Traditional Equities vs Digital Assets

Prior to 2008, investment clubs leveraged asset allocation by spreading risk across asset classes like real estate, equities, fixed income, currencies and commodities to maximize risk and return over time. However, since the creation of bitcoin in 2008, the digital asset space is now a proven new asset class surpassing 1 trillion USD as of June 2022 per Coinmarketcap.

Adding digital assets in an investment portfolio becomes intuitive after qualitatively and quantitatively comparing digital assets to traditional equities by breaking down digital assets into underlying components like coins, tokens and NFTs.

How are digital assets different from equities?

Investopedia defines an asset class as a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulation.

Equities and fixed income have different risk and return profiles. For example, in bankruptcy, bonds are paid before equity holders meaning higher equity returns all else equal. Digital assets are regulatory, statistically and qualitatively different from both!

1. Qualitative Comparison – Crypto Coins vs Traditional Equities

Cryptos come in two forms; tokens and coins. Tokens represent ownership, while coins represent what investors could potentially own.

Bitcoin is a crypto coin meaning that bitcoin behaves more like currencies than equities. Bitcoin’s original function was to facilitate peer to peer transactions similar to dollar transactions, but at a much slower and expensive rate and is therefore not a great replacement for fiat. Bitcoin also behaves like gold because there is a limited supply of 21 million bitcoin and is outside of government control

All coins like bitcoin operate on their own blockchains. Ethereum is also a coin, but also allows for smart contracts.

2. Qualitative Comparison – Tokens and NFTs vs Traditional Equities

Unlike bitcoin or Ethereum, tokens like Uniswap, IMX or NFTs do not own a blockchain and are more similar to equities.

The difference is that equity ownership is stored centrally with a broker, while tokens and NFTs are registered with immutable wallet addresses.Like traditional equity, coins and tokens including NFT’s can also be used as collateral. In return for lending against collateral, the lender earns a token yield similar to how an equity lender earns an interest rate. Finally, like equities, cryptos and NFTs can be further divided into subgroups based on economic objectives.

Unlike equities, tokens and NFTs are smart contracts, which is a form of immutable code creating trust between untrusting parties for purposes other than simple peer to peer transactions. Note, that tokens and NFTs are basically the same except that tokens are fungible, while NFTs are unique. NFTs are basically impossible to replicate tokens.

Most crypto projects and companies are built on smart contracts and as a result, the digital token and NFT ecosystem has exploded. For example, Uniswap is a governance token for a DeFi platform and IMX is a token used to purchase NFT’s on the ImmutableX network.

• Immutable X is built on top of the Ethereum chain and is a layer two scaling solution, but not a sidechain like Polygon meaning the token does not have its own blockchain.
• The scaling solution is a Validium ZK roll up enabling Immutable X to process 9000tps at almost 0 fees compared to Ethereum’s current 30tps and up to 100 dollar transaction fees, while relying on the Ethereum blockchain’s superior decentralization and security.
• Owning traditional equity is a claim on future revenues. For example, equity holders of Amazon receive a tiny part of all transaction fees generated by Amazon’s website.
• In digital assets, the equity ownership can be replaced by tokens or NFTs.
• Soon, Immutable X token holders can stake native IMX tokens to capture profits in proportion to NFT token transactions generated on Immutable X, which means owning IMX tokens is similar to owning equity in Amazon.
• If users love NFT projects on the ImmutableX platform, then transactions will generate a higher yield to holders of IMX, which increases the value of the ImmutableX platform. NFTs traded on platforms like ImmutableX are unique and some of these NFT projects like bored apes are valued like Van Gogh paintings.

Given all the new use cases developed through coins, tokens and NFTs, the underlying return drivers in the crypto space are unique when compared to factors driving legacy markets.

Quantitative Comparison

1. Return

Per the DQYDJ return calculator, bitcoin has generated a return of 265% annualized for the period March 2011 until March 2022 (1). This return can be compared to the 12% annualized for the S&P 500 equity index during the same period. That means 1 USD invested in bitcoin is now worth 46,000 USD, while the same dollar is worth less in S&P500.

2. Volatility

Per the Marketmilk volatility calculator, the annualized bitcoin price volatility spanning the last 3 years was 163% (2), which is much higher than the approximately 15% realized historically by S&P 500.

3. Correlation

The final data point to analyze between bitcoin and equities is historical correlation using different lookback periods. Per the Yahoo finance calculator, the 14 day rolling correlation as of March 2022 between bitcoin and S&P 500 is 0.83. If instead analyzing the 30 and 100 day lookbacks, the correlation between BTC and S&P is at a record high 0.86 as of March 2022.

Conclusion:

From a qualitative perspective, traditional equities and digital assets are both ownership claims, tools used for borrowing and return dependent by economic objective. However, digital assets can be so much more. While equity ownership is fungible, digital assets can also be non fungible. In addition, staked digital assets can create further economic value by validating blockchains. Obviously, history is not necessarily indicative of the future, as statistical relationships break down, but from a statistical perspective, I would argue that digital assets based on the return and volatility of BTC vs S&P 500 also quantitatively represent a new asset class.

With above comparison in mind, investment clubs should consider adding digital assets to their portfolios!

[1] https://dqydj.com/bitcoin-return-calculator/ [2] https://marketmilk.babypips.com/symbols/BTCUSD/volatility?source=coinbase