up investors to exposure to significant downside volatility. With popular cryptocurrencies like bitcoin having experienced drawdowns of over half of their value multiple times, and that type of volatility expected to continue in the space, direct exposure can indeed be risky.
Crypto equities are also subject to higher volatility because of their exposure in an inherently volatile space, but Bitwise has found some early indicators that crypto equity investment could experience different (and less) volatility over short-term periods of correction than the actual cryptoassets.
Since the introduction of the Bitwise Crypto Innovators 30 Index in May until the end of August, the crypto equities contained within only fell a maximum of 20%, while the Bitwise 10 Large Cap Crypto Index fell from its highest to lowest by 50.87% during the same time period. While it’s still a narrow window of tracking, this is still a promising find.
While the crypto equities are often leveraged to the price cycles of crypoassets such as bitcoin, in the short term, there are often different potential leveraging factors at play for the crypto equities. During the crash that happened in bitcoin price that was exacerbated by China’s shutdown of crypto mining, bitcoin miners, who are predominantly located in North America, were able to grow their market share. Likewise, many exchanges experienced their prices increasing with increased trading volume driven by lowering cryptoasset prices. Additionally, there are some companies contained within the crypto equities markets that are not reliant at all on crypto for their revenue and can provide a more defensive stance in times of volatility.
Overall, while more data and research is needed regarding these findings, they prove promising for investors seeking crypto exposure. “Early indicators suggest that crypto equities provide a compelling way for investors to gain exposure to the crypto economy, with significant correlations with cryptoasset prices, leveraged in different ways to those prices, and early indications of defensive behavior during sharp drawdowns,” the authors wrote.
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