When looking into the cryptocurrency industry, exchange traded fund investors should first consider the “picks and shovels” approach to investing in the crypto boom and look at the companies building the infrastructure that gives crypto an opportunity to thrive.
In the recent webcast, The Case for Crypto Equities, Bitwise’s director of research, David Lawant, highlighted the growing array of publicly traded crypto companies that allow the ecosystem to thrive. For starters, crypto miners help secure the crypto ecosystem. These miners process transactions and contribute to the security of public blockchains. Mining has evolved into an industrial-scale business with high capital intensity. Looking ahead, publicly traded crypto miners are expected to reach aggregate revenues of about $1.0 billion in 2021, up from $163 million in 2020.
Next up, crypto mining equipment manufacturers help power crypto miners. Lawant explained that these equipment manufacturers provide the backbone or infrastructure, such as specialized hardware or hosting services, to crypto miners. Data center providers are now emerging with installed hosting capacity. Additionally, the infrastructure is sold in long-term contracts, which allows these firms to be less exposed to crypto’s daily price fluctuations.
Exchanges and custodians help let cryptocurrencies flow unimpeded. Lawant noted that they provide on- and off-ramps for trading and safe crypto asset storage. Currently, Coinbase’s IPO has shined a light on the impressive economics of this segment. Spearheaded by the success of Coinbase, publicly traded crypto exchanges are projected to hit aggregate revenues of about $7.5 billion in 2021, up from $1.3 billion in 2020.
Trading and asset management are also becoming a growing component in the ecosystem. These companies trade proprietary capital or provide funds, services, and other tools that help investors access this space. This is an emerging subsector that can be leveraged to crypto prices.
Lastly, Lawant highlighted the supporting services like banking. This subsector connects crypto to the traditional financial world. Today, it is comprised of only one company, Silvergate (SI), which was the one of the first banks to service crypto firms. Since then, it has leveraged this position to build a competitive moat. The Silvergate Exchange Network (SEN) provides real-time, 24/7 USD-crypto transactions between institutional investors and crypto exchanges.
Bitwise Asset Management’s CIO, Matthew Hougan, argued that investors should look beyond physical cryptocurrencies and consider the case for investing in crypto equities.
Hougan underscored the diversification benefits of crypto equities — the correlations between crypto equities and crypto assets range between 0.50 and 0.75. Furthermore, crypto equities have exhibited some defensive qualities in the latest crypto asset price correction. There is still some correlation between the two, since crypto equities are leveraged to crypto asset price movements to different degrees.
Hougan also expressed a belief that crypto equities could be a great growth opportunity for long-term investors seeking to break into a nascent industry. Crypto equities are among the fastest-growing segments of the public equity markets. Crypto equities are disproportionately profitable for the top-line growth they generate. Additionally, the segment exhibits favorable growth and profitability dynamics that are not reflected in 2021 P/E multiples — for example, crypto equities are trading at cheaper valuations to the technology, business services, and consumer services sectors.
Furthermore, the sector enjoys wide economic moats. Hougan pointed out that crypto companies have been somewhat shielded from competition. Traditional financial firms have been slow to enter the market due to regulatory and headline risk, allowing crypto companies to build large moats.
Investors can turn to something like the Bitwise Crypto Industry Innovators ETF (BITQ), which offers a way to gain exposure to the crypto market without the challenges of directly holding crypto assets like bitcoin and ethereum.
BITQ seeks to track the Bitwise Crypto Industry Innovators 30 Index, designed with Bitwise’s industry expertise to capture “pure-play” companies engaged in actual, material activity in the crypto sector. Additionally, the index includes companies with at least $100 million of liquid crypto assets on their balance sheets.
In most cases, companies in the new index must derive at least 75% of their revenue from directly servicing cryptocurrency markets or have at least 75% of their net assets accounted for by direct holdings of liquid crypto assets. Such companies may, for example, offer crypto brokerage services, financial and banking services, mining solutions, technology solutions, or analytics solutions. The index rebalances quarterly.
The index is designed specifically to capture the unique characteristics of the crypto equity market. For example, the index has a “fast-entry” rule that allows new IPOs and direct listings to enter the index one day after their debuts, allowing the index to adapt to the rapidly changing market.
Financial advisors who are interested in learning more about investing in the crypto sector can watch the webcast here on demand.